There is no Such Thing as a Good Tax (Winston Churchill)

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2 There is no Such Thing as a Good Tax (Winston Churchill) Tax structure refers to the systematic arrangement of various taxes and the factors influencing them such as tax base, tax rate, frequency of change in rate, imposing authority etc. that constitute a tax system of a country. The taxes which constitute the tax structure of a country can be classified into direct and indirect taxes. India has well structure taxation system. It has three tiers in nature with clearly demarcated authorities between Central Government, State Government and Local Bodies. This demarcation is derived from the constitution of India. The constitution empowered these three tiers to levy different types of taxes and duties according to the laws. The Central government levies taxes on income, wealth, security transaction tax (STT), custom duty, excise duty, service tax etc. The State government levies taxes on sales (VAT), excise, tax on agriculture income, land revenue, stamp duty, employment tax etc. The Local Bodies can levy taxes on property, house tax, water and sewage tax, consumption tax, toll tax, octroi etc. In the present chapter, the provisions regarding the most important type of direct taxes i.e., Income Tax and Wealth Tax which are the major source of Government revenue have been discussed. The income tax is a tax on income. Every person whose total taxable income in any previous year exceeds the minimum exemption limit shall be liable to pay income tax in current year at a specified rate prescribed in the relevant Finance Act. The income tax is governed by the Income Tax Act, The wealth tax is a tax on wealth or property. It is levied on the net wealth of the person if it exceeds the minimum exemption limit. It is governed by Wealth Tax Act, Now from assessment year , wealth tax has been abolished. A brief note on Security Transaction Tax (STT), a type of direct tax, is also given at the end of the chapter. 92

3 Types of Taxes Direct Taxes Indirect Taxes Table 4.1 Indian Tax Structure Central Government State Government Local Bodies Income Tax including Tax on Agriculture Property Tax, Corporation Tax, Wealth Income, Employment House Tax, Water Tax, Security Transaction Tax, Stamp Duty, Other and Sewage Tax, Tax State Taxes Road Tax, Others Excise Duty, Custom Sale Tax (VAT), Excise Octroi Tax, Toll Duty, Central Sales Tax, Duty, Entertainment Tax, Tax, Consumption Service Tax, Others Other State Taxes Tax, Others 4.1 Income Tax Act, 1961 Income tax is one of the most important types of direct taxes which is levied and collected by the Central Government on the total income of the person. It is the key source of raising public revenue. The Government of India has set up a separate income tax department for this purpose and passed the Income Tax Act, 1961 to govern the said tax. Although income tax is levied and collected by the Central Government but a certain portion of it is distributed among the States for their welfare projects. The income tax department functions under the direct control and supervision of Central Board of Direct Taxes (CBDT) and is a part of Department of Revenue, Ministry of Finance, Government of India. Basically income tax is a tax levied on previous year s total taxable income of a person at the rates applicable during the current year. It is governed by Income tax Act Income Tax Act, 1961 extends to the whole of India. It came into force on the April1 st, The Act contains 298 sections and XIV schedules 1. Income-tax Rules 1962, which came into force on 1 st day of April 1962, would form part of the Income tax Act 1961, for its efficient application. The rates of income tax and various other rates are revised by the Finance Act which is passed every year by the Parliament. Thus, the 93

4 present law of income tax consist Income tax Act 1961, Income tax Rules 1962, Annual Finance Act, Circulars and Notifications issued by Central Board of Direct Taxes (CBDT) and judicial decisions made by Supreme Court and High Courts. Income tax Act, 1961 had been amended at several times. The following amending legislations have been passed from time to time to amend this Act: 1) Taxation Laws (Amendment) Act, 1962, 1965, 1967, 1970, 1972, 1975, 1978, 1984, 1986, 1991 and ) Income-tax (Amendment) Act, 1963, 1965, 1972, 1973, 1976, 1981, 1986, 1989, 1996, 1997 and Income tax (Amendment) Act, 1998, 3) Direct Tax Laws (Amendment) Act, 1964, 1974, 1987 and Some of the Important provisions of Income tax Act, 1961 are given below for its proper understanding Applicability and Enforcement [Sec. 1] 2 This Act may be called the Income-tax Act, 1961 and extends to whole of India including Jammu and Kashmir and came into force on April 1, Important Definition Under Section 2 and 3 of the Income tax Act, 1961, definitions of important terms used in the act have been given, some of which are as under: 1) Agricultural Income [Section 2(1A)] 2) Assessee [Section 2(7)] 3) Assessment [Section 2(8)] 4) Assessment Year [Section 2 (9)] 5) Income [Section 2(24)] 6) Maximum Marginal Rate [Sec. 2(29C)] 7) Person [Section 2(31)] 8) Previous Year [Section 3] 9) Total Income [Section 2(45)] 10) Resident [Sec 2(42)] 11) Heads of Income [Section 14] 94

