Income Tax

Prof. S B GabhawallaS B Gabhawalla & CoChartered Accountants

The Course Coverage

Framework & Basic Principles Taxability of Income from Salaries Taxability of Business Incomes Taxability of Capital Gains Deductions & Exemptions Allied Tax Concepts

- In com e- S cop e o f In com e

- S ch em e o f th e A c t

Tax on In com e

-P erson-A ss essee

o f a p erson

-A ss essm en t Y ear-P reviou s Y ear

ch arg ed an n u a lly

In com e Tax

Section 4 as charging section

Person & Assessee

ARTIFICIAL JURIDICAL PERSONP E

R S

O

N

INDIVIDUAL

HINDU UNDIVIDED FAMILY

COMPANYFIRM

AOP / BOILOCAL AUTHORITY

rele

vant

for I

ncom

e Ta

x D

epar

tmen

t ?

Person - Individual

From birth till death Incomes of minors are clubbed with parent After death, income is assessed as “Estate”

Slab-wise Tax Rates depending on the nature of the assessee (summarised in next slide)

Individuals – Tax Rates

Income upto 1,00,000/- (Rs. 1,35,000/- for ladies & Rs. 1,85,000/- for senior citizens)

Nil

Between 1,00,000/- to Rs. 1,50,000/- (N.A. for senior citizens Read Rs. 1,35,000/- for ladies)

10%

Between Rs. 1,50,000/- to Rs. 2,50,000/- (Read Rs. 1,85,000/- for senior citizens)

20%

Above Rs. 2,50,000/- 30%

Person – HUF - Concept

Mr. A - Mrs. A Mr B (son) & Mrs. B

Mr C (grandson) & Mrs. C Mr D (greatgrandson) & Mrs D

Mr E (greatgreatgrandson) & Mrs E Ms. F (unmarried grand-daughter)

Karta – Mr. A (manages the property & business)

Co-parceners – B, C & D (can enforce partition)

Members – all (can claim maintenance)

Person – HUF - Nucleus

Through ancestral property (property inherited from any of three immediate male ancestors)

If son is single when inherited – assessed as individual income till he is married

No need for more than one co-parcener

Through gifts for the family Family denotes plurality of co-parceners

Person – HUF – Income & Taxation

Nucleus can be invested in businesses to derive profits or in securities to derive investment incomes

Incomes purely of a personal character cannot be attributed to a HUF – eg. Salaries, commission, etc

Incomes taxed similarly as “Individuals” Any payments by HUF to members not treated as

income

Person – Company

Distinct entity from shareholders/ directors Directors’ remuneration deductible Dividend liable for double taxation

Dividend Distribution Tax @ 12.50% Flat rate of tax

Indian companies 30% Foreign companies40%

Person – Firm

Distinct entity for taxation but no separate legal status

“Agreement” & “Business” are necessary conditions

Payments to partners deductible subject to conditions

Flat Firm Tax Rate 30% Share of profits exempt in hands of the partner

Person - Others

Local Authority Artificial Juridical Person AOP/ BOI Co-operative Society

- In com e- S cop e o f In c om e

- S ch em e o f th e A c t

Tax on In c om e

-P erson-A ss ess ee

of a p e rson

-A ss essm en t Y ear-P reviou s Y ear

ch arg ed an n u a lly

In com e Tax

Section 4 as charging section

Charged annually

Each year an independent year Common Financial Year Assessment Year

period of twelve months starting from the 1st April of every year and ending on 31st March of the next year

Denoted as 2002-2003 , etc We are concerned with the law for Asst Year 2006-2007

Previous Year Generally 1st April to 31st March

- In com e- S cop e o f In c om e

- S ch em e o f th e A c t

Tax on In com e

-P ers on-A ss es see

of a p e rs on

-A ssessm en t Y ear-P reviou s Y ear

ch arg ed an n u a lly

In c om e Tax

Section 4 as charging section

Taxability of IncomesGeneral Propositions

Capital receipts not taxable unless specified Personal receipts not taxable Mutual Activities do not result in income Income from illegal sources liable to be

taxed Income diverted at source not taxable

Scope of Income

Non TaxableTaxableOutside India

TaxableTaxableIn India

Non ResidentResidentPerson

Income

--Residential Nexus--

--Te

rrito

rial N

exus

--

(To be refined later)

