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hi,
i must really thank you for such a good information. Infact i am new in job of hr and being a part of comp & benefit team i was lookin for such a precise information. Thanks once again and keep on posting the updates.
From United States
i must really thank you for such a good information. Infact i am new in job of hr and being a part of comp & benefit team i was lookin for such a precise information. Thanks once again and keep on posting the updates.
From United States
Hi JSF,
A really good presentation you have attached. I must say really a good job you have done.
It can be attached with the employee handbook which is given to the new employee so that the employee who had started working for the first time get acquaint with the information about the taxes levied on him and how can he plan his income to save tax.
with regards
RK Sinha
From India, Ludhiana
A really good presentation you have attached. I must say really a good job you have done.
It can be attached with the employee handbook which is given to the new employee so that the employee who had started working for the first time get acquaint with the information about the taxes levied on him and how can he plan his income to save tax.
with regards
RK Sinha
From India, Ludhiana
Dear JSF
Its good but needs some amendment.
Please find a copy of Income Tax Primer.
Income Tax Primer
Income Tax Liability
It is proposed to give basic information about Income Tax which every industrialist should know. The intention is only to give an overview, without using any technical jargon. It is obviously advisable to consult an expert, if one is not familiar with the intricacies of the law. The legal position is as applicable for financial year 2005--2006 (Assessment Year 2006-2007) unless specified otherwise. Provisions applicable for financial year 2006-07 (AY 2007-08) are also indicated at appropriate places.
Income Tax is payable by every assessee at the rates prescribed from time to time. These rates are fixed by Finance Act every year. The Finance Bill is presented at the time of presenting Budget. The relation between Finance Act and Budget is so close that often people associate budget only with taxation. Really, taxation is only one of the aspects of the Budget.
Who can be assessee ? - The assessee may be * Individual * HUF * Company * Partnership Firm * Association of Firms * Local Authority like Municipality etc. * Artificial Judicial person not falling in any of the aforesaid categories e.g. a Hindu deity.
Different sources of income - An assessee may get income from different sources e.g. * Salaries * House property income * Profits and gains of business or profession * Capital Gains * Income from other sources not falling under any of preceding heads e.g. interest on securities, lotteries, races. Income from each of these sources is first calculated. All this income is added to find out total income of the assessee. Permissible deductions are reduced and then income-tax payable is calculated at the prescribed rates.
Income from one head can be set off against loss from other head, unless specifically prohibited. In Rajasthan State Warehousing Corporation v. CIT 2000 AIR SCW 629, it was held that if income is derived from various heads, assessee is entitled to claim deduction permissible under respective head whether or not computation under each head results in taxable income. If income to assessee arises under any of the heads of income but from different items e.g. different house properties or different securities etc., and income from one or more items alone is taxable whereas income from the other item is exempt under the Act, the entire permissible expenditure in earning the income from that head is deductible. - . - If assessee carries business in various ventures, entire expenditure incurred on all ventures is deductible if all ventures constitute one business Financial Year and Assessment Year - One very confusing aspect of Income Tax for a common man is the difference between Financial Year and Assessment Year. The Financial Year for income tax purposes (called ‘Previous Year’) is always the year ending 31st March. The ‘assessment year’ is next to the ‘Financial Year’ or ‘Previous Year’ e.g. for Financial Year (FY) 2005-06 (1st April 05 to 31st March 2006), the ‘Assessment Year’ (AY) is 2006-07. Thus, income-tax rates prescribed for Assessment Year 2006-07 are applicable in respect of income earned during financial year 2005-06.
It may be noted that an assessee can have separate accounting year for his own purposes e.g. a Company can close its accounts on any day of the year, an individual may start his year on Diwali or any other auspicious day. However, for income tax purposes, the accounts must be closed only on 31st March.
Rate of Income Tax payable
Major types of assessees and the tax payable is summarised here.
Individual - An individual may get income from salary, house rent, business, profession, interest etc. He does not have to pay income tax on dividend income at all. An individual may carry out business under some different name. However, this is only for convenience of business or trade. The income of a proprietary firm is added to his income for purpose of income tax. If a person gets salary from a partnership firm where he is a partner, the income is treated as ‘business income’ though termed as ‘salary’.
The income tax rates are as follows :
For A Y 2006-07 (FY 2005-06) for individual, HUF/AOP other than woman or senior citizen
0 - Rs 1,00,000 Nil
Rs 1,00,001 to Rs 1,50,000 10% of income above Rs. 1,0,000, plus education of 2% on income tax (total 10.2%)
Rs 1,50,001 to Rs 2,50,000 Rs 5,000 plus 20% of income above Rs 1,50,000, plus education of 2% on income tax
Rs 2,50,001 to Rs 10,00,000 Rs 25,000 plus 30% of income above Rs 2,50,000,plus education of 2% on income tax
Rs 10,00,001 and above Rs 2,50,000 plus 30% of income above Rs 10,00,000, plus 10% of income tax as surcharge plus education cess of 2% of income tax and surcharge
In case of resident senior citizen (man or woman) who is 65 years or more at any time in the year, the income upto Rs 1,85,000 is exempt. Thus, he/she gets relief of Rs 12,000 in income tax. In case of resident woman (who is less than 65 years of age), income upto Rs 1,35,000 is exempt. She gets relief of Rs 3,500 in income tax. Subsequent slabs are correspondingly reduced.
Note that no standard deduction is available for AY 2006-07.
HUF - An Hindu Undivided Family (HUF) consists of all persons lineally descended from a common male ancestor. It is assessable in respect of income derived from the joint family corpus. However, income earned by individual members of HUF in their individual and personal capacities is taxed as their personal income. Such income is not treated as income of HUF. Thus, it is possible to have an income from a proprietary firm (in individual capacity) as well as income from a business of HUF. Both are eligible for separate tax exemptions. Business of HUF can, of course, be conducted in a different name. In such case, the HUF will be proprietor of the firm in the name of which business is being conducted.
It may be noted that there is no question of ‘forming’ an HUF, as every male Hindu automatically has ‘HUF’. A Hindu male can have his own separate HUF even if his father or son has separate HUF. One HUF with only one male member is permissible. Any ‘HUF’ can have business run by head of the HUF called ‘karta’.
If an individual throws his separate property into the property of HUF, income from such converted property will be included in the total income of such individual. Hence, the HUF business should be from independent source of capital and not from the funds provided by an individual member of the HUF. Thus, if an HUF intends to conduct a business, its financial resources have to be carefully planned.
HUF should start business with loans / gifts from unrelated persons / bankers. Accounts and finances of HUF business should be kept separate. Otherwise, there is a possibility that income of HUF will be clubbed with the income of an individual.
The income of HUF is chargeable at the same rate as individual income. Thus, if an individual splits his business - partly in his individual capacity and partly in name of firm owned by HUF, considerable tax saving is possible, if done systematically and carefully.
Rate of income tax are same as those applicable to an individual.
Partnership Firm - Income of the partnership firm has to be calculated after deducting salary and interest payable to partners at prescribed rates. The tax on balance income for AY 2006-07 (BY 2005-06) is 30% plus surcharge of 10%, plus education cess of 2% on income tax and surcharge [For AY 2005-06 (FY 2004-05), rate was 35% plus surcharge 2.5% plus education cess of 2%].
The income tax rate is same as applicable to a domestic company.
Company - The tax on income for AY 2006-07 (FY 2005-06) is 30% for Indian company pus surcharge of 10% plus education cess 2%. It was 35% plus surcharge 2.5% plus education cess 2% for AY 2005-06
Dividend Distribution Tax - A domestic company paying dividend will have to pay dividend distribution tax u/s 115-O @ 12.5% plus surcharge of 10% plus education cess 2% (i.e. total 14.025%). The dividend will be tax free at the hands of assessees.
Wealth-tax - Wealth tax for individual, HUF or a company is 1% in respect of wealth over Rs 15 lakhs. One house or part of house belonging to an individual or HUF is excluded for purpose of wealth tax. The assets have to be valued as per Valuation Rules.
Gift-tax - Gift Tax has been abolished in respect of gifts made on or after 1-10-1998. However, gifts received from persons who are not relatives will be taxable.
Income from salary
Income under the head ‘salary’ comprises of remuneration in any form (including perquisites) received by an employee from employer. Thus, there should be contractual employer-employee relationship. The contract may be express, oral or implied. ‘Salary’ includes * wages * dearness allowance * Bonus * gratuity * annuity or pension * advance of salary * Fees / Commissions perquisites/ profits received from employer in addition to salary * Leave encashment while in service * Employer’s contribution to provident fund in excess of 12% of salary of employee.
In Karamchari Union v. UOI 2000 AIR SCW 806 = AIR 2000 SC 1226 = (2000) 109 Taxman 1 = 2000 LLR 897 = 243 ITR 143 (SC), it has been held that CCA (City Compensatory Allowance), DA (Dearness Allowance) and HRA (House Rent Allowance) are in nature of income forming part and parcel of salary and are taxable.
Valuation of perquisites - The employer often gives some perquisites to the employees. Value of these perquisites is added to the income of employees. The valuation of perquisites is done as follows :
* Perquisite of Rent Free Accommodation is valued according to following rules. - In case of private sector employees, value of perquisite of rent free unfurnished accommodation is taken as 10% of salary of employee, if accommodation is in city with population exceeding 4 lacs as per 1991 census. Otherwise, it will be 7.5%. In case of Government Employees, value will be ‘licence fee’ determined by Central / State Government. If some rent is recovered from the employee, the value of perquisite will be reduced to that extent. This is not applicable for accommodation in remote are like mining site, onshore oil exploration site etc.
* If temporary accommodation upto 15 days on transfer is provided, it will also be valued @ 24% of salary paid for the period or actual hotel charges, whichever is lower.
* If accommodation is furnished, in addition to above, 10% of cost of furniture (including TV, radio, refrigerator, AC etc.) will be treated as perquisite. If the furniture is hired from third party, actual hire charges less any amount recovered from employee will be the perquisite.
* If motor car is provided by employer, valuation is done depending on HP of motor car, whether chauffeur is provided and whether car is for exclusive private use or partly for official and partly for personal purposes.
* If sweeper, watchman or gardener is provided by employer, the perquisite will be valued at the actual cost to the employer.
* Some benefits like gas, electricity, water are valued at actual cost to employer. Cost of education of employee’s children is also valued at cost incurred.
* If amenities like interest free or concessional interest loan, travelling expenses for holiday to employee or his relatives, free meals, gifts over Rs 5,000 per annum, payment of credit card expenses of employees for personal expenses, club memberships etc. are provided, these will be valued at cost and treated as perquisites.
* If some movable asset is provided to employee, perquisite will be @ 10% of the actual cost of perquisite (In case of computer, depreciation @ 50% and in case of car, depreciation @ 20% is allowed to find ‘actual cost’)
* Reimbursement of medical expenses for medical treatment of employee or member of family of employee is exempt upto Rs 15,000 per year. In case of treatment in Government or approved hospital, or expenditure on medical treatment outside India, reimbursement of medical expenses is exempt without any ceiling.
* House Rent Allowance (HRA) is partly exempt as provided in the rules. It should be noted that if the employee stays in his own house or if he incurs no expenditure on house rent, the whole HRA is taxable. The rules for granting exemption from HRA are quite complicated, but broadly, these can be summarised as follows - (a) If employee does not pay any house rent, whole of HRA received is treated as perquisite. (b) If the actual amount of rent paid by him is less than 10% of salary of the employee, in that case also, whole of HRA is taxable and there is no exemption. (c) If the actual amount of rent paid by him is more than 10% of salary of the employee, the HRA received in excess of 10% of salary is exempt. In other words, HRA received to the extent of only 10% of salary is taxable and balance is exempt. However, maximum HRA that can be eligible for exemption under this clause is 50% of salary in case of accommodation in four metropolitan cities and 40% of salary in other cities.
For purpose of calculating amount exempt from HRA, the term ‘salary’ includes only basic and DA but does not include any other allowance or perquisite.