5 12) Exempted Incomes [Section 10 and Section 86] 13) Deductions from Income [Section 80C to 80 U] 14) Gross Total Income [ Section 80B(5)] Agricultural Income [Section 2(1A)] Agricultural income means: 1) Any rent or revenue derived from land which is situated in India and is used for agricultural purposes 2) Any income derived from such land by agricultural operations including processing of the agricultural produce, raised or received as rent-in-kind so as to render it fit for the market or sale of such produce 3) Any income derived from any building owned and occupied by the receiver of the rent or revenue of any such land, or occupied by the cultivator or the receiver of rentin-kind used for agriculture operation. Assessee [Section 2(7)] Assessee means a person: 1) Who is liable to pay any tax; or 2) Who is liable to pay any other sum of money under this act; or 3) In respect of whom any proceeding under the Income tax Act has been taken for the assessment of his income or assessment of fringe benefit; or 4) In respect of whom any proceeding under the Income tax Act has been taken for the assessment of any other person in respect of which he is assessable; or 5) In respect of whom any proceeding under the Income tax Act has been taken for the assessment of loss sustained by him or by such other person; or 6) In respect of whom any proceeding under the Income tax Act has been taken for the assessment of refund due to him or to such other person; or 7) Who is deemed to be an assessee under any provisions of this act; or 8) Who is deemed to be an assessee in default under any provisions of this Act? Assessment [Section 2(8)] The process of determination of income or loss or refund or tax liability on an assessee is known as assessment. 95

6 Assessment Year [Section 2 (9)] Assessment year means the period of twelve months commencing on April 1 st every year and ended on March 31 st of the next year. Income [Section 2(24)] The term income is not exactly defined in the act. There is an inclusive definition of income. Income includes: 1) Profits and gains. 2) Dividend. 3) Voluntary contributions received by a trust created wholly or partly for charitable or religious or educational purposes etc. 4) The value of any perquisite or profit in lieu of salary taxable under the head salaries. 5) Any special allowance or benefit specifically granted to the assessee to meet expenses wholly, necessarily and exclusively for the performance of his duties. 6) Any allowance granted to the assessee either to meet his personal expenses at the place where he performs his duties or at a place where he ordinarily resides or to compensate him for the increased cost of living. 7) The value of any benefit or perquisite obtained from a company by a director or by a person who has a substantial interest in the company or by a relative of the director or of such person. 8) Any winnings from lottery, crossword puzzles, races, card games, gambling, betting, etc. 9) Any sum paid by company in respect of any obligation which, if the company would not have paid, would have been payable by the director or the person having substantial interest in the company. 10) The value of any benefit or perquisite obtained by any representative assessee; 11) Any sum paid by the representative assessee in respect of any obligation which, if the representative assessee would not have paid would have been payable by the beneficiary. 12) Profits or gains from business or profession. 13) Any sum received under a keyman insurance policy including the sum received by way of bonus on such policy. 96

7 14) Compensation received for past losses, expenses or obligation already allowed as deduction. 15) Other incomes which shall be deemed as income for income tax purpose. Maximum Marginal Rate [Sec. 2(29C)] Maximum marginal rate means the rate of income-tax (including surcharge on income-tax, if any) applicable in relation to the highest slab of income in the case of an individual or association of persons or, body of individuals as specified in the Finance Act of the relevant year. Person [Section 2(31)] The term person includes: 1) an individual, 2) a Hindu undivided family, 3) a company, 4) a firm, 5) an association of persons or a body of individuals, whether incorporated or not, 6) a local authority, and 7) every artificial juridical person, not falling within any of the preceding sub-clauses. Previous Year [Section 2(34)] Previous year means the previous year as defined in section 3. According to Section 3, previous year means the financial year immediately preceding the assessment year. Financial year begins on April 1 st to March 31 st. Total Income [Section 2(45)] Total income means the total amount of income referred to in section 5 (scope of total income) computed in the manner laid down in Income Tax Act, In simple word if we subtract the deduction of 80C to 80U from the gross total income, we get total income. Resident [Sec 2(42)] Resident means a person who is resident in India within the meaning of section 6. 97

8 Heads of Income [Section 14] All the income shall, for the purposes of charge of income tax and computation of total income, be classified under the following heads of income: 1) Salaries 2) Income from house property 3) Profits and gains of business or profession 4) Capital gains 5) Income from other sources Exempted Incomes [Section 10 and Section 86] These incomes are either fully or partially exempted from income tax and therefore, to the extent of exemption, do not form a part of the total income and hence are not taxable. Deductions from Income Income tax Act allows certain specific reductions to be made from the income of an assessee while computing the total income. These reductions are termed as deductions. Two types of deductions have been provided under the Act, i.e., deductions from the specific heads of income and deductions from gross total income. Gross Total Income [Section 80B(5)] Gross total income means the aggregate income computed in accordance with the provision of Income Tax Act, 1961 before making any deduction under section 80C to 80U Basis of Charges [Sec. 4] 3 Section 4 of the Income Tax Act, 1961 puts the charge of the income tax on the person as subject to the other provisions contained in this act, Income tax shall be charged on the total income of the previous year of a person at the rate or rates fixed for the assessment year by the finance act. 98