Residential Status - Individuals

182 day test OR 60 day test & 365 days in 4 years test

Indian citizens taking employment abroad Indian citizens/PIO visiting India

730 days test in 7 years AND Resident in 2 out of 10 years

Residential Status - Others

Companies Indian companies

Always resident in India Other companies

Resident in India if control & management wholly in India

Other Assessees Resident in India if control & management partly in

India

Scope of Income (refined)

Person

Income

Resident & Ordinarily Resident

Resident but not Ordinarily Resident

Non Resident

In India Accrued Deemed to Accrue Received Deemed to receive

Taxable Taxable Taxable

Bss. controlled from India

Taxable Taxable Non Taxable

Outside India Taxable Non Taxable Non Taxable

Scope of Income

Income Accrued in India (General Principles) Income Received in India (General Principles) Income Deemed to receive in India

Annual Accretion in RPF Transferred Balance to RPF Bad Debts Recovered Unexplained Investments Tax Deducted at Source

Income Deemed to Accrue in India

Income from Business Connection in India Property, Asset, Source in India Salaries earned in India Salary paid by Government to Indian citizen Dividend by Indian company Interest Royalties Fees for Technical Services

Base Erosion Approach

Scheme of the Act Concept of Income

Capital vs. Revenue

Income

Exemption

H1 H3H2 H4 H5

Aggregation

Deductions

IncomePerson

TAX

• ExemptionsExemptions• Heads of IncomeHeads of Income• Aggregation Rules Aggregation Rules • DeductionsDeductions• Tax LiabilityTax Liability

Heads of Income

Salaries Employer – Employee Relationship

Income from House Property

Buildings not used for business

Business Income Frequency & Intention

Capital Gains Transfer of a Capital Asset

Income from Other Sources

Residuary Head of Income

Salaries: The Starters..

Test: Employer – Employee Relation

Basis of Charge:Accrual or Receipt whichever is earlier

Scheme (Taxation): Primarily Gross Basis

Scheme of Taxation

Basic Salary Add Allowances (to the extent not exempt)

Add Perquisites (as valued)

Add Retirement Benefits (to the extent not exempt)

Less Profession Tax Entertainment Allowance

Allowances

Exemption based on expenditure and multiple limits House Rent Allowance Entertainment Allowance Leave Travel Concession/Allowance

Exemption based on expenditure Exemption based on monetary limits

Expenditure Allowances

Allowance is based on expenditure Tour Allowance Transfer Allowance Daily Allowance while on tour Helper Allowance Research Allowance Uniform Allowance Conveyance Allowance (does not include from residence

to office and back)

Monetary Allowances

Hill Area Allowance Border Area Allowance Tribal Area Allowance Allowance for Transport

Employees Compensatory Field Area

Allowance Compensatory Modified

Area Allowance Counter Insurgency

Allowance

Underground Allowance High Altitude Allowance Active Field Allowance Island Duty Allowance Children Education

Allowance Rs. 100 Hostel Allowance Rs.300 Conveyance Allowance

(from residence to office & back) Rs. 800

House Rent Allowance

Exemption is least of Excess of Rent Paid over 10% of Salary 50% of salary for metro cities, 40% for others Actual Receipt

Salary means Basic, DA(if it forms a part of retirement benefits) & Commission (if it is paid as a specific percentage of sales achieved by the employee)

Leave Travel Concession

Fare Based on the mode of travel

for self or family Spouse, children*, dependents

For travel to any place in India For 2 journeys in a block of 4 calender years

From 1986 Carry Forward to 5th year if unused

Entertainment Allowance

Exemption only to Government employees 20 % of salary (excluding allowances) Rs. 5,000/- Actual Receipt