* Leave Travel Allowance to any place in India is available only two times in a block of four years. It is for self, family and upto two children. The allowance is limited to economy airfare or AC first class rail fare by shortest route. The allowance is exempt subject to amount of expenses actually incurred by the employee for such travel. The employee will have to keep account of actual expenses incurred. It appears that actual travel by air or AC is not required, but the overall ceiling on expenses is subject to limit of air fare / rail fare.
* If shares of a company are issued to employees at price lower than the price at which the shares are offered to other shareholders / public, the difference will be treated as a perquisite. If the shares are offered only to employees, difference between market price and the price at which shares are offered to the employee will be treated as perquisite.
[However, in case of ESOP of listed companies, it is not treated as perquisite. Capital gains are payable only when the shares are sold].
* Club fees paid on behalf of employee, insurance premiums paid on behalf of employee, income tax paid on behalf of employee are all treated as perquisites and its cost is added to income of employee.
CERTIFICATE FROM EMPLOYER – Employer is required to issue certificate in form 12BA, giving details of value of each perquisite provided to the employee, if the value of perquisites exceeds Rs 1.50 lakhs. If value of perquisites is less than Rs 1.50 lakhs, the relevant details should be given in From 16 itself, which every employer is required to issue to the employee.
Standard Deduction from Salary Income - No standard deduction is alloable for AY 2006=- (FY 2005-06). Earlier, employees were eligible for standard deduction.
Exemptions for salary income - Following are exempt from income tax-
* Transport allowance upto Rs 800 per month granted to an employee to meet his expenditure for the purpose of commuting between place of residence and the place of his duty (w.e.f. 1.8.1997)
* Conveyance and transport allowance granted to employee to meet cost of travel on tour are exempt. Allowance granted to meet expenditure incurred on conveyance in performance of duties of an office or employment are exempt. In LIC Officers v. LIC of India (2000) 112 Taxman 227 (Bom HC DB), it was held that conveyance allowance is exempt only if expended for meeting expenses wholly and necessarily incurred or to be incurred in performance of duties of office. Conveyance allowance at flat rate irrespective of place of residence, work and posting will not be exempt from income tax.
* Conveyance and transport allowance granted to employee to meet cost of travel on transfer are exempt. Expenses granted to meet cost of travel on transfer and cost of packing and transportation of personal effects on such transfer are exempt.
* Gratuity received under Payment of Gratuity Act is exempt upto 15 days of wages for each completed year of service or part of year in excess of six months, on the basis of wages last drawn by employee. The exemption is subject to ceiling of Rs 3.50 lakhs. Death-cum- retirement Gratuity received by employees of Central Government, State Government, public sector employees and members of defence services are totally exempt without any limit.
* Voluntary retirement amount received by an employee upto Rs five lakhs is exempt. The voluntary retirement scheme should be as per Income Tax Rules.
* Payment received from approved superannuation fund is exempt.
* Leave encashment at the time of retirement is exempt upto 30 days for every year of completed service. Earned leave so encashed should not be for more than 8 months. Maximum eligible amount for exemption is Rs 1,35,360. In case of Central or State Government employees, it is fully exempt without any ceiling.
* Use of employer’s vehicle or transport provided for journey of employee from residence to his place of work and back is not treated as perquisite and its cost is not treated as income.
* Refreshments during office hours to employees and recreational facilities provided to group of employees are not treated as perquisites.
Income from House Property
Income from house property consists of buildings and lands appurtenant thereto. However, income only from vacant plot or land is treated as ‘income from other sources’. Following should be noted.
* In case of let out property, income will be ‘fair annual value’ or ‘actual rent received’ whichever is more. However, if property is let out only for part of the year or not let out, income will be ‘fair annual value’ or ‘actual rent received’ whichever is less.
* ‘Annual Value or Property’ is the sum for which the property could reasonably be expected to let from year to year. Municipal Valuation of ratable value can be taken as one of the tests to determine bonafide value of the property. If the house property is given on rent, actual rent received will be the ‘annual value of the house property’. If no rent is received,
* From the ‘Annual Value of House Property’, in case of let out property, following will be allowed as deduction – (a) Municipal tax – The deduction will be permitted on actual payment basis (b) Standard deduction of 30% of (gross annual value less municipal tax) (c) Interest on capital borrowed to acquire or construct the house property subject to limit explained below
* Annual Value of a self-occupied property is taken as ‘Nil’, if it is not let out. In such cases, none of the aforesaid expenses are allowed as deduction. However, if the self-occupied property is acquired or constructed or repaired from borrowed funds, interest payable on such funds upto Rs 30,000 per annum is allowed as deduction. The interest allowable as deduction will be upto Rs 1,50,000 per annum in case of house property acquired or constructed with borrowed capital on or after 1.4.1999, but before 1.4.2003 from AY 2002-03 (FY 2001-02). [The ceiling was Rs 1,00,000 for FY 2000-01 and Rs 75,000 for FY 1999-00]]
Naturally, this will be a ‘loss’ as the annual value of self occupied property is ‘Nil’. This ‘loss’ can be set off against any other income of the assessee. In other words, if funds are borrowed to acquire or construct or repair self-occupied property, interest upto Rs 1,50,000 paid per annum is allowable as deduction from any other income.
* House property or any portion thereof occupied by the owner for purpose of his business or profession is excluded and any expense of current repairs, municipal taxes, depreciation on property etc. is allowable as business expenditure.
Profits and Gains of Business or Profession
The term ‘business’ covers trade, commerce or manufacture. ‘Professional Income’ is income from exercise of any profession or vocation which calls for an intellectual or manual skill. It covers doctor, lawyers, accountants, consulting engineers, artists, musicians, singers etc.
Profits of business or gains from profession are calculated after allowing all legitimate business expenditure. Some important deductions admissible in computing income from business or profession are as follows —
Rent, rates, taxes, repairs and insurance for business or professional premises
Current repairs and insurance of machinery, plant and furniture
Depreciation on building, machinery, plant or furniture (discussed below)
Revenue expenditure on scientific research
Capital expenditure on scientific research related to business (except land)
Expenditure on technical know how is permitted to be amortised in six equal installments over a period of six years.
Preliminary expenses in relation to formation of a company or in connection with extension of an undertaking or setting up of a new industrial unit can be amortised in 10 equal installments over 10 years. The preliminary expenditure is permitted only upto 2.5% of cost of project.
Insurance expenses
Bonus or commission to employees
Interest on borrowed capital
Contributions towards approved provident fund, superannuation fund and gratuity fund
Bad debts in respect of income considered in previous years can be written off and allowable as deduction.
Entertainment expenditure actually incurred in connection with business is permissible as deduction.
Advertisement expenditure is fully allowed as deduction. However, expenditure incurred on advertisement in any souvenir, brochure, pamphlet etc. of a political party is not allowed as a deduction.
All travelling expenditure actually incurred
Expenditure in maintenance of guest house is permissible as deduction
Any other expenditure which is not of capital nature or personal expenses of the assessee is allowed if it is expended wholly and exclusively for the purposes of business or profession.
Depreciation - In any business, raw material is used fully and immediately, while plant and machinery is used slowly over a period of time. After the estimated life of machinery, its value becomes Nil. Hence, it is fair that cost of machinery is charged over the period of its estimated useful life. This is the basic principle of depreciation on capital goods. Since land does not depreciate, no depreciation is allowed on land.
Under Income Tax, depreciation is calculated on the basis of ‘block of assets’. ‘Block of assets’ means a group of assets falling within a class of assets, in respect of which the same % of depreciation rate has been prescribed. e.g. all machinery having rate of depreciation as 25% will form one block of asset, machinery having 40% rate of depreciation will form another ‘block of asset’ and so on.
Depreciation is allowed on actual cost of the asset. Interest paid on borrowed funds and capitalised as pre-commencement expenses before the asset is commissioned is added to cost of the asset and depreciation claimed on such expenditure. Thus, pre-production expenditure can be included in cost of the machinery and depreciation can be charged on such ‘actual cost’. In Chellapalli Sugar v. CIT AIR 1975 SC 97 = 98 ITR 167 (SC), it as held that it includes all expenditure necessary to bring such asset into existence. [Thus, it will include installation charges]. It was held that interest on loans upto date of commencement of business forms part of 'actual cost' of plant for purpose of depreciation.
Depreciation is calculated on Written Down Value (WDV) method. e.g. if cost of machinery is Rs 100 and rate of depreciation is 10%, depreciation in first year will be Rs 10 and written down value (WDV) of machinery will be Rs 90 (100-10). In next year, depreciation will be 10% of Rs 90 i.e. Rs 9. Next year, the WDV of machinery will be Rs 81 and depreciation allowed will be Rs 8.10 and so on. If the asset is put to use for purpose of business for less than 180 days, only 50% of normal depreciation is permissible. In other words, full depreciation for the year is permissible only if asset is commissioned before 30th September of that year.
If depreciation cannot be fully claimed in a particular year for want of profits, the un-absorbed depreciation can be carried forward for any number of succeeding assessment years. [section 32(2)]. [Earlier limit of 8 years removed vide Finance Act, 2001]
The depreciation rates in respect of some important assets are as follows :
* Residential building – 5%. Others – 10%. Purely temporary structures – 100%.
* Furniture and fittings including electrical fittings – 15%
* Motor cars 20% . Buses, lorries, and taxis used in business of running them on hire – 40%, aeroplane – 40%. Ships – 25%
* Pollution control equipment and specified energy saving devises - 100%
* Normal machinery - 25%
* Computers including software - 60%.
* Books by professionals – 100% for annual subscription and 60% for others - books in library - 100%.
* Ships - 25% (25% for vessels used in inland waters).
* Intangible assets - know-how, patents, copyrights, trade marks, licenses, franchises or any other right of similar nature - 25%.
In Mysore Minerals v. CIT 1999 AIR SCW 3146 = 1999(5) SCALE 340 = 239 ITR 775 = AIR 1999 SC 3185 = 106 Taxman 166 (SC), it was held that claimant of depreciation need not be owner of asset in legal sense. Person in whom for the time being vests the dominion over the asset and who is entitled to use it in his own right is eligible to claim depreciation. – followed in Dalmia Cement v. CIT 2000 AIR SCW 4198 (SC 3 member bench).
However, if assessee has not acquired dominion over the asset, he will not be entitled to depreciation on that asset. – Tamilnadu Civil Supplies v. CIT (2001) 116 Taxman 369 = 2001 AIR SCW 4777 (SC 3 member bench).
DEPRECIATION COMPULSORY – As per Explanation 5 to section 32(1)(ii), inserted w.e.f. 11.5.2001, depreciation is compulsory in computing total income even if assessee had not claimed the same. This amendment applies to AY 2002-03 onwards. [In CIT v. Mahendra Mills (2000) 2 SCALE 384 = AIR 2000 SC 1960 = 243 ITR 56 = (2000) 109 Taxman 225 (SC), it was held that assessee has option to claim or not to claim depreciation. The depreciation cannot be thrust upon him. Now, this judgement is ineffective from AY 2002-03]
DEPRECIATION IN CASE OF IMPORTED MACHINERY OBTAINED ON LOAN IN FOREIGN CURRENCY – If machinery is imported on loan repayable in foreign currency, the amount payable in rupees will go on changing due to fluctuations in foreign exchange rates, as the installments and interest are spread over a period. In such case, the value of machinery should be increased on basis of entire loan outstanding and not merely installments of loans that fell due during the accounting period. – CIT v. Arvind Mills (1992) 193 ITR 255 = 60 Taxman 192 (SC) – quoted and followed in CIT v. Madras Fertilizers (2002) 124 Taxman 581 (Mad HC DB).
Expenditure not allowed as deduction - Following expenditures are not allowed as deduction for purpose of income tax.
* Tax, duty, cess, fees payable under any law, Employer’s contribution to provident fund or ESIC, bonus to employees, commission to employees are eligible as deduction only if they are paid on ‘due dates’ on which these were payable. Even if these are not paid on due dates but are paid before filing of return, these are allowed as deduction, if proof of payment is filed along with the return. However, in case of employer’s contribution to provident fund, superannuation fund or gratuity fund, the same is allowed as deduction only if it was paid before due date of payment.
