PREFACE. Page 1 of 68 - Income Tax Notes Jamnalal Bajaj Institute of Mgmt Studies

Transcription

1 PREFACE Income tax is a field which interests almost every body since it takes away almost a fourth of our hard earned money without any concrete promise to give any thing in return. For the corporates, it is even worse since the slice being taken gets even bigger. It is endeavour of every one to reduce his tax burden to bare minimum. While professional tax consultants and Chartered Accounts are a great help in this regard, good self knowledge of Income tax regulations will be of definite help in keeping the tax burden low. These notes have been created not to just pass the MBA exam but also to carry forward some real knowledge in the field of Income tax which will come handy to every reader in the years to come. Thus, some additional matter which possibly may not be required for exam, has also been included. Such matter has been put in blue colour/light print. Text which has been underlined (other than paragraph headers) are important concepts and should be understood and remembered clearly. It is recommended that entire text, blue/light print as well as black, be read carefully once or twice and understood. During the subsequent readings, blue/light text can be omitted. Paragraphs marked with broad vertical lines on right hand side are very important concepts and should be understood clearly. These notes should be read with past question papers. There are generally only one or two problems in the question paper where calculations are involved. Remaining 6 to 7 questions are pure theory. Therefore, understanding of the concepts is essential. Page 1 of 68 - Income Tax Notes

2 BASIC CONCEPTS Income tax is an annual tax on income. Income of PERSON is to be charged to tax in the following year. However, govt has introduced concept of advance tax to mobilize the resources on regular basis. It is now compulsory to pay minimum of 90% of annual tax as advance tax failing which interest would have to be paid for the shortfall. Heads of Income: Income from different sources is treated differently to accommodate the peculiarities of each of the source. Thus, income is segregated into five different heads for the ease of application of different rates of deductions and taxes. (d) (e) Salary House Property Capital Gains Business and Profession Other income. Income Tax Act, 1961 has 23 Chapters containing 298 Sections numbered serially from 1 to 298. (Each chapter starts with next serial number after the last serial number of previous chapter). Each section is divided into sub sections which are further subdivided into clause and sub clause. Then follow explanations and Provisio (Exceptions to Provisions or special applications (Preconditions). Sub section 1 Section 9 S 9 (1) (V) Sub Clause Clause V IT Act is applicable to whole of India including J&K. Definitions There are two kinds of definitions in the IT Act. Exclusive Definitions: In a definition, when word means is used, it translates that there is no scope for discretion or arbitrariness over what is stated. No addition or deletion can be made by any authority. Definition is exhaustive. Such definitions are normally found in the deductions, allowances, rebates, etc. Page 2 of 68 - Income Tax Notes

3 Inclusive Definitions: When a definition starts with It includes, it is called Inclusive Definition. Such definitions are basically broad guide lines and therefore not exhaustive. In such cases, definition is open to interpretation by the IT officer and he may include any more heads over and above what is stated in the Act. Such definitions are common place where chargeable heads are listed. Assessment Year [Sec 2(9)]: Assessment Year is the year in which the Income Tax Return is to be filed (and assessed by the Income Tax Department). So, for the income earned in Financial Year of , the Income Tax return has been filed in Sep 05 i.e. in Financial Year and thus Assessment Year for income earned in is It always starts on April 1, and ends on March 31 of the next year. Example: Assessment year starts on 01 April 2005 and ends on 31 March Previous Year [Sec 3]: It is financial year in which income is earned. Thus, it is the year previous to Assessment Year. Income of the Previous Year is taxed in the following Assessment Year. For the Assessment Year , Previous Year is Previous Year normally starts (but not always) on 01 April and ends on 31 March of the following year. The first previous year in the case of a new assessee or a newly set up business will be the period commencing from the date of setting up of the business/profession. Example No.1. Mr Mohan sets up a new business on 15 August What are the previous year and assessment year for Mr Mohan? Solution: Previous Year 15 Aug 2004 to 31 Mar 2005 (Since new business was started on 15 Aug 05). Assessment Year 01 Apr 2005 to 31 MAR 2006 (Assessment Year always starts on 01 Apr and finishes on 31 Mar of the following year without any exception) Income to be Taxed in the Previous Year Itself. Income of a Previous Year is almost always assessed and taxed in the Assessment Year which follows the Previous Year. However, there are certain circumstances where income of the previous year is taxable in the previous Year itself: 1. Income of a non- resident from shipping 2. Income of a person leaving India permanently or for long period 3. Income of Bodies formed for short duration 4. Income of a person trying to alienate his assets 5. Income of a discontinued business. This exception has been instituted to ensure that tax evasion does not take place due to time lag. All the above entities have high possibility of default in tax compliance if allowed time till regular Assessment Year. Page 3 of 68 - Income Tax Notes