Perquisites

Value of benefits received in kind If purely for official purposes, cannot be taxed even

though it might result in some value addition Perquisites

Taxable in all cases Taxable in case of specified employees Exempt in all cases

Perquisites Taxable in all cases

Rent Free/ Concessional Accommodation 15% of salary or actual hire charges if lower Additional 10% of the cost of furniture or actual

higher charges If accommodation in hotel, 24% of the salary or

charges paid to hotel whichever is lower If employee is paying some rent, deduct from the

value

Perquisites Taxable in all cases

Use of an Asset 10% of the actual cost or hire charges paid Exempt in case of laptops and computers, telephones and

mobiles Transfer of an Asset

Sale price less the depreciated value Depreciation Rates for this purpose

Computers & Electronic Items 50% WDV Motor Cars 20% WDV Others 10% SLM

Depreciation for completed year

Perquisites taxable for specified employees

Medical Facilities Exempt if In a hospital maintained by the employer In a Government hospital In an approved hospital for prescribed diseases Mediclaim Premium, Group Mediclaim Other Medical Treatment upto Rs. 15,000/- Overseas Medical Treatment

Treatment Cost Cost of Travel & Stay for self & family Cost of Travel & Stay for one attendant Cost of Travel excluded only if gross income < 2 lakhs

Retirement Benefits

Provident Fund Superannuation Fund Pensions Gratuity Encashment of unutilised leave Retrenchment Compensation Voluntary Retirement Compensation

Provident Fund

Statutory Prov. Fund

Recognised Prov. Fund

Unrecognised Prov. Fund

Employers’ Contribution

Exempt Exempt upto 12% of salary

Exempt

Employees’ Contribution

Eligible for rebate

Eligible for rebate

Not eligible for rebate

Interest Exempt Exempt upto a notified rate

Exempt

Withdrawals Exempt Exempt if completed 5 years

Taxable

Approved Superannuation Fund

Employers’ Contribution exempt upto 27% of salary

Employees’ Contribution eligible for rebate Interest is exempt Pension on retirement is taxable Commutation on retirement partly exempt Payment on death totally exempt In all other cases, taxable

Pensions

Uncommuted Pensions Received by the retired employee Salaries Received by the legal heir I.O.S

Commuted Pensions on retirement If receiving gratuity also, 1/3rd of non commuted

value is exempt If not receiving gratuity, ½ is exempt For Government employees, totally exempt

Gratuity

Government Employees – Exempt Covered by the Payment of Gratuity Act

15 days salary for each year of service Rs. 350000/- Actual Receipt

Not Covered by the Payment of Gratuity Act ½ months’ average salary for each completed year of service Rs. 350000/- Actual Receipt

Encashment of Leave Salary

Government Employees – Exempt Others

Cash Equivalent of earned unused leave Earned 30 days for each completed year of service Salary is average of last 10 months

10 months average salary Rs. 300000/- Actual Receipt

Other Retirement Benefits

Retrenchment Compensation Upto Rs. 5,00,000 Amount calculated under Industrial Disputes Act

Voluntary Retirement Compensation Applies to all employees, Results in reduction of

workforce which is not filled up Completed 10 years of service/ 40 years of age, Employee

is not re-employed in same company/group Not to exceed 3 months for each completed year or

uncompleted months

Taxability of Business Income

Tax on Net Income from Business Net Income = (+) Gross Receipts (-) Expenses Role of Accounting for both (+) & (-) Net Income is therefore as determined by the books

of accounts & method of accounting followed

Expenses related to non-taxable businesses cannot be adjusted against incomes of taxable businesses

Format of determining net income

To Expenses By Sales

To Amortizations By Other Income

To Income Tax

To Provisions

To Net Profit

Need for Adjustments

Net Profit as per Profit & Loss Account Add:

Items debited but not allowed Items not credited but taxable

Less: Items credited but exempt/ taxable elsewhere Items not debited but allowed

Taxable Income

What are these adjustments?

Expenses specifically allowed Expenses disallowed Residuary Category

Not CapitalNot Violation of LawFor the Purposes of Business

Depreciation

Expenses specifically allowed:Social Angle of Income Tax Act

Expenditure on Scientific Research Revenue Expenditure related to business Capital Expenditure related to business (excluding cost of land) Donation to Scientific Research Associations/National

Laboratory/University/IIT (1.25 times weighted deduction) Revenue & Capital Expenditure (not being land & building) on

approved in-house projects (1.5 times weighted deduction) Expenditure on family planning