* If expenditure is incurred in business or profession by payment of cash over Rs 20,000, then 20% of such expenditure is straightaway disallowed.
Payment over Rs 20,000 should be made by cheque or demand draft. However, this restriction is not applicable in case of payments to # RBI, other banks and financial institutions # Government * Payment for agricultural produce, poultry, fish etc. to the cultivator, grower or producer (i.e. payments to middlemen are not excluded from this provision) # when payment was required to be made when banks were closed on account of holiday or strike. [Similarly, a person can accept loans or deposits of Rs 20,000 or more only by account payee bank draft or cheque].
* Interest on delayed payment made to Small Scale Industries is not allowable as deduction.
* Section 37(1) of Income Tax Act states that any expenditure incurred for any purpose which is an offence or which is prohibited by law shall not be allowed as deduction.
Minimum Alternate Tax (MAT) - Many companies charge depreciation in their books on straight line method. Thus, the profit shown is higher in the accounts maintained for company law purposes and they can declare dividend. However, for income tax purposes, they charge depreciation on WDV which is higher. Thus, for income tax purposes, they may show low profit or even loss, while in balance sheet prepared for company law purposes, they will show high profits, which is called ‘book profits. Hence, such companies have to pay minimum income tax 7.5% of such book profits for AY 2006-07 plus surcharge of 10% plus education cess of 2% [section 115JA and 115JB].
This tax is termed as ‘Minimum Alternate Tax’ (MAT).
In Apollo Tyres v. CIT (2002) 122 Taxman 562 (SC 3 member bench), it was held that the assessing officer cannot reopen the accounts certified by auditors and adopted in general meeting. He has limited powers of making additions and reductions as provided in the section. [In this case, it was held that assessing officer cannot add back the depreciation for earlier years provided in accounts].
Different accounting for balance sheet and income tax purposes - Method of depreciation, valuation of stock etc. is different under Companies Act and Income Tax Act. Hence, one method of accounting for income tax and other for Companies Act is permitted. The practice has been specifically approved in United Commercial Bank v. CIT 1999 AIR SCW 4050 = AIR 2000 SC 94 = 106 Taxman 601 (SC).
Accounting profits and assessable profits are conceptually different. – CIT v. Bipinchandra Maganlal (1961) 41 ITR 290 (SC).
Other important provisions in respect of business income
Some important provisions in relation to income from business or profession are as follows -
MAINTENANCE OF BOOKS OF ACCOUNT - In respect of professional in legal, medical, engineering, architecture, accountancy or technical consultancy must maintain books, if their gross receipts are less that Rs 1.50 lakhs, they have to maintain such books of account as may enable Income Tax Officer to compute their taxable Income. If their gross receipts exceed Rs 1.50 lakhs, they have to maintain books of account as specified in rule 6F i.e. cash book, journal, ledger, copies of bills exceeding Rs 25 issued by him, original bills in respect of expenditure exceeding Rs 50 and payment vouchers etc. Person carrying on medical profession has to maintain additional books as prescribed. [Section 44AA and rule 6F]
Persons carrying on business or professionals other than those mentioned above have to maintain books of accounts if annual income exceeds Rs 1,20,000 or gross receipts or turnover exceed Rs. ten lakhs in case of business also have to maintain books of account.
ACCOUNTS ON MERCANTILE OR CASH BASIS - Accounts should be maintained either on mercantile basis or cash basis. Hybrid i.e. mixed system is not permitted. [In cash system, income or expenditure is considered only when it is actually received / paid. In mercantile system, income/expenditure is considered on accrual and payable basis. Actual receipt or payment may occur in subsequent financial year and may not happen in that particular year.]
INCOME TAX AUDIT REPORT - If gross receipts or turnover of business exceeds Rs 40 lakhs per annum, the accounts have to be compulsorily audited. In case of professional income, accounts have to be audited if gross receipts exceed Rs ten lakhs. This audit report should be submitted along with income tax return. [section 44AB].
Capital Gains
Capital gains means any profit or gains arising from transfer of a capital asset. Such capital asset may be building, non-agricultural land, machinery, shares etc. Broadly, ‘capital gain’ is the difference between the price at which the asset was acquired and the price at which the same asset was sold. In technical terms, capital gain is the difference between cost of acquisition and the fair market value on the date of sale or transfer of asset. If the asset is sold at price even higher than the fair market value of asset, the difference between the sale proceeds and the fair market value is treated as business income.
The ‘cost of acquisition of capital asset’ is to be increased by Cost Inflation Index. The index is announced by Central Government every year. The index was 100 for 1981-82, 172 for 1989-90, 244 for 1993-94, 331 for 1997-98, 351 for 1998-99, 389 for 1999-2000, 406 for 2000-01, 426 for 2001-02, 447 for 2002-03, 465 for 2003-04, 480 for 2004-05 and 519 for 2006-07.. The cost of acquisition will be adjusted on basis of the above index and then capital gain will be calculated. The formula is Cost of acquisition x Cost Inflation Index of the year in which the asset is transferred / Cost Inflation Index of the year of acquisition. If the asset was acquired before 1.4.1981, the Cost Inflation Index of that year will be treated as 100. Thus, if an asset was brought in 1989-90 for Rs one lakh and sold in 1997-98 for Rs three lakhs, the adjusted cost of acquisition will be (1,00,000 x 331)/172 i.e. Rs 1,92,442, and capital gains will be Rs 1,07,558 (3,00,000 - 1,92,442). Such adjustment is permissible only for long term capital gains and not for short term capital gains.
Expenditure incurred on any improvement in asset is permitted as deduction and that cost can also be adjusted on the same principles as above.
If a company issues bonus shares, the cost of acquisition of bonus shares will be treated as ‘Nil’. Thus, if the bonus shares are sold, net sale proceeds of bonus shares will be liable to capital gains.
Expenditure incurred in connection with transfer (like stamp duty, registration charges, legal fees, brokerage etc.) are allowed as deduction.
Capital gain is charged as income of the financial year in which the transfer took place.
Capital gain can be classified as ‘short term’ or ‘long term’. A short term capital gain is when the asset was held by the assessee for a period of upto 36 months. If the asset was held for more than 36 months, the gain will be long term gain. The period is only 12 months (instead of 36 months) in case of shares or any other security listed in stock exchange or units of UTI or units of mutual fund.
The income tax rate is 20% on long term capital gains, while calculating the long term capital gains, indexation of purchase price is required. Tax on long term capital gain shall be subject to ceiling of 10% of capital gains calculated without indexing.
The short term gains are added in other income of the assessee and the income tax is payable according to the normal rate applicable to the assessee.
Capital gains arising from sale of residential house is exempt if the original asset (i.e. the house) was held for more than three years and a new house was purchased within one year before or two years after the sale of original asset, or a new residential house is constructed within three years. The cost of new asset (residential house) should be more than the amount of capital gains.
Any other long term capital gain is exempt if the capital gains are invested within 6 months in 3 year bonds issued by NABARD or NHAI and that investment is retained for three years. - section 54EC
Income from other sources
All income other than income from salary, business and profession or capital gains is covered under ‘Income from other sources’. Provisions in respect of some important sources of ‘other income’ are summarised below.
Dividends - Dividends on shares of domestic companies or units of UTI or mutual fund received from a company on or after 1-4-2003 will not be taxable at the hands of the assessee for AY 2004-05 (FY 2003-04).
[section 10(34) and 10(35)]. [The dividend distribution tax will be payable by company/mutual fund u/s 115-O]
For the AY 2003-04 (FY 2002-03), income from dividend was taxable at the hands of shareholder. Provisions of TDS apply. However, income of dividend was eligible for deduction u/s 80L upto Rs 12,000 (along with interest income) [Now, dividend is completely tax free at hands of assessee w.e.f. 1-4-2003].
WINNING FROM LOTTERIES, RACES ETC. - Winning from lotteries, card games etc. is exempt upto Rs 5,000. Winning from horse races is exempt upto Rs 2,500. The balance is subject to tax @ 40%.
Interest on bank deposits and loans - Interest on bank deposits and loans is treated as ‘other income’. Exemption u/s 80L was availabe upto AY 2005-06, but has been withdrawn from AY 2006-07 (FY 2005-06).
NOTE ON INTEREST RATES – Interest rates, particularly on postal savings have been considerably reduced. Some interest rates as on 1.3.2003 are given here –
Post Office Savings Account – 3.5%; PO Time deposit 5 years – 8%; Kisan Vikas Parta – Doubles in 7 years and 8 months
Public provident Fund (PPF 15 years) – 8% w.e.f. 1-3-2003 (9% w.e.f. 1-3-2002, and 9.5% w.e.f. 1-3-2001) – Minimum Rs 500 Max Rs 70,000
Rebate / Exemption from Income Tax Liability
Following rebates / exemptions are available.
Deduction on account of specified investments - A deduction from gross total income is granted if investment is made in specified areas. [section 80C] [earlier deduction u/s 88 has been withdrawn w.e.f. AY 2006-07 (AY 2005-06)].
The investments eligible are - LIC premiums # Contribution to Public Provident Fund Scheme # Contributions to employee provident fund # 6 years NSC certificates # Unit linked insurance plan of UTI # Investment in approved equity shares / debentures (usually, debentures / shares issued for infrastructure projects are approved for purpose of eligibility) # Units of mutual fund approved by Board # Installments of refund of housing loans upto Rs 20,000.
Deduction upto Rs 1,00,000 from gross income is available.
Rebate to senior citizen / women - Senior citizen over 65 years do not get any rebate, but income tax slabs have been adjusted to reduce their tax liability by Rs 12,000.
Deduction of medical insurance premium, pension fund - Following deductions are permissible -
(a) Medical insurance premium upto Rs 15,000 (section 80D). The limit was Rs 10,000 for AY 1999-2000.
(b) Contribution to LIC pension fund upto Rs 10,000 per annum. (section 80CCC)
(c) Contribution to approved charitable institutions - in some cases 50% of amount paid is allowed as deduction, while in some cases, 100% amount paid is allowed as deduction (section 80G).
Deduction from tax liability to certain industries - Industries are given certain deductions under section 80-IA and 80I-B, as summarised below :
* New Industrial undertaking in industrially backward area is eligible for certain deduction from profits for 10 assessment years. The unit should start production before 31-3-2002.
* In case of small scale industry, the condition of location in backward area does not apply, i.e. it can get deduction in profit irrespective of
location. However, it should commence manufacture before 31.3.2002.
* Cold storage plants are eligible for the tax incentive
* The deduction is not permissible if the industrial undertaking or SSI unit manufactures article specified in Eleventh Schedule. The major articles covered in ‘Eleventh Schedule’ are - beer, wine, alcoholic spirits, tobacco products, cosmetics, toilet preparations, tooth paste, tooth powder, soap, aerated water, confectionery, chocolates, gramophones and record players, photographic machines, office machines, steel furniture, safes, strong boxes, latex foam sponge and polyurethane foam, crown corks and PP caps for packaging or fitting.
* It should be a new unit and not formed by splitting or reconstruction of an already existing business.
* It should not be formed by transfer to a new business machinery or plant which was previously used
* The deduction is 30% if the assessee is a company and 25% if assessee is firm / cooperative society / individual / HUF etc.
Exemption in respect earnings in convertible foreign exchange - Income in convertible foreign exchange is exempt. Even supporting manufacturer is eligible for exemption from profit. The exemption is being reduced in phases and by AY 2005-06, there will be no deduction permissible on export profits. [In case of EOU, STP, EHTP and EPZ, the concession will continue upto 31-3-2009 and there will be no deduction from AY 2010-2011].
Other provisions of Income Tax
Certain other important provisions of income tax are discussed here.
Clubbing of Income - Often salary or other expenses from business are shown in name of close relatives like spouse (wife / husband) or minor child, to reduce tax liability. In such case, if the individual has a substantial interest in the concern, the income of such wife, husband or minor child will be added to the income of such individual. The ‘substantial interest’ means at least 20% of voting power in case of a company or 20% profits of the partnership firm. This is termed as ‘clubbing of income’. The clubbing provision is not applicable if spouse possesses technical or professional qualifications and the income is solely due to application of his / her technical knowledge and experience.