4 Note: All income tax assessees are to follow Financial Year concept i.e. 01 Apr to 31 Mar as income period for filing tax returns even if they are maintaining their business accounts on calendar year basis. Assessee [Sec 2(7)]: Assessee means any Person by whom Income tax is payable. Who are included in Person? There are 7 categories of Persons. This definition is inclusive and therefore further additions at the discretion of IT officer are possible. (d) (e) (f) (g) An Individual (defined as a natural person living human being) A Hindu Undivided Family (HUF) A company A Firm An association of person or a body of individuals, whether incorporated or not. A local authority and Every artificial judicial person not falling within any of the preceding categories. Is income from illegal professions taxable? Yes. Any income in the hands of an assessee is taxable irrespective of its source, whether legal or illegal. But funds transfer is not an income. Therefore, funds transfer are not charged to tax. Deduction: Deduction is a case where assessee is permitted to reduce the approved amount from his salary prior to calculating tax on it. Tax is then calculated on the residual amount. Provisions of Section 80 are available as deductions. Loss from Self Occupied House Property is also allowed as deduction. Rebate: In case of rebate, tax is calculated on salary inclusive of amount eligible for rebate and then rebate allowed is calculated and reduced from the tax liability already calculated. Provisions under Section 88 like PF contributions, Insurance Premiums, Principal repayment of House Loan, etc are rebate clauses. Page 4 of 68 - Income Tax Notes

5 RESIDENTIAL STATUS For Income Tax purposes, persons are classified as Resident, (i) (ii) Non Resident Resident and Ordinarily Resident Resident but Not Ordinarily Resident Resident classification is not to be confused with Indian citizenship of a person. A resident can be a foreign national while a Non Resident can still be a full citizen enjoying his voting rights. For Assessing the Residential Status of Any Person: Rule 1. Under section 6(1), an individual will be treated as Resident in India in any previous year, if he satisfies at least one of the following TWO BASIC CONDITIONS: He should have stayed in India for a period or periods amounting to 182 days or more in the previous year. OR He should have stayed in India for a period or periods amounting in all to 60 days or more in the previous year AND 365 days or more during 4 years preceding the previous year. If he satisfies ANY ONE of the above 2 conditions, he will be treated as a Resident of India for the previous year. Exceptions: By virtue of explanation (1) to section 6(1), the period of 60 days referred to in above has been extended as follows: (i) An Indian citizen who leaves India during the previous year for the purpose of employment (but not for education, medical treatment, etc) or an Indian citizen who leaves India during the previous year as a member of crew of an Indian ship will be considered as a Resident of India, if his stay in India for the previous year is 182 days or more. Page 5 of 68 - Income Tax Notes

6 (ii) Indian citizen or a person of Indian origin who comes on a visit to India during the previous year will be considered as a Resident of India, if his stay in India in the previous year is 182 days or more. In simplified form, it means that only Rule 1 is to be applied and Rule 1 is to be disregarded in cases of (i) (ii) Person who leaves India for employment or Any Indian or person of Indian origin who comes to India for visit. Rule 2. For Assessing Whether a Person is Resident and Ordinarily Resident: Rule 3. To find out whether an individual is a Resident and Ordinarily Resident, one has to proceed as follows: Step 1: Find out if an individual is resident in India by applying the Rule 1 above. Step 2: If he satisfies at least one of the two conditions laid down, then find out if he is a Resident and Ordinarily Resident by applying the following TWO ADDITIONAL CONDITIONS: He should have been a resident in India for at least 2 out of last 10 years preceding the previous year. He should have stayed in India for a total of 730 days or more during the last 7 years preceding the previous year. Under section 6(6), an individual will be treated as Resident And Ordinarily Resident in any previous year, if in addition to satisfying any of the two basic conditions listed in the Rule 1 above, he/she also satisfies both the Additional Conditions: Note: Both the additional conditions are cumulative. If any individual does not satisfy any condition of Rule 1, i.e. he is not a Resident in India, then no further investigation (application of additional condition) is necessary. For Assessing Whether a Person is Resident but not Ordinarily Resident : An individual who satisfies at least one of the Basic Conditions i.e. conditions given under Rule 1 above but does not satisfy both the additional conditions given at Rule 2 above, then he will be treated as a Resident but not Ordinarily Resident in India. Page 6 of 68 - Income Tax Notes

7 Rules of Residence for an Individual in Brief: The tables given below summaries the rule of the residence. Resident and Ordinarily Resident Must satisfy at least one of the basic condition and both of the additional conditions. Rule 4. Resident but not Ordinarily Resident Must satisfy at least one of the basic conditions and only one or none of the additional conditions. Non - Resident Must satisfy none of the basic conditions. Determining the Residential Status of a Firm and Association of Persons [Sec 6(2)] A Partnership Firm and Association of Persons are said to be Resident and Ordinarily Resident in India if control and management of theirs is wholly or partly situated within India during the relevant previous year. They are, however treated as Non Resident in India only if control and management of their affairs is situated Wholly Outside India. The above rule may be summarized as follows: Place of Control Control and management of the affairs of the firm / association of a person is Wholly in India Wholly outside India Partly in India and partly outside India Resident Status Resident Non resident Resident Note: A firm / Association of Persons can never be Resident but not Ordinarily Resident in India. Rule 5. Determining the Residential Status of a Company [Sec 6(3)] Note: An Indian company is always Resident in India. However, a foreign company is treated as Non-Resident if, during the previous year, control and management is situated even partly outside India. Thus, a foreign company is Resident in India only if, during the previous year, control and management of its affairs is situated Wholly in India. A company can never be Resident but not Ordinarily Resident in India. Incidence of Tax in Case of Resident and Ordinarily Resident Assessee [Sec 5(1)] A Resident and Ordinarily Resident assessee is assessable to tax in respect of: Income which accrues or arises or is deemed to accrue or arise to him in India during the previous year; and Page 7 of 68 - Income Tax Notes