Capital Expenditure allowed over 5 years

Expenses specifically allowed

Insurance Premiums for stocks & employees health

Bonus & Commission to employees Interest on Borrowed Capital

Used for the purposes of business Contributions to Recognised Provident Fund,

Superannuation Fund, Gratuity Fund, Staff Welfare Scheme

Expenses specifically allowed

Bad Debts If income already considered/ loan in ordinary

course of money-lending business Written off in books of accounts Subsequent Recovery taxable

Residuary Category

Not Capital in Nature For the purposes of business

Personal Expenditure not allowed Incurred during the previous year Not for any Violation of Law (eg. Penalties)

Amounts not deductible

Income Tax/ Wealth Tax/Tax on Perquisites Fringe Benefit Tax Payments to members of AOP/BOI Provisions made for non statutory employee

welfare funds Payments to partners by a partnership firm

Remuneration in excess of limits Interest on capital in excess of 12% p.a.

Amounts not deductible:Payments to relatives

Payments to relatives in excess of fair value Relatives defined to include: spouse, brother,

sister, lineal ascendant and descendant Receipts not covered No corresponding adjustment in the

assessment of the relative

Amounts not deductible:Non TDS Items

Overseas Payments are deductible only if the applicable taxes are deducted at source and paid

Specified Domestic Payments are deductible only if the applicable taxes are deducted at source and paid

If the payments are disallowed in the current year because the taxes are not deducted or paid, they shall be allowed in the year of payment

Amounts not deductible :Cash Expenditure

Expenditure above Rs. 20000/- to be made by account payee cheque otherwise a disallowance of 20% is attracted

Exceptions carved out in genuine cases like Payments to Government Agencies, payments on

a bank holiday, payments in a village not serviced by a bank, etc.

Amounts not deductible:Unpaid Statutory Dues

Items covered Payment to be made by

Effect of late pymt.

Tax, duty or cessBonus/Commission to employeesInterest on Loan of financial institutionsInt. on term loan of scheduled bankLeave Salary to employeeContribution to PF/SAF/SWS

Due date of filing the return of income

Deduction allowable in the year of payment

Depreciation: Conditions

Ownership Use during the previous year For the purposes of Business

Depreciation: Concept

Not on individual assets but on block of assets Written Down Value Method at rates specified In the year of purchase

Full year’s depreciation unless the asset put to use for less than 180 days (half depreciation)

In the year of sale No Depreciation

Block of Assets – Same group & same rate

Depreciation: Block of Assets & Rate

Buildings used for residential purposes (5%) Other Buildings (10%) Furniture & Fixtures (10%) Plant & Machinery (15%) Motor Cars (15%) Computers & Software (60%) Intangible Assets (15%) Pollution Control Equipments (100%) Energy Saving Devices (80%)

Depreciation: Written Down Value

Opening WDV (a) xx Add Actual Cost of Assets Purchased

Used > 180 days (b) xx Used < 180 days (c) xx

Less Sale Price of Assets Sold (d) xx Closing WDV (e) = ( a + b + c - d) xx

Depreciation : WDV (Contd.)

If Closing WDV is negative Treat the amount as Short Term Capital Gains

Adjustable against business losses to the extent of depreciation written off

No Depreciation will be available even if there are other assets in the block

If Closing WDV is positive but there are no assets in the block Treat the amount as Short Term Capital Loss No Depreciation will be available even though the WDV

is positive

Depreciation : WDV (Contd.)

If Closing WDV is positive and there are assets in the block Do not calculate profit or loss but provide

depreciation on (e) If e > c

Depreciation = full * (a+b-d) + half * c If e < c

Depreciation = half * e

Capital GainsThe Starters..

Capital Receipts not taxable unless specifically included

Essentials Profits/Losses on Transfer of a Capital Asset

Profit/Loss..

Sale Price Deductions

Cost of Acquisition Cost of Improvement Cost of Transfer

Machinery Provisions may fail !