9 4.1.4 Scope of Total Income/Incidence of Total Income [Sec. 5] 4 The scope of total income is determined according to the residential status of an assessee in India during the previous year related to the relevant assessment year. The residential status can be determined on the basis of residence in India. In determining the scope/incidence of total income, the citizenship of an assessee has no concern. Residential status and place & time of accrual or receipt of income are most important for incidence of tax. Incidence of tax for Ordinarily Resident: In calculating the total income of ordinarily resident person in any previous year includes: 1) Income received or deemed to be received in India in such year by or on behalf of such person whether accrue or arisen anywhere; or 2) Income accrues or arises or deemed to be accrue or arise to them in India during in such year whether receive anywhere; or 3) Income accrues or arises to them outside India in such year. Incidence of Tax for Not Ordinarily Resident: In calculating the total income of not ordinarily resident person in any previous year includes: 1) Income received or deemed to be received in India in such year by or on behalf of such person whether accrue or arisen anywhere; or 2) Income accrues or arises or deemed to be accrue or arise to them in India during in such year whether receive anywhere; or 3) Income accrues or arises to them outside India in such year from a business controlled in or a profession set up in India. Incidence of tax for Non-Resident: In calculating the total income of nonresident person in any previous year includes: 1) Income received or deemed to be received in India in such year by or on behalf of such person whether accrue or arisen anywhere; or 2) Income accrues or arises or deemed to be accrued or arise to them in India during in such year whether receive anywhere. 99

10 Table 4.2 Scope/Incidence of Income at Glance Incomes Income received in India whether accrued or arisen in India or outside India. Income deemed to be received in India whether accrued or arisen in India or outside India. Income accruing or arising in India whether received in India or outside. Income deemed to accrue or arise in India whether received in India or outside India. Income received and accrued outside India From a business controlled in or a profession set up in India. Income received and accrued outside India from a business controlled from outside India or a profession set up outside India. Income received & accrued outside India from any other source. Income accrued or arisen and received outside India in earlier years but later on remitted to India during the previous year. Whether Taxable or Not Not Ordinarily Resident Ordinarily Resident Non- Resident Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes No Yes No No Yes No No No No No Residential Status [Sec. 6] 5 Residential status of an assessee is determined on the basis of residence in India during the relevant previous year which has further used for determining the scope of total income. On the basis of residence, the assessee can be classified into following categories 6 : 100

11 1) Resident and Ordinarily Resident 2) Not Ordinarily Resident 3) Non-Resident Residential status is different from citizenship. An Indian citizen may have a status of non-resident or a foreigner may have a status of ordinarily resident. There are different set of provisions for determining the residential status of the person. Now we look at the provisions of determining the residential status. Residential Status of Individuals [Section 6(1)] To determine the residential status of an individual there are two conditions. These conditions are used as a criterion for determining the type of residential status. These conditions are basic conditions and additional conditions. Figure 4.1 Residential Status Residential Status Resident Non-Resident Ordinarily Resident Not Ordinarily Resident Basic Conditions: The basic condition consists following two conditions: i) He is in India for a period or periods amounting in all to 182 days or more in the relevant previous year; or, ii) He is in India for 60 days or more during the relevant previous year and has been in India for 365 days or more during the four years immediately preceding the relevant previous year. Exceptions: About the 60 days stay in India a) An individual who is a citizen of India leaves in any previous year for the purpose of employment outside India or as a member of the crew of an Indian ship the period of 60 days stay is extended to 182 days. b) An individual, who is a citizen of India, or is a person of Indian origin, who, being outside India, comes on a visit to India in any previous year, the period of 60 days stay is extended to 182 days. 101

12 Additional Conditions: The additional condition consists following two conditions: i) He has been resident in India in at least two out of ten previous years preceding the relevant previous year; and, ii) He has been in India for at least seven hundred thirty days in all during the seven previous years immediately preceding the relevant previous year. 1) Resident and Ordinarily Resident [(Section 6(1)]: An individual is said to be a resident and ordinarily resident in India in any relevant previous year if he satisfy any one of the above basic conditions (i) or (ii) and both the additional conditions (i) and (ii). 2) Resident and Not Ordinarily Resident [Section 6(6)(a)]: An individual is said to be a resident and not ordinarily resident in India in any relevant previous year if he satisfy any one of the above basic conditions (i) or (ii) but does not satisfy any or both of the aforesaid additional conditions. 3) Non-Resident [Section 2(30)]: An individual is said to be a non-resident in India in any relevant previous year if he does not satisfies none of the above basic conditions (i) or (ii) whether they satisfy any or both of the aforesaid additional conditions. Conditions Basic Conditions Additional Conditions Table 4.3 Residential Status of an Individual at a Glance 7 Types of Residential Status Resident and Resident and Ordinarily Not Ordinarily Resident Resident Satisfy any one condition Satisfy both condition Satisfy any one condition Satisfy any one or none condition Non-Resident Satisfy none off condition Satisfy both or any one or none condition Residential Status of Hindu Undivided Family (HUF), Firm, other Association of Persons [Section 6(2)] The residential status of HUF, firm and other association of persons can be determined as follows: 102