8 Income, which accrues or arises to him outside India during the relevant previous year. In simple form Any and every income earned where ever by a R&OR is taxable. Incidence of Tax in Case of Resident But Not Ordinarily Resident Assessee [Sec 5(1)] In case of a Resident but Not Ordinarily Resident assessee, income is not chargeable to tax if it satisfies all the following conditions: Income is neither received nor deemed to be received in India. It is neither accrued nor deemed to be accrued in India. It is derived from a business or a profession controlled/set up outside India. Incidence of Tax in the Case of a Non Resident Assessee [Sec. 5(2)] Non-resident is liable to tax only in respect of income received or deemed to be received in India by or on his behalf and accrues or arises or deemed to accrue or arise in India during the previous year. Page 8 of 68 - Income Tax Notes

9 INCOME FROM SALARY Definition of Salary The term salary does not have a uniform definition in Income Tax. It varies from clause to clause. So, definitions of salary for calculation of gratuity and exemption in respect house rent allowance are different. Salary under Section 17(1), includes the following: (d) (e) (f) (g) (h) (i) Wages, Any annuity or pension, Any gratuity, Any fees, commission, perquisite or profits in lieu of or in addition to any salary or wages, Any advance of salary, Encashment of leave while in service, Arrears of salary to the extent not already taxed on due basis, Funds transferred from an unrecognized Provident Fund to recognized Provident Fund, Contribution by the central government to the account of the employee under a pension scheme U/S 80CCD. Employer and Employee Relationship: In order to charge any income under the head salary, there must be the relationship of an employer and an employee or master and servant between payer and payee. There has to be a formal contract between the two for a fixed payment on time period basis say monthly pay. A professor employed in a university draws his monthly salary. This is charged under Salary Head. But if he gets some payment from other university for paper setting or guest lecture, it is not to be counted as salary. More Than One Salary: Duration of employment has no bearing on salary. A person can be employed in more than one place at the same time, say on part time basis, and draw two or may be three salaries every month. But, if each of his monthly payments is covered under the employee-employer relationship, all of them will be counted as salaries. The salaries received from all the employers should be clubbed together and charged under the head salaries. It is important to note that what ever may be the number of sources of salaries, the benefits like deductions and concessions will be available as if only one salary is being drawn. Simpler way to remember is that benefits are available to the salary Page 9 of 68 - Income Tax Notes

10 earner (Individual) and not to the salary. So, remember the Golden Rule - One assessee, one benefit. Benefits are accounted on cumulative basis. If the same benefit is claimed a second or third time, limit of exemption would be reduced to the extent already availed in past. Example: Current tax exempt limit for Gratuity Payment is Rs 3,50,000. Mr Bhaskar had received Rs 1,40,000 as tax exempted Gratuity payment from his previous employer. If he receives a gratuity of Rs 2,40,000 from his current employer now, his tax exempted limit for receipt of gratuity would be reduced by Rs 1,40,000 from Rs 3,50,000 and thus only Rs 2,10,000 would be treated as tax exempted gratuity payment and not Rs 3,50,000. He would be taxed for Rs 30,000 (2,40,000 2,10,000). Accrued Salary: Salary is taxed on accrual basis, which means that once the salary payment is due (employer is obliged to make the payment), it is taxable whether actually received or not. Once salary has accrued, its subsequent waiver is considered to be an application (use) of income and is liable to be taxed. Even donation of full salary to any charitable trust directly by the employer under the employee s direction is still taxable in the hands of the employee. (He can only claim any tax concessions/exemptions if available for donations to that particular charity). Voluntary Surrender of Salary: Surrender of salary back to employer gets no tax exemption. However, voluntary surrender of salary (either in part or full) to the Central Government, whether by govt employee or Pvt company employee, is exempt from tax under Section 2 of the Voluntary Surrender of salaries ( Exemption from Taxation). Income Tax on Salary if Tax is Paid by the Employer: If the salary is being paid net of tax, which means employer bears the burden of the tax on the salary of the employee, the taxable income from salary will consist of not only the salary received by the employee but also include the tax paid by the employer. Example Salary net of tax received by the employee- Rs 91000/- Tax paid by the employer - Rs 39000/- Net Taxable salary Rs /- Voluntary Payments: All the payments, on whatever count, received by the employee from the employer are counted as salary. Only certain payments as reimbursements of actual expenses incurred on behalf of the company are excluded. Gifts: Small gifts to the maximum limit of Rs 5000 in a year are exempt from tax. Bigger gifts given to employees to celebrate important occasions, like silver Jubilee of the company or on completion of 20 years of service, under a company s well laid down policy/scheme, are also exempted.. Other occasions of gift exempted in the hands of the employees are given below: Award/Gift by the employer, in appreciation of display of some exceptional personal qualities of the employee, like bravery or honesty. Page 10 of 68 - Income Tax Notes