If an asset is transferred to the spouse, income from such asset is also treated as income of the individual. [e.g. by transferring shares, house property etc.].
Similarly, if an individual throws his separate property into the property of HUF, income from such converted property will be included in the total income of such individual.
The clubbing provision has obviously been made to plug avoidance of income tax liability, by ‘showing’ some income in the name of spouse / minor child / HUF.
Permanent Account Number - Every person whose total sales, turnover or gross receipts are over Rs 50,000 are required to apply and obtain a Permanent Account Number (PAN). Government has decided to use PAN as a common business identification number to be used by various agencies and departments like customs, excise, DGFT etc.
Deposit / loan of Rs 20,000 or more - Deposits or loans of Rs 20,000 or more from a person can be obtained only by way of account payee draft or cheque. Repayment of loan or deposit or interest thereon of more than Rs 20,000 should also be made by account payee cheque or draft.
Advance Income Tax - Tax is deducted from salary payable to an employee. Since a businessman or professional earns his own income, there is no TDS (Tax Deduction at Source). Hence, he is liable to pay advance tax as he earns income. This is ‘Pay Tax as you Earn’. Thus, advance tax is payable on the basis of estimated income of the current financial year. [The income is ‘estimated’ because, actual income will be known only after the financial year is over]. Advance tax is payable only in cases where tax payable is in excess of Rs 5,000. The assessee has to pay advance tax on his own accord and no notice will be issued to him.
The advance tax is payable in installments as follows -
* IN CASE OF COMPANY - # 15% on or before 15th June # 30% on or before 15th September # 30% on or before 15th December # Remaining 25% on or before 15th March.
* IN CASE OF PARTNERSHIP FIRMS, PROPRIETORS, PROFESSIONALS ETC. - # 30% on or before 15th September # 30% on or before 15th December # Remaining 40% on or before 15th March.
Thus, 100% income tax in respect of estimated income of current financial year is payable by 15th March. If any instalment is not paid on due date, it can be paid subsequently.
If advance tax is not paid or short paid on due dates, mandatory interest is payable as follows :
* If advance tax was not paid before 31st March of the financial year, or advance tax paid was less than 90% of the assessed tax, interest @ 1.25% per month or part thereof is payable from 1st April till the month of payment. [section 234B]. The interest is not payable if total tax liability is less than Rs 5,000 or if at least 90% of assessed tax was paid before 31st March. [Interest rate was 1.5% per month upto 31.5.2001].
* If installments of advance tax are not paid on due dates, interest on shortfall is payable @ 1.25% per month. In case of last instalment which is due on 15th March, interest @ 1.25% is payable for one month if tax is not paid at all or is paid after 15th March. [section 234C]. [The interest rate was 1.5% per month upto 31.5.2001]. Note that this interest is calculated only upto 31st March, as from 1st April, interest @ 1.25% becomes payable on entire tax due under section 234B.
This interest is mandatory and there is no provision to grant exemption form payment of this interest.
If the return is not filed within due date, interest @ 1.25% is payable u/s 234B w.e.f. 1.6.2001. [Earlier, it was 1.5% per month). In addition, interest @ 1.25% is payable u/s 234A. Thus, if return is not filed on or before due date, interest payable is 2.5% for every subsequent month.
Special provisions in respect of Partnership firm - A partnership firm is presently assessed on the lines similar to the assessment of a company.
The firm can pay salary and interest on capital to the partners. Income tax is payable @ 35% of profits calculated after deducting salary and interest paid to partners. The salary paid to partners is treated as ‘business income’ in their hands and is taxable accordingly.
The partnership firm may or may not be registered. However, the partnership must be evidenced by a partnership deed. The deed should indicate * individual shares of the partners * Salary payable to working partners * Interest payable to partners. A true copy of partnership deed certified and signed by all the partners should be filed along with the first return of income. Subsequently, the copy is not required to be filed along with every return. However, if there is any change in the partnership agreement, a fresh copy has to be filed.
Return of partnership firm can be signed by managing partner.
SALARY TO WORKING PARTNERS - The salary payable to partners is as follows -
* Professional partnership firms - # upto book profit of Rs 1,00,000 - 90% of book profit - minimum Rs 50,000 # On next Rs 1,00,000 book profit - 60% # On balance of book-profit - 40%.
* Other than professional partnership firms (i.e. business firms) - # upto book profit of Rs 75,000 - 90% of book profit - minimum Rs 50,000 # On next Rs 75,000 book profit - 60% # On balance of book-profit - 40%.
The salary can be paid only to working partners. Such payment should be authorised by partnership deed. This salary is allowed as deduction from income of the partnership firm and is taken as business income of the individual partner.
INTEREST TO PARTNERS - The partners are entitled to get interest upto 12% on their capital in the partnership firm. [The interest rate was 12% upto 31-5-2002]. Such payment should be authorised by partnership deed. This interest is allowed as deduction from income of the partnership firm and is taken as ‘other income’ of the individual partner.
Tax deduction at source - A person is under liability to deduct income tax at source and pay it to Government. He should issue a certificate to the person from whom tax is deducted, so that the person can submit the same to Income Tax authorities. Tax deducted at source should be paid to Government within one week from date of deduction. At the end of the year, a return in prescribed form has to be filed with ITO.
TDS is rightly called ‘tedious’, but not deducting tax at source can invite penalties.
As can be seen from following, if the person making payment is individual or HUF, he is exempt from the provisions of TDS in most of the cases, if he is not required to submit income tax audit report u/s 44AB. However, TDS provisions apply to (a) salary payments made by an individual or HUF even if he is not required to submit any income tax audit report u/s 44AB (b) If the individual/HUF is required to submit Income Tax Audit report.
TDS FROM SALARY - Every employer has to deduct tax from salary of employees. While deducting tax at source, the employer can consider the investments made by employee which qualify for exemption, payment for purchase or construction of house, mediclaim insurance premium etc.
Income tax is to be deducted every month and should be paid to Government within a week after deduction. The employer can adjust deductions from month to month so that total deductions from salary of the whole year is equal to tax payable by employee on salary income.
The employer has to file an annual return before 30th June of tax deducted at source from all employees.
TDS FROM INTEREST PAYMENT - Tax should be deducted from interest paid if interest payable in financial year exceeds Rs 5,000. The deduction should be @ 22.44% if payment is to companies, 11.22% in case of firms, artificial persons or individuals having income exceeding Rs 10 lakhs, and @ 10.2% in other cases. An individual can get interest without deduction of tax at source, if he submits required declaration form.
TDS provisions are applicable to individuals and HUF also, if interest payment is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENTS TO CONTRACTORS - TDS provisions apply if contract value exceeds Rs 20,000. The tax deduction should be @ 2.244% in case of payment to contractors and @ 1.122% in case of payment to sub-contractors.
TDS provisions are applicable to individuals and HUF also, if payment to contractors/sub-contractors is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENT IN RESPECT OF ADVERTISEMENT CONTRACTS -
TDS provisions apply if contract value exceeds Rs 20,000. The tax deduction should be @ 1.122%.
TDS provisions are applicable to individuals and HUF also, if payment in respect of advertisement contracts is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENTS OF RENT - TDS provisions apply if aggregate sum of rent paid exceeds Rs 1,20,000 per annum. The tax deduction should be @ 16.83% in case of payment to individual or HUF and @ 22.44% if the payee is other than individual or HUF.
TDS provisions are applicable to individuals and HUF also, if payment of rent is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENTS FOR PROFESSIONAL OR TECHNICAL SERVICES -
TDS provisions apply if aggregate sum paid for professional or technical services exceed Rs 20,000 per annum. The tax deduction should be @ 5%.
TDS provisions are applicable to individuals and HUF also, if payment for professional or technical services is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM COMMISSION / BROKERAGE – TDS in respect of payment of commission or brokerage to resident is 5.61%. There is no TDS if commission / brokerage paid during the financial year is less than Rs 2,500. [section 194H]
TDS provisions are applicable to individuals and HUF also, if payment of commission/brokerage is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
PAYMENT OF TDS - The tax deducted at source should be paid vide challan No ITNS 269 (0020) in respect of corporates and ITNS 271 (0021) in respect of others. Annual return has to be filed.
Income Tax Returns
Every assessee should file an annual return in prescribed form. The prescribed forms are as follows -
FORM NO. 1 - For Companies
FORM NO. 2 OR 2D - Firms, HUF, Individuals whose income includes ‘profits and gains of business or profession’.
FORM 2C – Those who are required to file return even if income is below taxable limit under proviso to section 139(1) – termed as 1 by 6 scheme.
FORM 3 or 2D - This form is mainly for resident individuals and HUF who do not have any income from business or profession.
In addition to the return, an acknowledgment form in duplicate is required to be submitted. The ‘acknowledgment’ is really summary of the income tax return. The duplicate of acknowledgment is returned by income tax department duly acknowledged. This serves as proof of the details of income submitted by assessee.
The income tax return is really a self assessment memorandum. The assessee should calculate the tax and interest payable by him and pay it by challan. The payment will of course be after deducting the advance tax which he might have already paid.
The return should be accompanied by * Salary certificate * Profit & loss account or income and expenditure account in case of business / professional income * Details of income from house property e.g. municipal valuation / rent received / taxes paid etc. * Copies of proofs in respect of investments made which qualify of income tax rebates * Copy of audit report if his accounts are required to be audited * Tax deduction certificate, if any tax was deducted when he had received the payment * Copy of challans of advance tax * Copy of challan of self assessment tax.
It is a practice to submit a summary sheet giving details of computation of income and tax payable, though such summary sheet is not a legal requirement.
The due dates for filing return are as follows -
* (a) Individuals having only salary income (b) Non-corporate assessees (Individuals, HUF, partnership firms or societies) having income from business or profession but who do not have to get their accounts audited under Income Tax or any other law - 31st July
* (a) Non corporate assessees (Individuals, HUF, partnership firms or societies) having income from business or profession and who have to get their accounts audited (b) A working partner where the firm in which he is a working partner has to get its accounts audited (c) Corporate Assessee (d) Persons who have to file return under one by six scheme – 31st October
The dates are mandatory and there is no provision to extend the due date. If the return is filed beyond due date, mandatory interest @ 1.25% per month of tax due is payable. Belated return upto one year beyond due date is permissible. Mandatory interest @ 1.25% is payable, but no penalty is payable. Thus, if no tax was due, belated return upto one year can be submitted without payment of any interest.
A loss return must be filed in time. Otherwise, the carry forward of loss is not permitted. However, CBDT can grant extension for submitting return by a loss making company.
The return should be signed by individual, karta of HUF, managing partner, managing director etc. In some cases, return can be signed by authorised representative.
The return should be filed along with proof of payment of tax, interest. Payment should be by self assessment challan.
No intimation will be sent by Income Tax Officer, if any tax / interest / refund is not due on the basis of return of income / wealth filed.
Scrutiny of returns - Some of the returns are taken by ITO for detailed scrutiny. Notice for scrutiny has to be served within 12 months from end of the month on which return is furnished. The ITO can require assessee to attend his office or produce evidence in support of the return filed. The assessment must be completed within two years from end of the relevant assessment year.
PAYMENT OF TAX - The advance tax and self-assessment tax should be paid vide challan No ITNS 268 (0020) in respect of corporates and ITNS 270 (0021) in respect of others
From India, Bahadurgarh
Its good but needs some amendment.
Please find a copy of Income Tax Primer.
Income Tax Primer
Income Tax Liability
It is proposed to give basic information about Income Tax which every industrialist should know. The intention is only to give an overview, without using any technical jargon. It is obviously advisable to consult an expert, if one is not familiar with the intricacies of the law. The legal position is as applicable for financial year 2005--2006 (Assessment Year 2006-2007) unless specified otherwise. Provisions applicable for financial year 2006-07 (AY 2007-08) are also indicated at appropriate places.