Capital Asset

Wide definition Cannot however cover

Stock in trade Personal assets & privileges Agricultural Rural Land (Population < 10000)

Classification as short term & long term Equity/Preference Shares, Other listed securities & units

– 12 months Other Assets – 36 months

Privileges of Long Term

Indexation Benefits Substitution of Fair Market Value Lower Rate of Tax

Along with indexation benefits 20% In case of listed securities

Where STT is paid NIL without indexation benefits 10% With indexation benefits 20%

Privileges of Long TermReinvestment Benefits

Residential House – Residential House Reinvest Capital Gains Purchase 1 year

before/2 years after OR construct 3 years after

Any – Residential House Reinvest Sale

Consideration Purchase 1 year before/2

years after OR construct 3 years after

Any – Specified Capital Gains Bonds Reinvest Capital Gains Within six months

Lock in period of 3 years for the re-invested asset

Transfer

Extended Definition of Transfer Sale, Exchange, Relinquishment Extinguishment of Rights Compulsory Acquisition Conversion into Stock in trade Part Performance Co-operative Society

Exclusions from Transfer Deeming fiction for computation provisions

Transfer

Extended Definition Exclusions from Definition

Distribution of Assets by HUF Gift, Will, Irrevocable Trust Holding/Subsidiary Transactions Mergers/De-mergers – company/holders Conversion of debentures Stock lending scheme

Deeming Fiction for computation provisions

Transfer

Extended Definition Exclusions from Definition Deeming Fiction for computation provisions

Period of Holding Cost of Acquisition Market Value as on 01.04.1981

Special Considerations apply:

Depreciable Assets Gains will always be SHORT TERM

Immoveable Properties Reference to Stamp Duty Valuation

Other Heads of Income..

Income from House Property Interest on Housing Loan for 1 self occupied

property deductible upto Rs. 1,50,000/- Income from Other Sources

Gifts in cash exceeding Rs. 25,000/- taxable unless received from a relative

Aggregation

In case of loss in Set-off (current) Carry ForwardHouse Property Any head House PropertySpeculation Speculation only SpeculationDepreciation Except Salary Except SalaryOther Business Except Salary BusinessShort Term CG Short/Long

TermShort Term

Long Term CG Long Term Long Term

Some Important Exemptions

Share of Profits in a registered Firm Agricultural Incomes LIC Maturity Claim (Excl. Keyman Insurance) Specified Interest Incomes Income of Charitable Institutions Income of a new industrial undertaking

located in FTZ, EHTP, STP, SEZ, Which is a 100% EOU

Dividends (DDT Paid) & Long Term Capital Gains (STT Paid)

Some Important Deductions

Specified Investments Mediclaim Premiums Donations New Industrial Undertakings involved in

infrastructure development Infrastructure Specified Industries Backward Areas

Calculate the taxes at this stage

Apply slab-wise tax rates to net total income If there are incomes which are subject to special tax

rates, carve out those incomes Long Term Capital Gains @ 10% or 20% Short Term Capital Gains @ 10% Lottery Income @ 30% Income from open ended equity funds @ 10%

In case of agricultural income, include the same for rate purposes

The Final Steps..

Add Surcharge & Education Cess to the net tax liability as applicable – gives the gross tax liability (a)

TDS, Advance Tax & S.A. Tax are all prepaid taxes (b)

Difference is the tax payable/ refundable (a-b) File your return and relax! Remember – taxes and death are certain but taxes

are more painful as they repeat each year…

Allied Tax Concepts

Tax Deducted at Source Minimum Alternate Tax Dividend Distribution Tax Fringe Benefit Tax

Tax Deducted at Source

Deduction at the stage of payment Attempts to plug

Non reporting of income Lower reporting of income

Improves cash flow for the Government Additional Burden for the Assessee

TDS on Salaries

At the “average rate of tax” Both Residents and Non Resident covered Allowances to be considered with proof

No proof be insisted for HRA upto Rs. 3000 Deductions & Rebates to be allowed Multiple Employers? Multiple Sources of Income

Only Loss from HP can be considered

TDS on Other Interest

Only Residents covered TDS @ 10% for non corporate assessees &

20% for corporate assessees On Gross Amounts & Not Net Amounts Very wide in Scope

TDS on Other Interest

Specific Exceptions: Interest Amount less than Rs. 5,000 Interest to notified institutions Interest by a firm to its partners Interest by co-operative society to its members Interest under direct tax laws

Lower Deduction on Certificate No Deduction on Self Declaration (15G)

No cognisance if income above taxable limits (15H for senior citizens)