11 Award given to a player for medal winning performance in an international event. Basis of Charge: Salary is chargeable to tax either on due basis or on receipt basis whichever is earlier. Simply stated, the tax is due whenever either money is received or payment has become due, whichever is earlier. So, a salary which become due on 31 Mar 05 is taxable in AY whether actually received or not. Similarly, advance of salary for the month of Apr 05 received in Mar 05 is taxable in AY itself. Once tax is paid either on receipt basis or due basis, it will not be taxed again in the next year. Advance Salary: Advance salary is taxable in the Previous Year of receipt. It is possible that when advance salary is included and charged in a particular previous year, the rate of tax at which the employee is assessed may be higher than the normal rate of tax to which he would have been assessed. Section 89 (1) read with Rule 21A provides for relief in these types of cases. Salary Arrears: Arrears of salary, if not already charged on due basis, are to be charged in the year of receipt. Relief under Section 89 (1) is available in this case also. Place of Accrual of Salary: Any salary earned by way of work done in India is taxable irrespective time and place of payment. Therefore, pension of an employee who worked in India and has now settled down in UK is taxable in India. Similarly, payment against any leave encashment if the leave was earned in India is again taxable in India. Exception: By virtue of Section 10(7), any allowance or perquisites paid or allowed outside India by the Government to a citizen of India for rendering services outside India will be fully exempt. Loan: Loan is not salary. However, if loan is given on concessional rate of interest, savings made by the employee due to low interest rate is to be considered as profits in lieu of salary and charged to tax. Gratuity [Section 10(10)]: Gratuity was to be a voluntary payment (Now a Statutory payment) made by an employer in appreciation of services rendered by the employee. In Case of Government Employees: Any death cum- retirement gratuity (DCRG) received is wholly exempt from tax. In Case of Employees Covered by the Payment of Gratuity Act, 1972: Such gratuity is exempt from tax to the extent of the least of the following- (i) 15 days salary (7 days in the case of employees of a seasonal establishment) for every completed years of service or part thereof in excess of six months. (ii) Rs 3,50,000. (iii) Explanations: Gratuity actually received. Page 11 of 68 - Income Tax Notes

12 (i) (ii) (iii) Salary means salary last drawn by the employee and includes DA but does not include any bonus, performance linked commission, HRA, overtime wages and any other allowance. If, however, under the terms of employment, commission is payable at a fixed percentage of turnover achieved by an employee, such commission will be considered as salary. Salary for 15 days or 7 days, as the case may be, is calculated by dividing the salary last drawn by 26 i.e., maximum number of working days in a month. In the case of a piece-rated employee, 15 days salary would be computed on the basis of monthly average of total wages received for a period of 3 months immediately preceding the termination of his employment. In Case of Any Other Employees: In all other cases, (employees not covered under Gratuity Act 1972) gratuity received on retirement, death, termination, resignation or incapacitation prior to retirement is exempt from tax to the least of the following: - (i) (ii) (iii) Rs 3,50,000 in respect of gratuity becoming payable on or after Half month s average salary for each completed year of service. (Advantage of converting part of year into full year is not available in this case. 21 years and 11 months and 29 days will be counted as 21 years only and not 22 years) Actual amount received as Gratuity. Explanations: (i) Average monthly salary is calculated by adding up the salary drawn during last 10 months and dividing by 10. If the person does not draw full salary in the month of retirement, it is excluded in calculation. Therefore, if a person retires on 15 Mar 2005, 10 months will be counted backwards starting from salary for Feb (ii) Salary for this purpose means basic salary and includes DA. If, however, under the terms of employment, commission is payable at a fixed percentage of turnover achieved by an employee, such commission will be considered as salary but will exclude all other allowances and perquisites. (d) An employee can not claim tax exemption in excess of Rs 3,50,000 in his life time. Thus, in cases where an employee has received some gratuity from one employer, his tax free limit of gratuity from the next employer would be reduced to that extent. Thus, if 1,50,000 has been claimed once as tax free Page 12 of 68 - Income Tax Notes

13 receipt of gratuity, he will be exempted up to Rs 2,00,00 only for gratuity received from any subsequent employers. (e) (f) Income tax concession to Gratuity is available only when it is paid as terminal benefit, ie. Employee is quitting his/her job. Gratuity paid to an employee while in service is not exempt from tax. For getting exemption under this Section, employee must be a salaried employee, i.e. there must exist the relationship of employer employee. Gratuity received in any other mode is not exempt. For example, gratuity payable by the LIC of India to its insurance agents does not qualify for exemption because such agents are not salaried employees of the LIC. Leave Salary [Section 10(10AA)] Leave Salary to Central/State Government Employees: In case of Central / State Government employees, any amount received as cash equivalent of leave salary in respect of period of earned leave at his credit at the time of retirement/ superannuation is completely exempt from tax. But leave encashed during the service is fully taxable. Leave Salary to Other Employees: In case of non-government employees (including employees of a local authority or statutory corporation) leave salary is exempt from tax to the extent of the least of the following: (i) (ii) (iii) (iv) Cash equivalent of the leave salary in respect of the period of earned leave standing to the credit of employee at the time of retirement/ superannuation. For this purpose, earned leave entitlement cannot exceed 30 days for every year of actual service rendered for the employer, or 10 months average salary, or Rs 3,00,000, or The amount of leave encashment actually received at the time of retirement. Meaning of Salary : Same as in gratuity section. (d) More Than One Employer: Remember the basic principle of income tax benefits One assessee, one benefit. Benefits are accounted on cumulative basis. So the limits stated above are to be followed whether the benefit is received from one source or ten sources. (e) Income tax relief in the incidence of encashment of leave is only available as part of terminal benefit, i.e. when employee quits the job. Any encashment of leave while in service is fully taxable. Page 13 of 68 - Income Tax Notes