Income Tax is payable by every assessee at the rates prescribed from time to time. These rates are fixed by Finance Act every year. The Finance Bill is presented at the time of presenting Budget. The relation between Finance Act and Budget is so close that often people associate budget only with taxation. Really, taxation is only one of the aspects of the Budget.
Who can be assessee ? - The assessee may be * Individual * HUF * Company * Partnership Firm * Association of Firms * Local Authority like Municipality etc. * Artificial Judicial person not falling in any of the aforesaid categories e.g. a Hindu deity.
Different sources of income - An assessee may get income from different sources e.g. * Salaries * House property income * Profits and gains of business or profession * Capital Gains * Income from other sources not falling under any of preceding heads e.g. interest on securities, lotteries, races. Income from each of these sources is first calculated. All this income is added to find out total income of the assessee. Permissible deductions are reduced and then income-tax payable is calculated at the prescribed rates.
Income from one head can be set off against loss from other head, unless specifically prohibited. In Rajasthan State Warehousing Corporation v. CIT 2000 AIR SCW 629, it was held that if income is derived from various heads, assessee is entitled to claim deduction permissible under respective head whether or not computation under each head results in taxable income. If income to assessee arises under any of the heads of income but from different items e.g. different house properties or different securities etc., and income from one or more items alone is taxable whereas income from the other item is exempt under the Act, the entire permissible expenditure in earning the income from that head is deductible. - . - If assessee carries business in various ventures, entire expenditure incurred on all ventures is deductible if all ventures constitute one business Financial Year and Assessment Year - One very confusing aspect of Income Tax for a common man is the difference between Financial Year and Assessment Year. The Financial Year for income tax purposes (called ‘Previous Year’) is always the year ending 31st March. The ‘assessment year’ is next to the ‘Financial Year’ or ‘Previous Year’ e.g. for Financial Year (FY) 2005-06 (1st April 05 to 31st March 2006), the ‘Assessment Year’ (AY) is 2006-07. Thus, income-tax rates prescribed for Assessment Year 2006-07 are applicable in respect of income earned during financial year 2005-06.
It may be noted that an assessee can have separate accounting year for his own purposes e.g. a Company can close its accounts on any day of the year, an individual may start his year on Diwali or any other auspicious day. However, for income tax purposes, the accounts must be closed only on 31st March.
Rate of Income Tax payable
Major types of assessees and the tax payable is summarised here.
Individual - An individual may get income from salary, house rent, business, profession, interest etc. He does not have to pay income tax on dividend income at all. An individual may carry out business under some different name. However, this is only for convenience of business or trade. The income of a proprietary firm is added to his income for purpose of income tax. If a person gets salary from a partnership firm where he is a partner, the income is treated as ‘business income’ though termed as ‘salary’.
The income tax rates are as follows :
For A Y 2006-07 (FY 2005-06) for individual, HUF/AOP other than woman or senior citizen
0 - Rs 1,00,000 Nil
Rs 1,00,001 to Rs 1,50,000 10% of income above Rs. 1,0,000, plus education of 2% on income tax (total 10.2%)
Rs 1,50,001 to Rs 2,50,000 Rs 5,000 plus 20% of income above Rs 1,50,000, plus education of 2% on income tax
Rs 2,50,001 to Rs 10,00,000 Rs 25,000 plus 30% of income above Rs 2,50,000,plus education of 2% on income tax
Rs 10,00,001 and above Rs 2,50,000 plus 30% of income above Rs 10,00,000, plus 10% of income tax as surcharge plus education cess of 2% of income tax and surcharge
In case of resident senior citizen (man or woman) who is 65 years or more at any time in the year, the income upto Rs 1,85,000 is exempt. Thus, he/she gets relief of Rs 12,000 in income tax. In case of resident woman (who is less than 65 years of age), income upto Rs 1,35,000 is exempt. She gets relief of Rs 3,500 in income tax. Subsequent slabs are correspondingly reduced.
Note that no standard deduction is available for AY 2006-07.
HUF - An Hindu Undivided Family (HUF) consists of all persons lineally descended from a common male ancestor. It is assessable in respect of income derived from the joint family corpus. However, income earned by individual members of HUF in their individual and personal capacities is taxed as their personal income. Such income is not treated as income of HUF. Thus, it is possible to have an income from a proprietary firm (in individual capacity) as well as income from a business of HUF. Both are eligible for separate tax exemptions. Business of HUF can, of course, be conducted in a different name. In such case, the HUF will be proprietor of the firm in the name of which business is being conducted.
It may be noted that there is no question of ‘forming’ an HUF, as every male Hindu automatically has ‘HUF’. A Hindu male can have his own separate HUF even if his father or son has separate HUF. One HUF with only one male member is permissible. Any ‘HUF’ can have business run by head of the HUF called ‘karta’.
If an individual throws his separate property into the property of HUF, income from such converted property will be included in the total income of such individual. Hence, the HUF business should be from independent source of capital and not from the funds provided by an individual member of the HUF. Thus, if an HUF intends to conduct a business, its financial resources have to be carefully planned.
HUF should start business with loans / gifts from unrelated persons / bankers. Accounts and finances of HUF business should be kept separate. Otherwise, there is a possibility that income of HUF will be clubbed with the income of an individual.
The income of HUF is chargeable at the same rate as individual income. Thus, if an individual splits his business - partly in his individual capacity and partly in name of firm owned by HUF, considerable tax saving is possible, if done systematically and carefully.
Rate of income tax are same as those applicable to an individual.
Partnership Firm - Income of the partnership firm has to be calculated after deducting salary and interest payable to partners at prescribed rates. The tax on balance income for AY 2006-07 (BY 2005-06) is 30% plus surcharge of 10%, plus education cess of 2% on income tax and surcharge [For AY 2005-06 (FY 2004-05), rate was 35% plus surcharge 2.5% plus education cess of 2%].
The income tax rate is same as applicable to a domestic company.
Company - The tax on income for AY 2006-07 (FY 2005-06) is 30% for Indian company pus surcharge of 10% plus education cess 2%. It was 35% plus surcharge 2.5% plus education cess 2% for AY 2005-06
Dividend Distribution Tax - A domestic company paying dividend will have to pay dividend distribution tax u/s 115-O @ 12.5% plus surcharge of 10% plus education cess 2% (i.e. total 14.025%). The dividend will be tax free at the hands of assessees.
Wealth-tax - Wealth tax for individual, HUF or a company is 1% in respect of wealth over Rs 15 lakhs. One house or part of house belonging to an individual or HUF is excluded for purpose of wealth tax. The assets have to be valued as per Valuation Rules.
Gift-tax - Gift Tax has been abolished in respect of gifts made on or after 1-10-1998. However, gifts received from persons who are not relatives will be taxable.
Income from salary
Income under the head ‘salary’ comprises of remuneration in any form (including perquisites) received by an employee from employer. Thus, there should be contractual employer-employee relationship. The contract may be express, oral or implied. ‘Salary’ includes * wages * dearness allowance * Bonus * gratuity * annuity or pension * advance of salary * Fees / Commissions perquisites/ profits received from employer in addition to salary * Leave encashment while in service * Employer’s contribution to provident fund in excess of 12% of salary of employee.
In Karamchari Union v. UOI 2000 AIR SCW 806 = AIR 2000 SC 1226 = (2000) 109 Taxman 1 = 2000 LLR 897 = 243 ITR 143 (SC), it has been held that CCA (City Compensatory Allowance), DA (Dearness Allowance) and HRA (House Rent Allowance) are in nature of income forming part and parcel of salary and are taxable.
Valuation of perquisites - The employer often gives some perquisites to the employees. Value of these perquisites is added to the income of employees. The valuation of perquisites is done as follows :
* Perquisite of Rent Free Accommodation is valued according to following rules. - In case of private sector employees, value of perquisite of rent free unfurnished accommodation is taken as 10% of salary of employee, if accommodation is in city with population exceeding 4 lacs as per 1991 census. Otherwise, it will be 7.5%. In case of Government Employees, value will be ‘licence fee’ determined by Central / State Government. If some rent is recovered from the employee, the value of perquisite will be reduced to that extent. This is not applicable for accommodation in remote are like mining site, onshore oil exploration site etc.
* If temporary accommodation upto 15 days on transfer is provided, it will also be valued @ 24% of salary paid for the period or actual hotel charges, whichever is lower.
* If accommodation is furnished, in addition to above, 10% of cost of furniture (including TV, radio, refrigerator, AC etc.) will be treated as perquisite. If the furniture is hired from third party, actual hire charges less any amount recovered from employee will be the perquisite.
* If motor car is provided by employer, valuation is done depending on HP of motor car, whether chauffeur is provided and whether car is for exclusive private use or partly for official and partly for personal purposes.
* If sweeper, watchman or gardener is provided by employer, the perquisite will be valued at the actual cost to the employer.
* Some benefits like gas, electricity, water are valued at actual cost to employer. Cost of education of employee’s children is also valued at cost incurred.
* If amenities like interest free or concessional interest loan, travelling expenses for holiday to employee or his relatives, free meals, gifts over Rs 5,000 per annum, payment of credit card expenses of employees for personal expenses, club memberships etc. are provided, these will be valued at cost and treated as perquisites.
* If some movable asset is provided to employee, perquisite will be @ 10% of the actual cost of perquisite (In case of computer, depreciation @ 50% and in case of car, depreciation @ 20% is allowed to find ‘actual cost’)
* Reimbursement of medical expenses for medical treatment of employee or member of family of employee is exempt upto Rs 15,000 per year. In case of treatment in Government or approved hospital, or expenditure on medical treatment outside India, reimbursement of medical expenses is exempt without any ceiling.
* House Rent Allowance (HRA) is partly exempt as provided in the rules. It should be noted that if the employee stays in his own house or if he incurs no expenditure on house rent, the whole HRA is taxable. The rules for granting exemption from HRA are quite complicated, but broadly, these can be summarised as follows - (a) If employee does not pay any house rent, whole of HRA received is treated as perquisite. (b) If the actual amount of rent paid by him is less than 10% of salary of the employee, in that case also, whole of HRA is taxable and there is no exemption. (c) If the actual amount of rent paid by him is more than 10% of salary of the employee, the HRA received in excess of 10% of salary is exempt. In other words, HRA received to the extent of only 10% of salary is taxable and balance is exempt. However, maximum HRA that can be eligible for exemption under this clause is 50% of salary in case of accommodation in four metropolitan cities and 40% of salary in other cities.
For purpose of calculating amount exempt from HRA, the term ‘salary’ includes only basic and DA but does not include any other allowance or perquisite.
* Leave Travel Allowance to any place in India is available only two times in a block of four years. It is for self, family and upto two children. The allowance is limited to economy airfare or AC first class rail fare by shortest route. The allowance is exempt subject to amount of expenses actually incurred by the employee for such travel. The employee will have to keep account of actual expenses incurred. It appears that actual travel by air or AC is not required, but the overall ceiling on expenses is subject to limit of air fare / rail fare.
* If shares of a company are issued to employees at price lower than the price at which the shares are offered to other shareholders / public, the difference will be treated as a perquisite. If the shares are offered only to employees, difference between market price and the price at which shares are offered to the employee will be treated as perquisite.
[However, in case of ESOP of listed companies, it is not treated as perquisite. Capital gains are payable only when the shares are sold].
* Club fees paid on behalf of employee, insurance premiums paid on behalf of employee, income tax paid on behalf of employee are all treated as perquisites and its cost is added to income of employee.
CERTIFICATE FROM EMPLOYER – Employer is required to issue certificate in form 12BA, giving details of value of each perquisite provided to the employee, if the value of perquisites exceeds Rs 1.50 lakhs. If value of perquisites is less than Rs 1.50 lakhs, the relevant details should be given in From 16 itself, which every employer is required to issue to the employee.
Standard Deduction from Salary Income - No standard deduction is alloable for AY 2006=- (FY 2005-06). Earlier, employees were eligible for standard deduction.