13 1) Resident and Ordinarily Resident: A Hindu Undivided Family (HUF), firm or other association of persons is said to be resident in India in any previous year if the control and management of its affairs is situated wholly or partly in India during the relevant previous year. The ordinarily resident status of HUF is depends on the status of manager, or Karta or Mukhia. If the Karta satisfy the aforesaid additional conditions the HUF can be treated as ordinarily resident. 2) Resident and Not Ordinarily Resident: A HUF is said to be a resident and not ordinarily resident in India in any relevant previous year if the manager or Karta of HUF is not satisfy any or both of the aforesaid additional conditions. A firm and other association of persons is never be Not Ordinarily Resident 3) Non-Resident: A Hindu Undivided Family (HUF), firm or other association of persons is said to be non-resident in India in any previous year if the control and management of its affairs is situated wholly outside India during the relevant previous year. Table 4.4 Residential Status of a HUF, Firm and Other Association of Persons at a Glance Person HUF Firm Other Associat ion of Persons Resident and Ordinarily Resident Control and Management is situated wholly or partly in India and Karta satisfy the both additional conditions Control and Management is situated wholly or partly in India Control and Management is situated wholly or partly in India Types of Residential Status Resident and Not Ordinarily Resident Control & Management is situated wholly or partly in India and Karta does not satisfy both the additional conditions Never Never Non-Resident Control and Management is situated wholly outside India Control and Management is situated wholly outside India Control and Management is situated wholly outside India 103

14 Residential Status of a Company [Section 6(3)] The residential status of a company can be determined as follows: 1) Resident and Ordinarily Resident: A company is said to be a resident in India in any relevant previous year if: i) It is an Indian company; or ii) During the relevant year, the control and management of its affairs is situated wholly in India. 2) Resident and Not Ordinarily Resident: A company is never be Not Ordinarily Resident 3) Non-Resident: A company will be a non-resident in any previous year if they do not satisfy the above ordinarily resident conditions. It means: i) It is not an Indian company; and ii) During the relevant year, the control and management of its affairs is situated wholly or partially outside India Income Exempted from Tax 8 Exempted incomes are those incomes on which tax is not chargeable. They are exempted from the tax. The income earners need not to pay any type of taxes on these incomes. These incomes can be classified into two categories: Income Fully Exempted from Tax [Sec. 10]: Those income which are neither included in total income nor income tax is payable on them while calculating the total income of any person in relevant previous year comes under this category. It consists following incomes: 1) Agricultural income 2) Amount received from Hindu Undivided Family (HUF) 3) Share in the firm s income as a partner 4) Remuneration received by a foreign national as employee of a foreign enterprise 5) Interest received on securities or bonds or on external account by a non-residents 6) Remuneration of employee of foreign government during his training in India 7) Income from royalty or fees for technical service of foreign company 8) Tax payable by Indian company on certain income of and on behalf of a non- 104

15 resident or a foreign company 9) Allowances or perquisites outside India 10) Income of foreign companies providing technical services in projects connected with security of India 11) Leave travel concession to an employee 12) Death-cum-retirement gratuity 13) HRA and Commutation of pension 14) Encashment of earned leaves 15) Retrenchment compensation 16) Payment under Bhopal Gas Leak Disaster Act, ) Provident fund 18) Interest, premium or bonus on specified investments 19) Educational scholarship 20) Allowances of M.P., M.L.A. and M.L.C. 21) Income of scientific research association 22) Income of newly established industrial undertakings in free trade zones, etc 23) Income of Khadi and Village Industries and Board 24) Special provisions in respect of newly established units in special economic zones 25) Income of SAARC fund 26) Income of mutual and investor protection fund 27) Income of political parties 28) Income from international sporting 29) Income of subsidiary company 30) Any other income specified in Section10 of the Income Tax Act, Income Partly Exempted from Tax [Sec 86]: Those income which are included in total income but no income tax is payable on them while calculating the total income of any person in relevant previous year comes under this category. It consist the share of profit received by a member of association of person or body of individuals if it is taxed at normal rate. At the time of individual tax assessment it will be calculated according to u/s 67A. 105

16 4.1.7 Head of Income Section 14 of the Income Tax Act, 1961 classified the total taxable income of an assessee into five heads. The taxable income of any person is being computed under these heads which is known as Gross Total Income. From the gross total income some deduction has been made to find out the net total income of that head. There are separate provisions for each head for calculating the net taxable income. The income heads are: 1) Salaries 2) Income from House Property 3) Profit and Gains of Business or Profession 4) Capital Gain 5) Income from Other Sources Computation of Total Income of an Individual After determining the residential status of an individual u/s 6, use the following chart to determine the total income and tax liability: Chart 4.2 Computation of Total Income and Tax Liability for the Assessment Year.. 1) Computation of Taxable/Total Income Rs. i) Income from Salaries (Sections 15 to 17).. ii) Income from House Property (Sections 22 to 27) iii) Profits and Gains of Business or Profession (Sections 28 to 44D) iv) Capital Gains (Sections 45 to 55A) v) Income from Other Sources (Sections 56 to 59) Gross Total Income.. Less: Deductions (Section 80C to 80U) Add: Agricultural Income (if any) Total Income Aggregate/Total Income.. Rounded-off to the nearest multiple of Rs. 10 (Section 288) 106