Commission or Brokerage

Payments to Residents covered If amount exceeds Rs. 2,500 Commission in relation to securities not

covered by this provision TDS @ 5% Lower Deduction on Certificate

Rent

Both Residents & Non Residents covered Income exceeds Rs. 1,20,000 TDS @ 20%

Except in case of individual/HUF where rate is 15% Advance Rent also liable for deduction Lower Deduction on Certificate

Payments to contractors

Only Residents Covered Individual Payers excluded Basic Limit of Rs. 20,000 per contract / Rs. 50,000

per annum TDS @ 2%

In case of advertising contracts & sub-contracts , 1% applicable

Not applicable for sale of goods

Contracts: Specific Examples

C & F Agents – Applicable Couriers – Applicable Transporters – Applicable Electricians – Applicable Routine AMC – Applicable

Professional / Technical Services

Only Residents covered Only above Rs. 20,000 TDS @ 5% Scope

Payments to recruitment agencies Payments to hospitals Payments to share registrar

Lower Deduction on Certificate

TDS on non residents

All incomes covered All Payers covered At Applicable Rates Application by payer for determination of income Application by receiver for non deduction of tax Application by receiver for lower deduction

Non Compliance - Consequences

Recovery of the TDS Amount Interest on delayed payment / non payment Penalty for non compliance Disallowance of Expenditure

Minimum Alternate Tax

To compensate for discrepancies between accounting and taxation principles

Accept the net profit as per Companies Act and make specific adjustments to convert it into book profits

Pay minimum tax @ 7.5 % of the book profits if the actual tax liability is lower

Does it really serve the purpose ?

Net Profit to Book Profit

Income Tax Reserves Contingent Liabilities Losses of Subsidiary Dividends Paid Expenses related to tax

free incomes

Withdrawals from Reserves

Exempt incomes u/s 10, 10A, 10B, 11, 12

Brought Forward Losses

Deductions u/s 80HHC/E/F

Not applicable for a sick industrial company

ADD SUBTRACT

Dividend Distribution Tax

Dividends – Tax Free in hands of shareholders, liable for DDT @ 12.5% for the company

Brings to light the problems relating to Earnings Stripping Capital Gearing Cascading Effect on Capital Structuring

Fringe Benefit Tax:Overview

A presumptive tax on collective benefits granted to employees and disguised as business expenses

Based as a percentage of specific expenditures Tax to be paid by the employer – non deductible business

expense However, individuals & HUFs not covered by the levy

Industry Specific Concessions

FBT payable @ 30%* - On – Value of fringe benefits By – Employer, For – Benefits provided or deemed to have

been provided FBT is payable whether employer is liable to

pay Income-tax or not

* Plus applicable surcharge & education cess

..FBT – Concept and Introduction

Value of the fringe benefits

Nature of expenditure Presumptive base

Cost of free or concession tickets 100% Employers contribution to superannuation fund

100%

Entertainment 20% Hospitality 20% Conference 20% Sales Promotion & Publicity, (excluding advertisement)

20%

Employee welfare 20% Conveyance, tour & travel (including foreign travel)

20%

Value of the fringe benefitsNature of expenditure Base Hotel, lodging and boarding 20% Repair, running & maintenance of motor cars

20%

Repair, running and maintenance of aircrafts

20%

Use of telephone (other than leased lines) 20% Maintenance of guest house 20% Festival celebrations 50% Use of club facilities 50% Use of health club and similar facilities 50% Gifts 50% Scholarships 50%

FBT base: industry specific concessions

Nature of industry Nature of expenditure Presumptive baseHotel Hospitality 5%

Taxi operators Repair, running & maintenance of motor cars (including fuel expenses and depreciation)

5%

Pharmaceuticals 1. Conveyance, tour and travel (including foreign travel);

2. Hotel, lodging and boarding

5%

5%

Software 1. Conveyance, tour and travel (including foreign travel);

2. Hotel, lodging and boarding

5%

5%

Construction Conveyance, tour and travel (including foreign travel);

5%

FBT Base: Exemptions

Expenditure on paid vouchers Expenditure on advertisement Expenditure on leased telephone lines Expenditure on accommodation used for

training purposes Expenditure to mitigate occupational hazards

or provide first-aid facilities in employers hospital.

Thank YouWish You all the best

Income Tax

Prof. S B GabhawallaS B Gabhawalla & CoChartered Accountants