Exemptions for salary income - Following are exempt from income tax-
* Transport allowance upto Rs 800 per month granted to an employee to meet his expenditure for the purpose of commuting between place of residence and the place of his duty (w.e.f. 1.8.1997)
* Conveyance and transport allowance granted to employee to meet cost of travel on tour are exempt. Allowance granted to meet expenditure incurred on conveyance in performance of duties of an office or employment are exempt. In LIC Officers v. LIC of India (2000) 112 Taxman 227 (Bom HC DB), it was held that conveyance allowance is exempt only if expended for meeting expenses wholly and necessarily incurred or to be incurred in performance of duties of office. Conveyance allowance at flat rate irrespective of place of residence, work and posting will not be exempt from income tax.
* Conveyance and transport allowance granted to employee to meet cost of travel on transfer are exempt. Expenses granted to meet cost of travel on transfer and cost of packing and transportation of personal effects on such transfer are exempt.
* Gratuity received under Payment of Gratuity Act is exempt upto 15 days of wages for each completed year of service or part of year in excess of six months, on the basis of wages last drawn by employee. The exemption is subject to ceiling of Rs 3.50 lakhs. Death-cum- retirement Gratuity received by employees of Central Government, State Government, public sector employees and members of defence services are totally exempt without any limit.
* Voluntary retirement amount received by an employee upto Rs five lakhs is exempt. The voluntary retirement scheme should be as per Income Tax Rules.
* Payment received from approved superannuation fund is exempt.
* Leave encashment at the time of retirement is exempt upto 30 days for every year of completed service. Earned leave so encashed should not be for more than 8 months. Maximum eligible amount for exemption is Rs 1,35,360. In case of Central or State Government employees, it is fully exempt without any ceiling.
* Use of employer’s vehicle or transport provided for journey of employee from residence to his place of work and back is not treated as perquisite and its cost is not treated as income.
* Refreshments during office hours to employees and recreational facilities provided to group of employees are not treated as perquisites.
Income from House Property
Income from house property consists of buildings and lands appurtenant thereto. However, income only from vacant plot or land is treated as ‘income from other sources’. Following should be noted.
* In case of let out property, income will be ‘fair annual value’ or ‘actual rent received’ whichever is more. However, if property is let out only for part of the year or not let out, income will be ‘fair annual value’ or ‘actual rent received’ whichever is less.
* ‘Annual Value or Property’ is the sum for which the property could reasonably be expected to let from year to year. Municipal Valuation of ratable value can be taken as one of the tests to determine bonafide value of the property. If the house property is given on rent, actual rent received will be the ‘annual value of the house property’. If no rent is received,
* From the ‘Annual Value of House Property’, in case of let out property, following will be allowed as deduction – (a) Municipal tax – The deduction will be permitted on actual payment basis (b) Standard deduction of 30% of (gross annual value less municipal tax) (c) Interest on capital borrowed to acquire or construct the house property subject to limit explained below
* Annual Value of a self-occupied property is taken as ‘Nil’, if it is not let out. In such cases, none of the aforesaid expenses are allowed as deduction. However, if the self-occupied property is acquired or constructed or repaired from borrowed funds, interest payable on such funds upto Rs 30,000 per annum is allowed as deduction. The interest allowable as deduction will be upto Rs 1,50,000 per annum in case of house property acquired or constructed with borrowed capital on or after 1.4.1999, but before 1.4.2003 from AY 2002-03 (FY 2001-02). [The ceiling was Rs 1,00,000 for FY 2000-01 and Rs 75,000 for FY 1999-00]]
Naturally, this will be a ‘loss’ as the annual value of self occupied property is ‘Nil’. This ‘loss’ can be set off against any other income of the assessee. In other words, if funds are borrowed to acquire or construct or repair self-occupied property, interest upto Rs 1,50,000 paid per annum is allowable as deduction from any other income.
* House property or any portion thereof occupied by the owner for purpose of his business or profession is excluded and any expense of current repairs, municipal taxes, depreciation on property etc. is allowable as business expenditure.
Profits and Gains of Business or Profession
The term ‘business’ covers trade, commerce or manufacture. ‘Professional Income’ is income from exercise of any profession or vocation which calls for an intellectual or manual skill. It covers doctor, lawyers, accountants, consulting engineers, artists, musicians, singers etc.
Profits of business or gains from profession are calculated after allowing all legitimate business expenditure. Some important deductions admissible in computing income from business or profession are as follows —
Rent, rates, taxes, repairs and insurance for business or professional premises
Current repairs and insurance of machinery, plant and furniture
Depreciation on building, machinery, plant or furniture (discussed below)
Revenue expenditure on scientific research
Capital expenditure on scientific research related to business (except land)
Expenditure on technical know how is permitted to be amortised in six equal installments over a period of six years.
Preliminary expenses in relation to formation of a company or in connection with extension of an undertaking or setting up of a new industrial unit can be amortised in 10 equal installments over 10 years. The preliminary expenditure is permitted only upto 2.5% of cost of project.
Insurance expenses
Bonus or commission to employees
Interest on borrowed capital
Contributions towards approved provident fund, superannuation fund and gratuity fund
Bad debts in respect of income considered in previous years can be written off and allowable as deduction.
Entertainment expenditure actually incurred in connection with business is permissible as deduction.
Advertisement expenditure is fully allowed as deduction. However, expenditure incurred on advertisement in any souvenir, brochure, pamphlet etc. of a political party is not allowed as a deduction.
All travelling expenditure actually incurred
Expenditure in maintenance of guest house is permissible as deduction
Any other expenditure which is not of capital nature or personal expenses of the assessee is allowed if it is expended wholly and exclusively for the purposes of business or profession.
Depreciation - In any business, raw material is used fully and immediately, while plant and machinery is used slowly over a period of time. After the estimated life of machinery, its value becomes Nil. Hence, it is fair that cost of machinery is charged over the period of its estimated useful life. This is the basic principle of depreciation on capital goods. Since land does not depreciate, no depreciation is allowed on land.
Under Income Tax, depreciation is calculated on the basis of ‘block of assets’. ‘Block of assets’ means a group of assets falling within a class of assets, in respect of which the same % of depreciation rate has been prescribed. e.g. all machinery having rate of depreciation as 25% will form one block of asset, machinery having 40% rate of depreciation will form another ‘block of asset’ and so on.
Depreciation is allowed on actual cost of the asset. Interest paid on borrowed funds and capitalised as pre-commencement expenses before the asset is commissioned is added to cost of the asset and depreciation claimed on such expenditure. Thus, pre-production expenditure can be included in cost of the machinery and depreciation can be charged on such ‘actual cost’. In Chellapalli Sugar v. CIT AIR 1975 SC 97 = 98 ITR 167 (SC), it as held that it includes all expenditure necessary to bring such asset into existence. [Thus, it will include installation charges]. It was held that interest on loans upto date of commencement of business forms part of 'actual cost' of plant for purpose of depreciation.
Depreciation is calculated on Written Down Value (WDV) method. e.g. if cost of machinery is Rs 100 and rate of depreciation is 10%, depreciation in first year will be Rs 10 and written down value (WDV) of machinery will be Rs 90 (100-10). In next year, depreciation will be 10% of Rs 90 i.e. Rs 9. Next year, the WDV of machinery will be Rs 81 and depreciation allowed will be Rs 8.10 and so on. If the asset is put to use for purpose of business for less than 180 days, only 50% of normal depreciation is permissible. In other words, full depreciation for the year is permissible only if asset is commissioned before 30th September of that year.
If depreciation cannot be fully claimed in a particular year for want of profits, the un-absorbed depreciation can be carried forward for any number of succeeding assessment years. [section 32(2)]. [Earlier limit of 8 years removed vide Finance Act, 2001]
The depreciation rates in respect of some important assets are as follows :
* Residential building – 5%. Others – 10%. Purely temporary structures – 100%.
* Furniture and fittings including electrical fittings – 15%
* Motor cars 20% . Buses, lorries, and taxis used in business of running them on hire – 40%, aeroplane – 40%. Ships – 25%
* Pollution control equipment and specified energy saving devises - 100%
* Normal machinery - 25%
* Computers including software - 60%.
* Books by professionals – 100% for annual subscription and 60% for others - books in library - 100%.
* Ships - 25% (25% for vessels used in inland waters).
* Intangible assets - know-how, patents, copyrights, trade marks, licenses, franchises or any other right of similar nature - 25%.
In Mysore Minerals v. CIT 1999 AIR SCW 3146 = 1999(5) SCALE 340 = 239 ITR 775 = AIR 1999 SC 3185 = 106 Taxman 166 (SC), it was held that claimant of depreciation need not be owner of asset in legal sense. Person in whom for the time being vests the dominion over the asset and who is entitled to use it in his own right is eligible to claim depreciation. – followed in Dalmia Cement v. CIT 2000 AIR SCW 4198 (SC 3 member bench).
However, if assessee has not acquired dominion over the asset, he will not be entitled to depreciation on that asset. – Tamilnadu Civil Supplies v. CIT (2001) 116 Taxman 369 = 2001 AIR SCW 4777 (SC 3 member bench).
DEPRECIATION COMPULSORY – As per Explanation 5 to section 32(1)(ii), inserted w.e.f. 11.5.2001, depreciation is compulsory in computing total income even if assessee had not claimed the same. This amendment applies to AY 2002-03 onwards. [In CIT v. Mahendra Mills (2000) 2 SCALE 384 = AIR 2000 SC 1960 = 243 ITR 56 = (2000) 109 Taxman 225 (SC), it was held that assessee has option to claim or not to claim depreciation. The depreciation cannot be thrust upon him. Now, this judgement is ineffective from AY 2002-03]
DEPRECIATION IN CASE OF IMPORTED MACHINERY OBTAINED ON LOAN IN FOREIGN CURRENCY – If machinery is imported on loan repayable in foreign currency, the amount payable in rupees will go on changing due to fluctuations in foreign exchange rates, as the installments and interest are spread over a period. In such case, the value of machinery should be increased on basis of entire loan outstanding and not merely installments of loans that fell due during the accounting period. – CIT v. Arvind Mills (1992) 193 ITR 255 = 60 Taxman 192 (SC) – quoted and followed in CIT v. Madras Fertilizers (2002) 124 Taxman 581 (Mad HC DB).
Expenditure not allowed as deduction - Following expenditures are not allowed as deduction for purpose of income tax.
* Tax, duty, cess, fees payable under any law, Employer’s contribution to provident fund or ESIC, bonus to employees, commission to employees are eligible as deduction only if they are paid on ‘due dates’ on which these were payable. Even if these are not paid on due dates but are paid before filing of return, these are allowed as deduction, if proof of payment is filed along with the return. However, in case of employer’s contribution to provident fund, superannuation fund or gratuity fund, the same is allowed as deduction only if it was paid before due date of payment.
* If expenditure is incurred in business or profession by payment of cash over Rs 20,000, then 20% of such expenditure is straightaway disallowed.
Payment over Rs 20,000 should be made by cheque or demand draft. However, this restriction is not applicable in case of payments to # RBI, other banks and financial institutions # Government * Payment for agricultural produce, poultry, fish etc. to the cultivator, grower or producer (i.e. payments to middlemen are not excluded from this provision) # when payment was required to be made when banks were closed on account of holiday or strike. [Similarly, a person can accept loans or deposits of Rs 20,000 or more only by account payee bank draft or cheque].
* Interest on delayed payment made to Small Scale Industries is not allowable as deduction.
* Section 37(1) of Income Tax Act states that any expenditure incurred for any purpose which is an offence or which is prohibited by law shall not be allowed as deduction.
Minimum Alternate Tax (MAT) - Many companies charge depreciation in their books on straight line method. Thus, the profit shown is higher in the accounts maintained for company law purposes and they can declare dividend. However, for income tax purposes, they charge depreciation on WDV which is higher. Thus, for income tax purposes, they may show low profit or even loss, while in balance sheet prepared for company law purposes, they will show high profits, which is called ‘book profits. Hence, such companies have to pay minimum income tax 7.5% of such book profits for AY 2006-07 plus surcharge of 10% plus education cess of 2% [section 115JA and 115JB].
This tax is termed as ‘Minimum Alternate Tax’ (MAT).