17 2) Computation of Tax Liabilities i) Tax on income liable to tax at special rate: a) Casual income (Lottery, card, betting, horse race, 30%.. b) Short-term Capital Gains u/s 15%.. c) Long-term Capital Gains:.. On listed securities or units of UTI or Mutual Fund.. Computed without indexing the cost of 10% Other 20%.... ii) Tax on other/balance income (Normal rates): As rate/slab prescribe by the Finance Act. [Aggregate income Income in (i) at normal rates].... Less: Tax on agricultural income.... Less: Rebate of tax u/s 88E.... Add: Surcharge (as specified) and Education 3% Gross Tax Payable.... Less: i) Rebate and Relief.. ii) Tax deducted at Source.. iii) Tax paid in Advance, etc..... Net Tax Payable Net Tax Payable/Tax Liabilities is rounded-off to the nearest multiple of Rs Income from Salaries A salary is the remuneration which is received by an employee from their employer for rendering the services. It is like a compensation which is paid by the employer to the employee in consideration for their services. Salary can be in cash or kind. Section 15 which is also known as charging section provides that the following incomes fall under the head salaries: 107

18 Salary due from an employer or former employer to an assessee in the previous year Salary paid or allowed in the previous years by or on behalf of an employer or former employer Arrear salary not charged in earlier year, paid or allowed in the previous year by or on behalf of an employer or former employer Meaning of Salary Section 17(1) gives an inclusive definition of Salary. Salary Includes: Wages Any annuity or pension Any gratuity Any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages Any advance of salary Any payment received by an employee in respect of any period of leave not availed by him The annual accretion to the balance at the credit of an employee participating in a recognized provident fund, to the extent to which it is chargeable to tax The aggregate of all sums that are comprised in the transferred balance of an employee participating in a recognized provident fund, to the extent to which it is chargeable to tax The contribution made by the Central Government or any other employer in the previous year, to the account of an employee under a notified pension scheme referred to in Section 80CCD Different forms of Salary An employee gets their salary in different forms. Some important forms of salary are as follows: Bonus Fees and Commission Advance Salary Arrear Salary 108

19 Annuity Profit in lieu of Salary Encashment of Earned Leave Compensation for retrenchment Death-cum-Retirement Gratuity Pension Voluntary Retirement Amount Tax paid by the employer for the perquisites Allowances Allowance is any fixed amount paid by the employer to the employee in cash other than salary is called allowance. It is paid for meeting the specific requirement related to the job. It can be categories into three types: 1) Fully Taxable Allowance: It consist those allowance which are fully (total amount) included under the head salary for determining the tax liabilities 2) Partly Taxable Allowance: It consist those allowance which are partly included under the head salary. Certain portions of these allowances are exempted from tax. The taxable portion of these allowances can be determined as follows: Taxable Portion = Actual Allowance Exempt Portion 3) Fully Exempt Allowance: It consist those allowance which are fully exempt. It is not included under the head salary for determining the tax liabilities. Some Important Allowances Dearness Allowance or Pay: This allowance is given to an employee to compensate him for the loss in the purchasing power of money due to increase in prices. It may be paid under the terms of employment or otherwise. House Rent Allowance [Section 10(13A) and Rule 2A]: It is given by the employer to the employee to meet the residential accommodation expenditure. It is exempt to the extent of the least of the following amounts: i) Actual House Rent Allowance received ii) Excess of rent paid over 10% of the salary for the relevant period iii) 50% of the salary where the residential house is situated at Mumbai, Calcutta, Delhi or Chennai and 40% of the salary in other cases, for the relevant period. Salary includes basic salary, DA (terms of employment) and commission on turnover 109

20 Allowances Fully Taxable Partly Taxable Fully Exempt i) Dearness Allowance ii) Dearness Pay iii) Over-Time Allowance iv) Servant s Allowance v) Proctor s Allowance vi) Non-Practicing Allowance vii) Warden s Allowance viii) Medical Allowance ix) Cost of Living Allowance x) City Compensatory Allowance xi) Lunch or Tiffin Allowance xii) Deputation Allowance xiii) Other Allowances i) House Rent Allowance ii) Entertainment Allowance iii) Special Allowances [u/s 10 (14) (i)]: a) Tour Allowance b) Daily Allowance c) Travel Allowance d) Conveyance Allowance e) Car or Conveyance Allowance f) Helper Allowance g) Uniform Allowance h) Academic Allowance iv) Special Allowances [u/s 10 (14) (ii)]: a) Education Allowance b) Hostel Allowance c) Composite Hill Allowance d) Allowance to Transport Employee e) Tribal Area Allowance f) Special Compensatory Allowance g) Compensatory Field Area Allowance h) Compensatory Modified Area Allowance i) Counter-Insurgency Allowance j) Transport Allowance v) Retrenchment Compensation vi) Compensation Received on Voluntary Retirement i) Foreign Allowance ii) Allowance to High Court Judges iii) Allowances from United Nations Organization iv) Compensatory Allowance to a Judge v) Sumptuary Allowance to a Judge 110

21 Entertainment Allowance: This allowance is given by an employer to his employee for entertaining the client. It is fully taxable but for the government employee it is deducted from the income from salary under section 16(ii). The least of the following will be exempt: i) Actual Entertainment Allowance Received ii) 20% of salary iii) Maximum Rs. 5,000 Salary includes basic salary, DA (term of employment) and fixed commission on turnover Children Education Allowance: It is one of the partly taxable allowances which are exempt Rs. 100 per month per child upto a maximum two child. Hostel Allowance: It is another partly taxable allowance which is exempt 300 per month per child upto a maximum two child Perquisites A perquisite is any benefits, amenities or facilities in kind which are generally attached to the position or designation in addition to salary. It is a personal advantage to the employee by the virtue of their employment position. According to Section 17(2) of Income Tax Act, 1961 A perquisite includes: 1) The value of rent-free accommodation provided to the assessee by his employer 2) The value of any concession in the matter of rent respecting any accommodation provided to the assessee by his employer 111