14 (f) (g) (h) Salary paid to the legal heirs of the deceased employee in respect of privileges leave standing to the credit of such employee at the time of his death is not taxable in the recipient s hands. Leave salary received by the family of a government servant who died in harness i.e., while in employment is not taxable in the hands of recipient. These provisions are applicable even in the case of voluntary retirement. Salary to a Partner: Salary paid to a partner by a firm is nothing but an appropriation of profits. Explanation (ii) to Section 15 clarifies that any salary, bonus, commission or remuneration, by whatever name called, due to or received by partner of a firm shall not be regarded as salary. Same is to be charged as income from profits and gains of business or profession. Pension: Pension is to be treated as salary for all purposes. In the case of a resident, pension is taxable whether it is in respect of services in India or abroad and whether paid in India or abroad. However, in the case of Non-Resident and a Resident But Not Ordinarily Resident, pension earned and received abroad but later on remitted to India is exempt from tax. Standard deduction is available in respect of pension. Commuted Pension: Commutation means Inter-Change. Many people convert part of their future right to receive pension into a lump-sum amount receivable immediately on retirement. Any payment in respect of commutation of pension is exempted from tax. However, monthly receipts of uncommuted portion of the pension, is chargeable to tax at par with salary. Basis of Charge: (d) Any commuted pension received by a government employee is wholly exempt from tax under Section 10 (10A). In the case of non-government employees: (i) (ii) Where he receives gratuity The commuted value of up to 1/3 rd of the pension which he is normally entitled to receive is exempt. In other cases The commuted value of one-half of such pension which he is normally entitled to receive is exempt. Pension is chargeable to tax on accrual basis. (Due basis, whether it is actually received or not). Arrears of pension are taxable whenever declared due, whether paid or not. Annuity: Annuity is not necessarily treated as salary. Annuity is a regular sum payable on annual basis. If a person invests some money in any scheme entitling him to series of equal annuals sums, such annual sums are called annuities. Annuity received from the present employer is to be taxed as salary. Annuity received from a past employer is taxable as profit in lieu of salary. Page 14 of 68 - Income Tax Notes

15 Annuity received from a person other than employer is taxable as income from other sources. Retrenchment Compensation [Section 10(10B)]: workman at the time of retrenchment under- The Industrial Disputes Act, 1947 (d) Compensation received by a Any other Act or Rules, Orders or Notifications issued there under, or Any standing order or Any award, contract of service is exempt from income tax to the extent of : An amount calculated in accordance with the provisions of Section 25 of the Industrial Disputes Act, 1947; or Rs 5,00,000. whichever is less. Exceptions: The aforesaid limits are not applicable in cases where the compensation is paid under any scheme approved by the Central Government. Compensation received by a workman at the time of closing down of the factory/establishment in which he is employed shall be deemed to be compensation received at the time of his retrenchment. Compensation received by a workman due to termination of employment at the time of the transfer of the ownership or management of the undertaking shall be deemed to be compensation received at the time of retrenchment if the following conditions are fulfilled : (i) The service of the workman has been interrupted by such transfer; (ii) The terms and conditions of service under the new owner/management are less favourable to him than before; Profits in Lieu of Salary: Monetary benefits paid to an employee under heads other than salary are called Profits in Lieu of Salary. Like - employer s contributions to the Provident Fund in excess of statutory requirements, Club membership, etc. It also includes following: Any compensation received from the present or former employer in connection with the termination of his employment. Any compensation received by an assessee from his present or former employer in connection with the modification of the terms and conditions of employment. Page 15 of 68 - Income Tax Notes

16 The payment must be arising due to master-servant relationship between the payer and the payee. If it is not on that account, but due to consideration totally unconnected with employment, such payment is not profit in lieu of salary. Example: Lachman Das was posted to a factory in Karachi. At the time of partition, he migrated to India. He suffered loss of personal property in Pakistan due to partition. He sought compensation for such losses from his employer. He received some payments as compensation. This compensation was not deemed to be taxable as profit in lieu of salary. Any payment received by an assessee from his employer or former employer or from provident fund or from other funds to the extent to which it does not consist of contributions by the assessee or interest on such contributions. For example, if any sum is paid to an employee from an unrecognized provident fund or an approved superannuation fund or any other similar fund, it is to be dealt with as follows: (i) (ii) That part of the sum which represents the employer s contribution to the fund and interest thereon is taxable under salaries. That part of the sum which represents employee s contribution and interest thereon is not chargeable to tax since the same have already been taxed under the head salaries and other sources respectively on an yearly basis. Exceptions: However, the above definition does not include the following payments: (d) Gratuity; Commuted pension; Retrenchment compensation; House rent allowance. (d) (e) Any payment received by an assessee under a Key-man Insurance policy including the sum allocated by way of bonus on such policy. Key-man are important people like CEO, Finance Director, etc for whom companies take extra insurance policies. Insurance premium on such policies are considered to be profits in lieu of salaries. Any amount received either before joining the employment or after quitting the employment. Salary From United Nations Organisations Salaries and pensions and other emoluments paid by United Nations to its employees are exempted from Income Tax. Page 16 of 68 - Income Tax Notes