In Apollo Tyres v. CIT (2002) 122 Taxman 562 (SC 3 member bench), it was held that the assessing officer cannot reopen the accounts certified by auditors and adopted in general meeting. He has limited powers of making additions and reductions as provided in the section. [In this case, it was held that assessing officer cannot add back the depreciation for earlier years provided in accounts].
Different accounting for balance sheet and income tax purposes - Method of depreciation, valuation of stock etc. is different under Companies Act and Income Tax Act. Hence, one method of accounting for income tax and other for Companies Act is permitted. The practice has been specifically approved in United Commercial Bank v. CIT 1999 AIR SCW 4050 = AIR 2000 SC 94 = 106 Taxman 601 (SC).
Accounting profits and assessable profits are conceptually different. – CIT v. Bipinchandra Maganlal (1961) 41 ITR 290 (SC).
Other important provisions in respect of business income
Some important provisions in relation to income from business or profession are as follows -
MAINTENANCE OF BOOKS OF ACCOUNT - In respect of professional in legal, medical, engineering, architecture, accountancy or technical consultancy must maintain books, if their gross receipts are less that Rs 1.50 lakhs, they have to maintain such books of account as may enable Income Tax Officer to compute their taxable Income. If their gross receipts exceed Rs 1.50 lakhs, they have to maintain books of account as specified in rule 6F i.e. cash book, journal, ledger, copies of bills exceeding Rs 25 issued by him, original bills in respect of expenditure exceeding Rs 50 and payment vouchers etc. Person carrying on medical profession has to maintain additional books as prescribed. [Section 44AA and rule 6F]
Persons carrying on business or professionals other than those mentioned above have to maintain books of accounts if annual income exceeds Rs 1,20,000 or gross receipts or turnover exceed Rs. ten lakhs in case of business also have to maintain books of account.
ACCOUNTS ON MERCANTILE OR CASH BASIS - Accounts should be maintained either on mercantile basis or cash basis. Hybrid i.e. mixed system is not permitted. [In cash system, income or expenditure is considered only when it is actually received / paid. In mercantile system, income/expenditure is considered on accrual and payable basis. Actual receipt or payment may occur in subsequent financial year and may not happen in that particular year.]
INCOME TAX AUDIT REPORT - If gross receipts or turnover of business exceeds Rs 40 lakhs per annum, the accounts have to be compulsorily audited. In case of professional income, accounts have to be audited if gross receipts exceed Rs ten lakhs. This audit report should be submitted along with income tax return. [section 44AB].
Capital Gains
Capital gains means any profit or gains arising from transfer of a capital asset. Such capital asset may be building, non-agricultural land, machinery, shares etc. Broadly, ‘capital gain’ is the difference between the price at which the asset was acquired and the price at which the same asset was sold. In technical terms, capital gain is the difference between cost of acquisition and the fair market value on the date of sale or transfer of asset. If the asset is sold at price even higher than the fair market value of asset, the difference between the sale proceeds and the fair market value is treated as business income.
The ‘cost of acquisition of capital asset’ is to be increased by Cost Inflation Index. The index is announced by Central Government every year. The index was 100 for 1981-82, 172 for 1989-90, 244 for 1993-94, 331 for 1997-98, 351 for 1998-99, 389 for 1999-2000, 406 for 2000-01, 426 for 2001-02, 447 for 2002-03, 465 for 2003-04, 480 for 2004-05 and 519 for 2006-07.. The cost of acquisition will be adjusted on basis of the above index and then capital gain will be calculated. The formula is Cost of acquisition x Cost Inflation Index of the year in which the asset is transferred / Cost Inflation Index of the year of acquisition. If the asset was acquired before 1.4.1981, the Cost Inflation Index of that year will be treated as 100. Thus, if an asset was brought in 1989-90 for Rs one lakh and sold in 1997-98 for Rs three lakhs, the adjusted cost of acquisition will be (1,00,000 x 331)/172 i.e. Rs 1,92,442, and capital gains will be Rs 1,07,558 (3,00,000 - 1,92,442). Such adjustment is permissible only for long term capital gains and not for short term capital gains.
Expenditure incurred on any improvement in asset is permitted as deduction and that cost can also be adjusted on the same principles as above.
If a company issues bonus shares, the cost of acquisition of bonus shares will be treated as ‘Nil’. Thus, if the bonus shares are sold, net sale proceeds of bonus shares will be liable to capital gains.
Expenditure incurred in connection with transfer (like stamp duty, registration charges, legal fees, brokerage etc.) are allowed as deduction.
Capital gain is charged as income of the financial year in which the transfer took place.
Capital gain can be classified as ‘short term’ or ‘long term’. A short term capital gain is when the asset was held by the assessee for a period of upto 36 months. If the asset was held for more than 36 months, the gain will be long term gain. The period is only 12 months (instead of 36 months) in case of shares or any other security listed in stock exchange or units of UTI or units of mutual fund.
The income tax rate is 20% on long term capital gains, while calculating the long term capital gains, indexation of purchase price is required. Tax on long term capital gain shall be subject to ceiling of 10% of capital gains calculated without indexing.
The short term gains are added in other income of the assessee and the income tax is payable according to the normal rate applicable to the assessee.
Capital gains arising from sale of residential house is exempt if the original asset (i.e. the house) was held for more than three years and a new house was purchased within one year before or two years after the sale of original asset, or a new residential house is constructed within three years. The cost of new asset (residential house) should be more than the amount of capital gains.
Any other long term capital gain is exempt if the capital gains are invested within 6 months in 3 year bonds issued by NABARD or NHAI and that investment is retained for three years. - section 54EC
Income from other sources
All income other than income from salary, business and profession or capital gains is covered under ‘Income from other sources’. Provisions in respect of some important sources of ‘other income’ are summarised below.
Dividends - Dividends on shares of domestic companies or units of UTI or mutual fund received from a company on or after 1-4-2003 will not be taxable at the hands of the assessee for AY 2004-05 (FY 2003-04).
[section 10(34) and 10(35)]. [The dividend distribution tax will be payable by company/mutual fund u/s 115-O]
For the AY 2003-04 (FY 2002-03), income from dividend was taxable at the hands of shareholder. Provisions of TDS apply. However, income of dividend was eligible for deduction u/s 80L upto Rs 12,000 (along with interest income) [Now, dividend is completely tax free at hands of assessee w.e.f. 1-4-2003].
WINNING FROM LOTTERIES, RACES ETC. - Winning from lotteries, card games etc. is exempt upto Rs 5,000. Winning from horse races is exempt upto Rs 2,500. The balance is subject to tax @ 40%.
Interest on bank deposits and loans - Interest on bank deposits and loans is treated as ‘other income’. Exemption u/s 80L was availabe upto AY 2005-06, but has been withdrawn from AY 2006-07 (FY 2005-06).
NOTE ON INTEREST RATES – Interest rates, particularly on postal savings have been considerably reduced. Some interest rates as on 1.3.2003 are given here –
Post Office Savings Account – 3.5%; PO Time deposit 5 years – 8%; Kisan Vikas Parta – Doubles in 7 years and 8 months
Public provident Fund (PPF 15 years) – 8% w.e.f. 1-3-2003 (9% w.e.f. 1-3-2002, and 9.5% w.e.f. 1-3-2001) – Minimum Rs 500 Max Rs 70,000
Rebate / Exemption from Income Tax Liability
Following rebates / exemptions are available.
Deduction on account of specified investments - A deduction from gross total income is granted if investment is made in specified areas. [section 80C] [earlier deduction u/s 88 has been withdrawn w.e.f. AY 2006-07 (AY 2005-06)].
The investments eligible are - LIC premiums # Contribution to Public Provident Fund Scheme # Contributions to employee provident fund # 6 years NSC certificates # Unit linked insurance plan of UTI # Investment in approved equity shares / debentures (usually, debentures / shares issued for infrastructure projects are approved for purpose of eligibility) # Units of mutual fund approved by Board # Installments of refund of housing loans upto Rs 20,000.
Deduction upto Rs 1,00,000 from gross income is available.
Rebate to senior citizen / women - Senior citizen over 65 years do not get any rebate, but income tax slabs have been adjusted to reduce their tax liability by Rs 12,000.
Deduction of medical insurance premium, pension fund - Following deductions are permissible -
(a) Medical insurance premium upto Rs 15,000 (section 80D). The limit was Rs 10,000 for AY 1999-2000.
(b) Contribution to LIC pension fund upto Rs 10,000 per annum. (section 80CCC)
(c) Contribution to approved charitable institutions - in some cases 50% of amount paid is allowed as deduction, while in some cases, 100% amount paid is allowed as deduction (section 80G).
Deduction from tax liability to certain industries - Industries are given certain deductions under section 80-IA and 80I-B, as summarised below :
* New Industrial undertaking in industrially backward area is eligible for certain deduction from profits for 10 assessment years. The unit should start production before 31-3-2002.
* In case of small scale industry, the condition of location in backward area does not apply, i.e. it can get deduction in profit irrespective of
location. However, it should commence manufacture before 31.3.2002.
* Cold storage plants are eligible for the tax incentive
* The deduction is not permissible if the industrial undertaking or SSI unit manufactures article specified in Eleventh Schedule. The major articles covered in ‘Eleventh Schedule’ are - beer, wine, alcoholic spirits, tobacco products, cosmetics, toilet preparations, tooth paste, tooth powder, soap, aerated water, confectionery, chocolates, gramophones and record players, photographic machines, office machines, steel furniture, safes, strong boxes, latex foam sponge and polyurethane foam, crown corks and PP caps for packaging or fitting.
* It should be a new unit and not formed by splitting or reconstruction of an already existing business.
* It should not be formed by transfer to a new business machinery or plant which was previously used
* The deduction is 30% if the assessee is a company and 25% if assessee is firm / cooperative society / individual / HUF etc.
Exemption in respect earnings in convertible foreign exchange - Income in convertible foreign exchange is exempt. Even supporting manufacturer is eligible for exemption from profit. The exemption is being reduced in phases and by AY 2005-06, there will be no deduction permissible on export profits. [In case of EOU, STP, EHTP and EPZ, the concession will continue upto 31-3-2009 and there will be no deduction from AY 2010-2011].
Other provisions of Income Tax
Certain other important provisions of income tax are discussed here.
Clubbing of Income - Often salary or other expenses from business are shown in name of close relatives like spouse (wife / husband) or minor child, to reduce tax liability. In such case, if the individual has a substantial interest in the concern, the income of such wife, husband or minor child will be added to the income of such individual. The ‘substantial interest’ means at least 20% of voting power in case of a company or 20% profits of the partnership firm. This is termed as ‘clubbing of income’. The clubbing provision is not applicable if spouse possesses technical or professional qualifications and the income is solely due to application of his / her technical knowledge and experience.
If an asset is transferred to the spouse, income from such asset is also treated as income of the individual. [e.g. by transferring shares, house property etc.].
Similarly, if an individual throws his separate property into the property of HUF, income from such converted property will be included in the total income of such individual.
The clubbing provision has obviously been made to plug avoidance of income tax liability, by ‘showing’ some income in the name of spouse / minor child / HUF.
Permanent Account Number - Every person whose total sales, turnover or gross receipts are over Rs 50,000 are required to apply and obtain a Permanent Account Number (PAN). Government has decided to use PAN as a common business identification number to be used by various agencies and departments like customs, excise, DGFT etc.
Deposit / loan of Rs 20,000 or more - Deposits or loans of Rs 20,000 or more from a person can be obtained only by way of account payee draft or cheque. Repayment of loan or deposit or interest thereon of more than Rs 20,000 should also be made by account payee cheque or draft.
Advance Income Tax - Tax is deducted from salary payable to an employee. Since a businessman or professional earns his own income, there is no TDS (Tax Deduction at Source). Hence, he is liable to pay advance tax as he earns income. This is ‘Pay Tax as you Earn’. Thus, advance tax is payable on the basis of estimated income of the current financial year. [The income is ‘estimated’ because, actual income will be known only after the financial year is over]. Advance tax is payable only in cases where tax payable is in excess of Rs 5,000. The assessee has to pay advance tax on his own accord and no notice will be issued to him.