22 3) The value of any benefit or amenity granted or provided free of cost or at concessional rate in any of the following cases: i) By a company to an employee who is director thereof; ii) By a company to an employee being a person who has a substantial interest in the company; iii) By any employer (including a company) to an employee to whom the provisions of: (a) and (b) above do not apply and whose income under the head salaries (whether due from, or paid or allowed by, one or more employers) exclusive of value of all benefits or amenities not provided for by way of monetary payment, exceeds Rs. 50,000. 4) Any sum paid by the employer in respect of any obligation which, but for such payment, would have been payable by the assessee. 5) Any sum payable by the employer, whether directly or through a fund, other than a recognized provident fund, or an approved superannuation fund, or a Deposit-linked Insurance Fund, to effect an assurance on the life of the assessee or to effect a contract for an annuity. 6) The value of any other fringe benefit or amenity as may be prescribed. 112

23 Perquisites General Perquisites Specific Perquisites Tax-Free Perquisites Taxable in the hands of every employee i) Rent-free accommodation. ii) Concessional rent-free accommodation iii) Payment of employee s obligation iv) Employee s life insurance premium or annuity premium payable by employer. v) Prescribed fringe benefits or amenities Taxable in Employees Hand i) Interest free or concessional loan to an employee. ii) Use of moveable asset by an employee or any member of his household. iii) Transfer of moveable asset to an employee or any member of his household. iv) Any other benefits are amenity. Taxable in Employer s Hand i) Free or concessional transport. ii) Traveling, touring and accommodation, etc. iii) Free food, beverages or refreshment facilities. iv) Any gift or voucher or token. v) Credit card facility. vi) Club expenditure. Taxable in the hands of specified Employees i) Director in the employer company, or ii) Employees having substantial interest in the employer company, or iii) Employees having monetary salaries income of more than Rs. 50,000 per annum). i) Facility of household servants. ii) Free gas, electricity and water. iii) Free education. iv) Medical facility. Tax-free in the hands of every employee i) Medical facilities. ii) Recreational facilities. iii) Conference iv) Tour and travel facility. v) Accommodation in remote area. vi) Refreshment facilities. vii) Conveyance facilities. viii) Telephone or mobile facility. ix) Lunch or dinner. x) Perquisites given in foreign country. xi) Accommodation to judges. xii) Goods sold at concessional rates. xiii) Contribution to group insurance scheme. xiv) Family planning facility. xv) Scholarship to employee s children. xvi) Free accommodation to ministers xvii) Interest free loan upto Rs. 20,000. xviii) Payment of Accident Insurance Premium. xix) Refresher course or Training facility. xx) Conveyance facility to High Court or Supreme Court Judges. xxi) Leave travel concession. xxii) Allotment of shares, debentures or warrants in certain cases. xxiii) Traveling expenses paid or reimbursed for business purposes. xxiv) Free education facility upto Rs. 1,000 p.m. per child. xxv) Car facility or car expenses. xxvi) Use of computer laptop. xxvii) Other perquisites. 113

24 Computation of Income from Salaries Income from salaries can be computed using the following format: Basic Salary/Wage Advance Salary Chart 4.3 Computation of Income from Salaries Rs. Dearness Allowance/Pay Bonus Fee and commission Profit in lieu of salary Taxable part of allowance Taxable part of perquisites Encashment of earned leaves Employer s contribution towards recognized provident fund in excess of 12% of salary Interest on recognized provident fund in excess of 9.5% Taxable part of retirement benefits Taxable part of commuted pension Other salary income Gross Salary Income Less: Entertainment Allowance u/s 16(ii) Professional tax u/s 16(iii). Income from Salaries 114

25 Retirement Benefits It is also a part of income from salary. When an employee retires or leaves or retrenched from the job, he is entitled to receive some amount from the employer. These payments consist following: 1) Pension [Section 17(1)(ii)]: Pension received by the Government and non- Government employee is fully chargeable to tax. But sometime an employee wants to receive a lump sum payment in lieu of periodical payment. This lump sum payment for foregoing pension is called commuted value of pension. The taxation provisions regarding this are as follow: Status of Employee Government employee Non-Government employee Whether Gratuity Received or not Received Gratuity may or may not be received. Gratuity received. Gratuity not received. Taxation provision under Section 10(10A) Entire commuted pension is exempt from tax. Commuted value of One-third pensions is exempt from tax. Commuted value of One- half pensions is exempt from tax. 2) Gratuity [Section 10(10)]: Gratuity is a payment made by the employer to an employee in appreciation of the past services rendered by the employee. It is a retirement benefit. The taxation provision regarding gratuity are as follow: Government or Local Authority Employee Any amount received by such employee is fully exempt from tax Non-Government Employee Covered by Payment of Gratuity Act, 1972 Least of the following amount is exempt from tax : i) 15 days (7 days in the case of seasonal establishment) salary for every completed year or in excess thereof of service, or ii) Actual Gratuity received, or iii) Max. Rs. 10,00,000 Not covered by Payment of Gratuity Act, 1972 Least of the following amount is exempt from tax : i) Half month s average salary for each completed year of service, or ii) Actual Gratuity received, or iii) Max. Rs. 10,00,000 Explanation: 15 days salary = Explanation: Half month 115