17 Compensation Received On VRS [Section 10 (10C)] Any compensation received by an employee of a public sector company or of any other company at the time of his voluntary retirement or termination of his service is exempt up to a maximum limit of Rs 5,00,000. However, such payment should be in accordance with a scheme of voluntary retirement or in the case of a public sector company referred, a scheme of voluntary separation. Such schemes should be in accordance with prescribed guidelines. Page 17 of 68 - Income Tax Notes

18 ALLOWANCES Total pay of employees includes, besides Basic Pay, various allowances. Allowances are given to employees to meet some particular requirements like house rent, expenses on uniform, conveyance etc. While initially, most of the allowances were exempt from the tax, their misuse for evading taxes, has led to withdrawal of most of the concessions available to allowances. Under the Act, allowance is taxable on due or receipt basis, whichever is earlier. Various types of allowances and their tax treatment are as follows: City Compensatory Allowance: City Compensatory Allowance is intended to compensate the employees for the higher cost of living in big cities. It is taxable at normal rate as part of the salary. House Rent Allowance [Section 10 (13A) and rule 2A]: The Act gives exemption in respect of house rent allowance as follows: Least of the following is exempt from tax : Explanations 50% of salary if residential house is situated at Bombay, Calcutta, Delhi or Madras or 40% of salary if the residential house is situated in any other place OR Actual house rent allowance received by the employee in respect of the period during which the rental accommodation is occupied by the employee during the previous year OR Excess of rent paid over 10% of salary. (i) (ii) (iii) (iv) Salary means basic salary (inclusive of Dearness Pay) and includes Dearness Allowance. It also includes commission based on a fixed percentage of turnover achieved by an employee but excludes all other allowances and perquisites. Basic salary, dearness allowance and commission are determined on due basis in respect of the period during which rental accommodation is occupied by the employee in the previous year. Similarly, salary for a period other than the pervious year need not be considered even though such amount is received during the previous year and is taxable on receipt basis. If the rent paid does not exceed 10% of salary, no exemption will be available. Page 18 of 68 - Income Tax Notes

19 (v) It is essential that he must incur expenditure towards rent of the house to claim IT exemption. Therefore, if an employee lives in his own house, no exemption is permissible. Entertainment Allowance: This allowance is meant to compensate the employees towards miscellaneous hospitality expenses in receiving business related visitors. Full Entertainment allowance is first to be included in the salary and then the permissible deduction is to be claimed. Only govt employees are allowed this deduction to the extent of Rs 5000/- or 10% of the salary which ever is less. Special Allowances [Section 10 (14)]: As stated earlier, most of the allowances are taxable at par with salary unless there are specific exemptions available under the Act. Section 10 (14) exempts the following allowances from income-tax: (i) (ii) Any special allowance or benefit granted to meet expenses wholly, necessarily and exclusively incurred in the performance of the duties provided such expenses are actually incurred for that purpose. Such allowances are listed in rule 2BB discussed below: Any allowance granted to the assessee to meet extraordinary personal expenses at the place where the duties of his office or employment of profit are ordinarily performed by him or at the place where he ordinarily resides, to compensate him for the increased cost of living. Again such allowances have been prescribed in rule 2BB discussed below. Please note that this exemption is available only if the place of posting or stay is Hard and not for nature of job. Rule 2BB: Following allowances (EXEMPT FROM TAX) have been prescribed for the purposes of Section 10 (14)(i): (d) (e) (f) Cost of travel on tour or on transfer; Daily allowance during travel and temporary duty Local conveyance in performance of duties. Hiring of helper in connection with official work. Any allowance granted for encouraging the academic research and training pursuits in Educational and Research Institutions; Uniform (dress) allowance. Prescribed allowances for the purposes of Section 10 (14) (ii) : Special Compensatory (Hilly Areas) Allowance or High Altitude Allowance or Uncongenial Climate Allowance or Snow Bound Area Allowance or Avalanche Allowance Rs 800 or Rs 7,00 or Rs 300 per month depending upon the specified locations. High Altitude (Uncongenial climate) Allowance Page 19 of 68 - Income Tax Notes

20 (d) (e) (f) (g) (h) (i) - between 9000 to feet Rs 1,060 p.m. - above feet Rs 1,600 per month. Any Special Compensatory Allowance in the nature of Border Area Allowance or Remote Locality Allowance or Difficult Area Allowance or Disturbed Area Allowance Rs 1,300 or Rs 1,100 or Rs 1,050 or Rs 750 or Rs 300 or Rs 200 per month depending upon the specified locations. Special compensatory Highly Active Field Area allowance up to Rs 4,200 per month. Island Allowance for Armed Forces in Andaman and Nicobar and Lakshadweep Island Rs 3,250 per month. Special Compensatory (Tribal Areas / Schedule Areas / Agency Areas) Allowance Rs 200 per month. Any allowance paid to drivers of long route transport to meet his personal expenditure during travel provided that such employee is not in receipt of daily allowance 70% of such allowance up to a maximum of Rs 6,000 per month. Children Education Allowance Rs 100 per month per child up to a maximum of two children. Any allowance granted to an employee to meet the hostel expenditure on his child - Rs 300 per month per child up to a maximum of two children. Compensatory Field Area Allowance Rs 2,600 per month in specified areas. Compensatory Modified Field Area Allowance Rs 1,000 per month in specified areas. Any special allowance in the nature of Counter Insurgency Allowance granted to the members of Armed Forces operating in areas away from their permanent locations for a period of more than 30 days Rs 3,900 per month. Any assessee claiming exemption in respect of the allowances mentioned at serial numbers (g) and (h) shall not be entitled to exemption in respect of the allowance referred to at serial. Any assessee claiming exemption in respect of the allowance mentioned at serial (i) shall not be entitled to the exemption in respect of disturbed area allowance referred to at serial No.2. (j) Any transport allowance granted to an employee (other than these referred to in Sl. (k) below) to meet his expenditure for the purpose of commuting between the place of his residence and the place of his duty Rs 800 per month. (k) Transport allowance granted to an employee who is blind or orthopaedically handicapped for commuting between his residence and place of duty Rs 1600 per month. Page 20 of 68 - Income Tax Notes