The advance tax is payable in installments as follows -
* IN CASE OF COMPANY - # 15% on or before 15th June # 30% on or before 15th September # 30% on or before 15th December # Remaining 25% on or before 15th March.
* IN CASE OF PARTNERSHIP FIRMS, PROPRIETORS, PROFESSIONALS ETC. - # 30% on or before 15th September # 30% on or before 15th December # Remaining 40% on or before 15th March.
Thus, 100% income tax in respect of estimated income of current financial year is payable by 15th March. If any instalment is not paid on due date, it can be paid subsequently.
If advance tax is not paid or short paid on due dates, mandatory interest is payable as follows :
* If advance tax was not paid before 31st March of the financial year, or advance tax paid was less than 90% of the assessed tax, interest @ 1.25% per month or part thereof is payable from 1st April till the month of payment. [section 234B]. The interest is not payable if total tax liability is less than Rs 5,000 or if at least 90% of assessed tax was paid before 31st March. [Interest rate was 1.5% per month upto 31.5.2001].
* If installments of advance tax are not paid on due dates, interest on shortfall is payable @ 1.25% per month. In case of last instalment which is due on 15th March, interest @ 1.25% is payable for one month if tax is not paid at all or is paid after 15th March. [section 234C]. [The interest rate was 1.5% per month upto 31.5.2001]. Note that this interest is calculated only upto 31st March, as from 1st April, interest @ 1.25% becomes payable on entire tax due under section 234B.
This interest is mandatory and there is no provision to grant exemption form payment of this interest.
If the return is not filed within due date, interest @ 1.25% is payable u/s 234B w.e.f. 1.6.2001. [Earlier, it was 1.5% per month). In addition, interest @ 1.25% is payable u/s 234A. Thus, if return is not filed on or before due date, interest payable is 2.5% for every subsequent month.
Special provisions in respect of Partnership firm - A partnership firm is presently assessed on the lines similar to the assessment of a company.
The firm can pay salary and interest on capital to the partners. Income tax is payable @ 35% of profits calculated after deducting salary and interest paid to partners. The salary paid to partners is treated as ‘business income’ in their hands and is taxable accordingly.
The partnership firm may or may not be registered. However, the partnership must be evidenced by a partnership deed. The deed should indicate * individual shares of the partners * Salary payable to working partners * Interest payable to partners. A true copy of partnership deed certified and signed by all the partners should be filed along with the first return of income. Subsequently, the copy is not required to be filed along with every return. However, if there is any change in the partnership agreement, a fresh copy has to be filed.
Return of partnership firm can be signed by managing partner.
SALARY TO WORKING PARTNERS - The salary payable to partners is as follows -
* Professional partnership firms - # upto book profit of Rs 1,00,000 - 90% of book profit - minimum Rs 50,000 # On next Rs 1,00,000 book profit - 60% # On balance of book-profit - 40%.
* Other than professional partnership firms (i.e. business firms) - # upto book profit of Rs 75,000 - 90% of book profit - minimum Rs 50,000 # On next Rs 75,000 book profit - 60% # On balance of book-profit - 40%.
The salary can be paid only to working partners. Such payment should be authorised by partnership deed. This salary is allowed as deduction from income of the partnership firm and is taken as business income of the individual partner.
INTEREST TO PARTNERS - The partners are entitled to get interest upto 12% on their capital in the partnership firm. [The interest rate was 12% upto 31-5-2002]. Such payment should be authorised by partnership deed. This interest is allowed as deduction from income of the partnership firm and is taken as ‘other income’ of the individual partner.
Tax deduction at source - A person is under liability to deduct income tax at source and pay it to Government. He should issue a certificate to the person from whom tax is deducted, so that the person can submit the same to Income Tax authorities. Tax deducted at source should be paid to Government within one week from date of deduction. At the end of the year, a return in prescribed form has to be filed with ITO.
TDS is rightly called ‘tedious’, but not deducting tax at source can invite penalties.
As can be seen from following, if the person making payment is individual or HUF, he is exempt from the provisions of TDS in most of the cases, if he is not required to submit income tax audit report u/s 44AB. However, TDS provisions apply to (a) salary payments made by an individual or HUF even if he is not required to submit any income tax audit report u/s 44AB (b) If the individual/HUF is required to submit Income Tax Audit report.
TDS FROM SALARY - Every employer has to deduct tax from salary of employees. While deducting tax at source, the employer can consider the investments made by employee which qualify for exemption, payment for purchase or construction of house, mediclaim insurance premium etc.
Income tax is to be deducted every month and should be paid to Government within a week after deduction. The employer can adjust deductions from month to month so that total deductions from salary of the whole year is equal to tax payable by employee on salary income.
The employer has to file an annual return before 30th June of tax deducted at source from all employees.
TDS FROM INTEREST PAYMENT - Tax should be deducted from interest paid if interest payable in financial year exceeds Rs 5,000. The deduction should be @ 22.44% if payment is to companies, 11.22% in case of firms, artificial persons or individuals having income exceeding Rs 10 lakhs, and @ 10.2% in other cases. An individual can get interest without deduction of tax at source, if he submits required declaration form.
TDS provisions are applicable to individuals and HUF also, if interest payment is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENTS TO CONTRACTORS - TDS provisions apply if contract value exceeds Rs 20,000. The tax deduction should be @ 2.244% in case of payment to contractors and @ 1.122% in case of payment to sub-contractors.
TDS provisions are applicable to individuals and HUF also, if payment to contractors/sub-contractors is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENT IN RESPECT OF ADVERTISEMENT CONTRACTS -
TDS provisions apply if contract value exceeds Rs 20,000. The tax deduction should be @ 1.122%.
TDS provisions are applicable to individuals and HUF also, if payment in respect of advertisement contracts is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENTS OF RENT - TDS provisions apply if aggregate sum of rent paid exceeds Rs 1,20,000 per annum. The tax deduction should be @ 16.83% in case of payment to individual or HUF and @ 22.44% if the payee is other than individual or HUF.
TDS provisions are applicable to individuals and HUF also, if payment of rent is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM PAYMENTS FOR PROFESSIONAL OR TECHNICAL SERVICES -
TDS provisions apply if aggregate sum paid for professional or technical services exceed Rs 20,000 per annum. The tax deduction should be @ 5%.
TDS provisions are applicable to individuals and HUF also, if payment for professional or technical services is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
TDS FROM COMMISSION / BROKERAGE – TDS in respect of payment of commission or brokerage to resident is 5.61%. There is no TDS if commission / brokerage paid during the financial year is less than Rs 2,500. [section 194H]
TDS provisions are applicable to individuals and HUF also, if payment of commission/brokerage is made by an individual or HUF, who is required to submit income tax audit report u/s 44AB. Provisions of TDS do not apply to small HUF and individuals who do not have to submit income tax audit report.
PAYMENT OF TDS - The tax deducted at source should be paid vide challan No ITNS 269 (0020) in respect of corporates and ITNS 271 (0021) in respect of others. Annual return has to be filed.
Income Tax Returns
Every assessee should file an annual return in prescribed form. The prescribed forms are as follows -
FORM NO. 1 - For Companies
FORM NO. 2 OR 2D - Firms, HUF, Individuals whose income includes ‘profits and gains of business or profession’.
FORM 2C – Those who are required to file return even if income is below taxable limit under proviso to section 139(1) – termed as 1 by 6 scheme.
FORM 3 or 2D - This form is mainly for resident individuals and HUF who do not have any income from business or profession.
In addition to the return, an acknowledgment form in duplicate is required to be submitted. The ‘acknowledgment’ is really summary of the income tax return. The duplicate of acknowledgment is returned by income tax department duly acknowledged. This serves as proof of the details of income submitted by assessee.
The income tax return is really a self assessment memorandum. The assessee should calculate the tax and interest payable by him and pay it by challan. The payment will of course be after deducting the advance tax which he might have already paid.
The return should be accompanied by * Salary certificate * Profit & loss account or income and expenditure account in case of business / professional income * Details of income from house property e.g. municipal valuation / rent received / taxes paid etc. * Copies of proofs in respect of investments made which qualify of income tax rebates * Copy of audit report if his accounts are required to be audited * Tax deduction certificate, if any tax was deducted when he had received the payment * Copy of challans of advance tax * Copy of challan of self assessment tax.
It is a practice to submit a summary sheet giving details of computation of income and tax payable, though such summary sheet is not a legal requirement.
The due dates for filing return are as follows -
* (a) Individuals having only salary income (b) Non-corporate assessees (Individuals, HUF, partnership firms or societies) having income from business or profession but who do not have to get their accounts audited under Income Tax or any other law - 31st July
* (a) Non corporate assessees (Individuals, HUF, partnership firms or societies) having income from business or profession and who have to get their accounts audited (b) A working partner where the firm in which he is a working partner has to get its accounts audited (c) Corporate Assessee (d) Persons who have to file return under one by six scheme – 31st October
The dates are mandatory and there is no provision to extend the due date. If the return is filed beyond due date, mandatory interest @ 1.25% per month of tax due is payable. Belated return upto one year beyond due date is permissible. Mandatory interest @ 1.25% is payable, but no penalty is payable. Thus, if no tax was due, belated return upto one year can be submitted without payment of any interest.
A loss return must be filed in time. Otherwise, the carry forward of loss is not permitted. However, CBDT can grant extension for submitting return by a loss making company.
The return should be signed by individual, karta of HUF, managing partner, managing director etc. In some cases, return can be signed by authorised representative.
The return should be filed along with proof of payment of tax, interest. Payment should be by self assessment challan.
No intimation will be sent by Income Tax Officer, if any tax / interest / refund is not due on the basis of return of income / wealth filed.
Scrutiny of returns - Some of the returns are taken by ITO for detailed scrutiny. Notice for scrutiny has to be served within 12 months from end of the month on which return is furnished. The ITO can require assessee to attend his office or produce evidence in support of the return filed. The assessment must be completed within two years from end of the relevant assessment year.
PAYMENT OF TAX - The advance tax and self-assessment tax should be paid vide challan No ITNS 268 (0020) in respect of corporates and ITNS 270 (0021) in respect of others
From India, Bahadurgarh
Hi ,
Are the investment.ppt and the Tax Primer available in this thread the latest and are they applicable for the current financial year. This is really needed for me to make the investment plan. Can i take them as valid and refer them for details ?
Does this provide the details on the available investment options, the rules and regulations attached to it (like max amount possible in that category etc), and the latest tax slabs etc ?
Please guide me..
Thanks in Advance,
KK2202
From India, Tiruvalla
Are the investment.ppt and the Tax Primer available in this thread the latest and are they applicable for the current financial year. This is really needed for me to make the investment plan. Can i take them as valid and refer them for details ?
Does this provide the details on the available investment options, the rules and regulations attached to it (like max amount possible in that category etc), and the latest tax slabs etc ?
Please guide me..
Thanks in Advance,
KK2202
From India, Tiruvalla
Its very helpful for investors, But in the document file the tax rebate written as Sec.88 now it was ammended as 80C, so, update accrodingly.
Its very good and outstanding contribution, So, Thanx to JSF for contributing such article.
Keep contribute.
Tks
Jagan
From India, Visakhapatnam
Its very good and outstanding contribution, So, Thanx to JSF for contributing such article.
Keep contribute.
Tks
Jagan
From India, Visakhapatnam
Gentleman good to hear from u.
Was posted on 26-10-2006…:)
Hope u r in a/c field.. y don’t u update & repost the same…?
JSF
“I would rather die standing up, than live life on my knees.”
From India, Bangalore
Was posted on 26-10-2006…:)
Hope u r in a/c field.. y don’t u update & repost the same…?
JSF
“I would rather die standing up, than live life on my knees.”
From India, Bangalore
Thank you so much for all the details. I have a query about HRA. If a person acquires property by way of loan and moves into the same house, his HRA will be taxable? Whats the advantage of moving into an own house then?
From India, Vijayawada
From India, Vijayawada
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Circular No 1-2018 Processing of income-tax returns under section 143(1) of the Income-tax Act .pdf
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