26 15/26 of salary last drawn. Salary = BS + DP + commission salary = 1/2 of average salary of last 10 months. Salary = BS + DP + commission 3) Encashment of Earned Leave: The provisions regarding taxability of leave salary are given below: Encashment of Earned Leave during Service Any amount received by any employee in respect of earned leave during service is fully taxable Encashment of Earned Leave After Retirement Government Non-Government Employee Employee Any amount received by such employee is fully exempt from tax Least of the following amount is exempt from tax: a) Amount of average salary for the approved period of earned leave not availed, or b) 10 month salary on the basis of average monthly salary of last 10 month, or c) Actual Leave encashment received, or d) Max. Rs. 3,00,000 Explanation: Approved period = 1 month every year. Salary = BS + DP + commission 4) Retrenchment Compensation [Section 10(10B)]: Compensation received by a workman at the time of retrenchment is exempt from tax to the extent of the least of the following: i) An amount calculated in accordance with the provisions of Section 25F(b) of the Industrial Disputes Act, 1947, or ii) Actual amount received, or iii) Max. Rs. 5,00,000 Section 25F(b): Amount is equal to 15 days average pay, for every completed year of service or any part thereof in excess of six months. 5) Compensation on Voluntary Retirement [Section 10(10C)]: Compensation received at the time of voluntary retirement shall be exempt at least of the following: i) Amount of salary for three month salary for each completed year of service, or 116

27 ii) Amount of salary for remaining service left on the basis of last dawn salary, or iii) Actual amount received, or iv) Max. Rs. 5,00,000 6) Provident Fund: Provident fund is the fund for future. It provides a support to the employee for their future requirement. Under this, a certain sum is deducted by the employer from the employee s salary as his contribution every month. The employer also contributes a certain percentage to the provident fund. These contributions are invested. The interest earned on these investments is also credited to the provident fund account of the employees. The balance thus keeps accumulating year after year. At the time of retirement or resignation, the accumulated amount is given to the employee. Kinds of Provident Fund There are basically four types of Provident Fund: 1) Statutory Provident Fund (SPF): This fund is set up under the Provident Fund Act, It is mainly meant for Government employees or semi-government employees, university or educational institutions affiliated to a university established by statute or other specified institutions. 2) Recognized Provident Fund (RPF): Recognized Provident Fund Scheme is a scheme to which the Employees Provident Funds Act, 1952 applies. According to this Act, any person who employs 20 or more employees, is under an obligation to register himself under the act, and start a provident fund scheme for the employees in his organization after three years of its establishment. A fund which is recognized by the chief commissioner or commissioner of income tax also known as recognized provident fund. Basically, it is maintained by schedule bank, factories, business houses, private organization etc. 3) Un-Recognized Provident Fund (URPF): A scheme started by the employer and the employees in an establishment. It is approved by Commissioner of Provident Fund but not approved by the Commissioner of Income-tax. It is maintained by any institution or private organization. 4) Public Provident Fund (PPF): This scheme was started from July It is 117

28 covered under Public Provident Fund Act, Any member of the public, whether in employment or not, may contribute to this fund. In other words, it is a scheme where there is an employee s own contribution only. In this scheme there is no employer s contribution. The minimum contribution to this Fund is Rs. 500 and maximum Rs. 70,000 per year. The contributions made to the scheme along with interests are repayable after 15 years, unless extended. The rate of interest, under the scheme is 8% per annum. Table 4.5 Treatment of Provident Fund Particulars SPF RPF URPF PPF 1) Employee Contributi on 2) Employer Contributi on 3) Interest on Provident Fund 4) Repayme nt of Lumpsum Amount on Retireme nt Deduction u/s 80C is available from gross total income subject of the limit specified therein. Fully exempt from tax. Fully exempt from tax. Fully exempt u/s 10(11). Deduction u/s 80C is available from gross total income subject to the limit specified therein. Exempt upto 12% of salary. Exempt upto 9.5% p.a. Exempt subject to certain conditions. No deduction u/s 80C is available. Not exempt but also not taxable every year. Not exempt but also not taxable every year. Accumulated employee s contribution is not taxable. Accumulated employer s contribution + interest on employer s contribution are taxable. Interest on employee s contribution is taxable. Deduction u/s 80C is available from gross total income subject to the limit specified therein. Not applicable as there is only employee contribution. Fully exempt. Fully exempt u/s 10(11). 118