21 (l) Underground Allowance - Rs 800 per month would be granted to an employee who is working in unnatural climate in underground coal mines. Allowance to High Court Judges: Any allowance paid to a Judge of a High Court under Section 22A of the High Court Judges Conditions of Service) Act, 1954 is not taxable. Compensatory Allowance Under Article 222(2) of the Constitution: Compensatory allowance received by judge under Article 222(2) of the Constitution is not taxable since it is neither salary not perquisite. Sumptuary Allowance: Sumptuary allowance given to High Court Judges under Section 22C of the High Court Judges (Conditions of service) Act, 1954 and Supreme Court Judges under Section 23B of the Supreme Court Judges (Conditions of Service) Act, 1958 is not chargeable to tax. Page 21 of 68 - Income Tax Notes

22 PERQUISITES As per the dictionary, Perquisites are defined as casual profit additional to normal revenue: thing that has served its primary use and to which a subordinate or servant has then a customary right: incidental benefit attached to employment etc: customary gratuity. Thus, the term perquisite indicates some extra benefit in addition to the amount that may be legally due by way of contract for services rendered. In the present times, the salary package of an employee normally includes monetary element and perquisite like housing, car etc. Perquisites may or may not be taxable. Important aspects of perquisites are as follows: (d) (e) (f) Perquisite may be in cash or in kind. Reimbursement of expenses incurred in the discharge of official duties is not a perquisite. Perquisite may arise in the course of employment or in the course of profession. If it arises from employment, then the value of the perquisite is taxable as salary. However, if it arises due to profession, the value of such perquisite is chargeable as profits and gains from business or profession. An advantage is termed as Perquisite only if it is legally acquired. Any illegally acquired advantage will not be considered to be perquisite but will be taxable as income from other sources. Premium paid by employer towards the personal accident policy of employee is completely exempt from tax. Income-tax paid by the employer out of his pocket on the salary of the employee is a perquisite in the hands of the employee whether the payment is contractual or voluntary. Definition: Under the Act, the term perquisite is defined by Section 17(2) to include the following: (d) (e) Value of rent free accommodation provided to the assessee by his employer Section 17(2) (i); Value of any concession in the matter of rent in respect of any accommodation provided to the assessee by his employer Section 17 (2) (ii); Value of any benefit or amenity granted or provided free of cost or at concessional rate in cases of Specified Employees: Any sum paid by the employer in respect of any obligation which would have been payable by the assessee Section 17 (2) (iv); Any sum payable by the employer whether directly or through a fund other than a recognized Provident Fund or approved Superannuation Fund or Deposit-Linked Insurance Fund to effect an assurance on the life of the assessee or to effect a contract for an annuity; Section 17(2) (v). Page 22 of 68 - Income Tax Notes

23 It should be noted that the aforesaid definition of perquisite is an inclusive one. More terms can be added in. Specified Employees: Director: An employee of a company who is also a director is a specified employee. It is immaterial whether he is a full-time director or part-time director. An Employee Who Has Substantial Interest in the Company: An employee of a company who has substantial interest in that company is a specified employee. A person has a substantial interest in a company if he is a beneficial owner of equity shares carrying 20% or more of the voting power in the company. Employee Drawing in Excess of Rs 50,000: An employee other than an employee described in & above, whose income, chargeable under the head salaries, exceeds Rs 50,000 is a specified employee. Normal Perquisites: employees: Following perquisites are generally allowed by an employer to his (d) (e) (f) (g) (h) Rent-free accommodation Accommodation at concessional rent; Furnishings for the above accommodation; Motor car; Free gas, electricity or water supply; Free education; Free transport; Free domestic servants. Rule 3 of the Income-tax Rules, 1962 contains the guidelines for the purpose of valuation of perquisites; Types of Perquisites: Perquisites may be divided into three broad categories: Perquisites taxable in the case of all employees. Perquisites exempt from tax in case of all employees Perquisites taxable only in the hands of specified employees. Perquisites Taxable in Case of All Employees: tax in all cases. Following perquisites are chargeable to Value of rent-free accommodation Page 23 of 68 - Income Tax Notes

24 (i) (ii) Value of concession in rent in respect of accommodation provided to the assessee by his employer Value of any benefit or amenity granted or provided free of cost or at concessional rate to Specified Employees; However, this sub-clause shall not apply in case of Employees Stock Option Plan. Exception: Rent-free official residence provided to a Judge of a High Court or to a Judge of the Supreme Court is not taxable. Similarly, rent-free furnished house provided to an Officer of Parliament, is not taxable. (d) Amount paid by an employer in respect of any obligation which otherwise would have been payable by the employee Section 17(2) (iv). Example: pay of the domestic servant hired by the employee but paid for by the employer is a taxable perquisite. However, a gardener s salary paid by company for maintenance of a company owned house allotted to an employee may not be chargeable to tax in the hands of employee since gardener may not have been employed by the employee otherwise. Insurance and Annuity premiums paid by the employer. However, there are schemes like Group Annuity Scheme, Employees State Insurance Scheme and Fidelity Insurance Scheme, which are not considered as perquisites and are exempted from tax. Value of any other fringe benefit or amenity as may be prescribed. Perquisites Exempt from Tax in All Cases: exempt from tax in all cases: Following perquisites from employer are (d) (e) (f) (g) (h) (i) (j) Residential telephone facility. Goods sold by an employer to his employees at concessional rates; Transport facility, free or concessional, if the employer is engaged in transport business; Privilege passes and privilege ticket orders granted by Indian Railways to its employees; Perquisites allowed outside India by the Government to a citizen of India for rendering services outside India; Sum payable (statutory requirement) by an employer to a recognized Provident Fund or an approved Superannuation Fund or Deposit-Linked Insurance Fund established under the Coal Mines Provident Fund or the Employees Provident Fund Act; Employer s contribution to Staff Group Insurance Scheme; Leave travel concession; Payment of annual premium on personal accident policy; Refreshment during working hours in office premises; Page 24 of 68 - Income Tax Notes

25 (k) (l) (m) (n) (o) (p) (q) Subsidised meals. Recreational facilities extended to employees in general i.e. not restricted to a few select employees; Amount spent by the employer on training of employees or amount paid for refresher management course including expenses on boarding and lodging; Medical facilities subject to certain prescribed limits; Rent-free official residence provided to a Judge of High Court or the Supreme Court; Rent-free furnished residence including maintenance provided to an Officer of Parliament, Union Minister and a Leader of Opposition in Parliament; Conveyance facility provided to High Court Judges under Section 22B of the High Court Judges (Conditions of Service) Act, 1954 and Supreme Court Judges under Section 23A of the Supreme Court Judges (Conditions of Service) Act, Perquisites Taxable Only in the Hands of Specified Employees [ Section 17 (2) (iii)]: All other perquisites which have not been included above will be taxable in the hands of specified employees: Types of Employees: For the purpose of valuation of the perquisite in respect of unfurnished accommodation the employees are divided into two categories: Central and State Government Employees: The value of the perquisite will be equal to the license fee. Private Sector Employees: (i) (ii) Where the accommodation is owned by the employer, the value will be as follows: (aa) (bb) 10% of salary in cities having population exceeding 4 lacs as per 1991 census; 7.5% of salary in other cities Where the accommodation is taken on lease or rent by the employer, the value will be equal to the actual amount of lease rental paid or payable by the employer or 10% of salary whichever is lower. Definition of Salary: Salary includes the pay, allowances, bonus or commission payable monthly or otherwise or any monetary payment, by whatever name called from one or more employer, as the case may be, but does not include the following, namely :- (i) Dearness Allowance or Dearness Pay unless it enters the computation of superannuation or retirement benefits of the employee concerned; Page 25 of 68 - Income Tax Notes

26 (ii) (iii) (iv) (v) Employer s contribution to the provident fund account of the employee; Allowances which are exempted from payment of tax; Value of perquisites specified in sub-section (2) of Section 17 of the Income-tax Act; Any payment or expenditure specifically excluded under proviso to sub-clause (iii) of clause (2) or proviso to clause of Section 17. Furnished Accommodation: When the accommodation provided to the employee is furnished by the employer, the computation of the value of the perquisite has to be done in the following manner :- First compute the value of the perquisite as if the accommodation is unfurnished. Then, add to the value arrived at under (i) above ; (i) (ii) 10% of the original cost of the furnishings per annum if the furnishings are owned by the employer; or If the employer has taken the furnishings on hire and provided them to the employee, add the hire charges borne by the employer. This addition in respect of furnished accommodation is applicable to all categories of employees. In this context, the term furnishings will include furniture like sofa sets, cots, dining table etc. TV sets, radio sets, refrigerator and other household appliances, air-conditioning plant or equipments. Provision of Motor-Car by Employer: Situations where no perquisite will arise - Only in case of specified employees as discussed earlier. If the car is used wholly for official purposes even if the car is owned by the employee or is owned/ hired by the employer. Method of Valuation of Motor Car: The method of valuation depends upon who owns the motor-car, who bears the maintenance and running charges, the H.P. rating of the car, whether a chauffeur has been provided and whether the car has been provided exclusively for personal use of the employee or partly for official use and partly for personal purposes. The method of valuation under various situations are discussed below. Sl. Circumstances Where cubic capacity of engine does not exceed 1.6 litres 1. Motor car is owned or hired by the employer and Where cubic capacity of engine exceeds 1.6 litres. Page 26 of 68 - Income Tax Notes