29 Income from House Property The total income of an assessee is classified into various heads. The Income from House Property is second of them. Simply, it is the income which is earned by the assessee by letting the owned house. Section 22 to 27 of the Income Tax Act, 1961 relates to the income from house property Basis of Charges [Section 22] This section is also known as charging section. According to this section annual value of house property is the basis for chargeability. It means the annual value of property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner, other than such portions of such property as he may occupy for the purposes of any business or profession carried on by him the profits of which are chargeable to income tax, shall be chargeable to tax under the head Income from house property. Essential Conditions: The essential conditions which must be satisfied for taxing the income under the head income from house property are as follows: 1) The property must consist of buildings and lands appurtenant thereto, 2) The assessee must be the owner of such house property, 3) The property should be used by the owner other than for their own business or profession Exemption from Income from House Property The Income Tax Act, 1961 states about the exemption of certain income from the income from house property. For the proper understanding of these exemptions, it can be classified into two categories: Fully Exempt Incomes It consist those property incomes which is not included in gross total income while computing the tax liabilities. 1) Income from farm house located near the agricultural land. 2) Income from property house property used for own business or profession. 3) Income from self-occupied house. 119

30 4) Income from property of Ladakh resident. 5) The annual value of any one palace which is being announced by an ex Indian ruler. 6) Income from property owned/held by charitable or religious trust, local authority, trade union, political party, scientific research association, hospital or other institution, university or other educational institution etc. 7) Income of a statutory authority derived from letting of godowns or warehouses purpose. Partly Exempt Incomes It consist those property incomes which are firstly included in gross total income but afterward deduction is being allowed. No tax is charged on these incomes. 1) Income derived by a cooperative society from the letting of godowns or warehouses for storage, processing or facilitating the marketing of commodities. 2) Income from house property of mutual concern clubs. 3) Income from house property of cooperative society provided its gross total income of the society does not exceed Rs. 20,000 and the society is not a housing society or an urban consumer s society or a society carrying on transport business or a society engaged in the performance of any manufacturing operations with the aid of power Annual Value [Section 23] 9 Section 23 of Income Tax Act, 1961 state that the annual value of any house property shall be deemed to be: 1) the sum for which the property might reasonably be expected to let from year to year, or 2) where the property or any part of the property is let and the actual rent received or receivable by the owner is in excess of the sum referred to in clause (1), the amount so received or receivable, or 3) where the property or any part of the property is let and was vacant during the whole or any part of the previous year and owing to such vacancy the actual rent received or receivable by the owner in respect thereof is less than the sum referred to in clause (1), the amount so received or receivable. 120

31 Determination of Annual Value The annual value of any house property can be determined by pursuing the following steps: Step I: Determine the gross annual value. Step II: From the gross annual value computed in Step I, deduct municipal tax paid by the owner during the previous year. The balance shall be the net annual value as per Income-tax Act Concept of Rent The Gross Annual Value (GAV) of house property is determined on the basis of various rents. These rents are: 1) Actual Rent: Actual rent is the rent which is paid by the tenant to the landlord for their house property. Sometimes the owner also provides some facilities like gardener, lift, electricity and water, scavenging, watch and ward facilities and parking etc under the term of tenancy and the cost of these facilities are borne by owner (included in rent) then the value of actual rent is arrived by deducting these expenses from the actual rent. After that any unrealized rent & rent pertaining to vacant period is also deducted to come across the value of actual rent. 2) Municipal Rent: These rents are determined by the local government i.e., municipal corporation or committee of city to collect various taxes such as house tax, water tax, sewerage tax and education and health tax, etc. For that purpose they make a periodical survey of house property in its local limits. Based on these survey rentals value is assigned. This rental value is called municipal rent or municipal value. 3) Fair Rent: Fair rent is that notional or reasonable rent which may be received in connection with house property if its let-out. A fair rent may be taken as rent of a similar property in the same or similar locality. 4) Standard Rent: The rent which is determined under the Rent Control Act is called standard rent. It is the maximum rents which can be legally recover from the tenant under Rent Control Act. Determination of Gross Annual Value (GAV) The Gross Annual Value (GAV) is ascertained on the basis of the actual rent, municipal rent/value, fair rent and standard rent of the house property. For determining 121

32 the gross annual value of house property following steps should be followed: 1) Determine Expected Rent: The expected rent can be determined by making the following comparison: Expected rent = Municipal rent or Fair rent (whichever is greater) but not exceeding the standard rent [if given] 2) Compare Expected Rent with Actual Rent i) If actual rent received is more than expected rent then, Gross Annual Value = Actual Rent ii) If actual rent received is less than expected rent then, Gross Annual Value = Actual Rent [If shortage is only due to vacancy]; or Expected rent [If shortage is due to other factors only]; or Expected rent rent of vacant period [If shortage is partly due to vacancy and partly due to other factors] Unrealized Rent The amount of rent which the owner cannot realize shall not include in the annual value of house property if the condition of Rule 4 are satisfied. The Rule 4 is: 1) The tenancy is bona fide. 2) The defaulting tenant has vacated, or steps have been taken to compel him to vacate the property. 3) The defaulting tenant is not in occupation of any other property of the assessee. 4) The assessee has taken all reasonable steps to institute legal proceedings for the recovery of the unpaid rent or satisfies the Assessing Officer that legal proceedings would be useless. Deductions from Annual Value [Section 24] 10 Section 24 of the Income Tax Act deals with the various deductions which is made from the annual value of the house property before arriving the income from house property. These deductions are as follows: 1) Standard Deduction: A sum equal to 30% of the annual value is allowed for all type of house property as standard deduction to compensate the expenses on that property. 2) Interest on Loan: It has a two conditions: 122