CHAPTER 1 INTRODUCTION

Government has to play an important role in all round development of society in the modern era. It
has not only to perform its traditional functions (defence, maintenance of law and order) but also to
undertake welfare and development activities such as health, education, sanitation, rural development, water supply etc. It has also to pay for its own administration. All these functions require
huge public finance. Taxes constitute the main source of public finance whereby government raises
revenue for public spending. Taxes have been broadly categorised into direct and indirect taxes. Direct taxes include those taxes which are paid by the person on whom these are levied like income
tax, wealth tax etc. On the other hand, indirect taxes are levied on one person, but paid by another
e.g. sales tax, excise duty, custom duty etc.
Income tax is the most important of all direct taxes and with the application of progressive rate
schedule, provision of exemption limit and incorporation of a number of incentive provisions. It can
be used not only to satisfy all the canons of a sound tax system but may also go a long way in realising variety of socio economic objectives set out by the economic system. It also helps in bringing
distributional justice through higher rate of tax on the rich class of the society. It may also act as a
tool for controlling inflation. Due to all these factors, income tax has assumed great importance in
the structure of direct taxation. Therefore, all politically advanced democracies impose some form
of personal taxation, generally based on income.
The concept of tax can be traced back to the time when the empires and the kingdoms were raised
to govern the people. Monies were required to provide public infrastructure and facilities to ensure
a good life for subjects, as well as defence services to protect the kingdom. To this end, the ruler
would collect a particular amount from each of his subjects to accumulate money for efficient administration. This is seen as the origin of taxation - a form of compulsory exaction of money by the
Government for the common good. Tax is a fee charged by the Government on the income of a person, or an activity undertaken by him or her, or on a product. It is the basic source of revenue for

the Government. The Government in turn spends this taxed fund proportionally on various infrastructure development activities, as well on its defence and education systems, health and sanitation
facilities, and so on.

What is a Tax?
Let us begin by understanding the meaning of tax. Tax is a fee charged by a government on product, income or activity. There are two types of taxes direct taxes and indirect taxes. If tax is levied
directly on the income or wealth of a person, then it is a direct tax e.g. income-tax. If tax is levied
on the price of a good or service, then it is called an indirect tax e.g. excise duty. In the case of indirect taxes, the person paying the tax passes on the incidence to another person.

type of tax

direct

income tax

indirect

wealth tax

excise duty

customs duty

service tax

value added
tax

Why are Taxes Levied?

The reason for levy of taxes is that they constitute the basic source of revenue to the government.
Revenue so raised is utilized for meeting the expenses of government like defence, provision of education, health-care, infrastructure facilities like roads, dams etc.

Overview of Income-Tax Law in India

Income-tax is the most significant direct tax. We would be introducing the Income-tax law of India.
The income-tax law in India consists of the following components

components of
income tax law

income tax act

annual finance act

income tax rules

legal decisions of
courts

The various instruments of law containing the law relating to income-tax are explained below:

Income-tax Act, 1961: The levy of income-tax in India is governed by the Income-tax Act,
1961. This Act came into force on 1st April, 1962. The Act contains 298 sections and XIV schedules. These undergo change every year with additions and deletions brought about by the annual
Finance Act passed by Parliament. In pursuance of the power given by the Income-tax Act, 1961
rules have been framed to facilitate proper administration of the Income-tax Act, 1961.

The Finance Act: Every year, the Finance Minister of the Government of India presents the
Budget to the Parliament. Part A of the budget speech contains the proposed policies of the Government in fiscal areas. Part B of the budget speech contains the detailed tax proposals. In order to
implement the above proposals, the Finance Bill is introduced in the Parliament. Once the Finance
Bill is approved by the Parliament and gets the assent of the President, it becomes the Finance Act.

Income-tax Rules:

The administration of direct taxes is looked after by the Central Board of

Direct Taxes (CBDT). The CBDT is empowered to make rules for carrying out the purposes of the
Act. For the proper administration of the Income-tax Act, 1961, the CBDT frames rules from time
to time. These rules are collectively called Income-tax Rules, 1962. It is important to keep in mind
that along with the Income-tax Act, 1961, these rules should also be studied.

Circulars and Notifications: Circulars are issued by the CBDT from time to time to deal
with certain specific problems and to clarify doubts regarding the scope and meaning of the provi-

sions. These circulars are issued for the guidance of the officers and/or assessees. The department is
bound by the circulars. While such circulars are not binding the assessees they can take advantage
of beneficial circulars.

Case Laws: The study of case laws is an important and unavoidable part of the study of incometax law. It is not possible for Parliament to conceive and provide for all possible issues that may
arise in the implementation of any Act. Hence the judiciary will hear the disputes between the assessees and the department and give decisions on various issues. The Supreme Court is the Apex
Court of the country and the law laid down by the Supreme Court is the law of the land. The decisions given by various High Courts will apply in the respective states in which such High Courts
have jurisdiction.

Levy of Income-Tax
Income-tax is a tax levied on the total income of the previous year of every person. A person includes an individual, Hindu Undivided Family (HUF), Association of Persons (AOP), Body of Individuals (BOI), a firm, a company etc.

SCHEME OF TAXATION OF INCOME IN INDIA

The constitution authorises the Central Government to levy and collect tax on income other than
agricultural income under Income Tax Act, 1961. The proceeds of income tax are shared between
the Union and the State Governments as per the recommendations of the Finance Commission. Income tax is chargeable on the total income of the previous year of a person at the rates prescribed
by Finance Act every year.

Income Tax can be classified in two parts viz. Personal Income Tax and Corporate Tax. Income tax
levied on individuals, hindu undivided families (HUFs), firms, association of persons (AOPs), body
of individuals (BOIs), local authorities and artificial juridicial persons is called Personal Income
Tax and income tax levied on companies is called Corporate Tax. The incidence of tax on any person depends upon the place of origin of income and the residential status of the taxpayer. According
to their residential status, persons have been classified into three broad categories:
1. Resident
2. Resident but not ordinarily resident
3. Non-Resident

INTRODUCTION AND BASIC CONCEPTS

Income tax is levied by the Central Government under entry 82 of the Union of Schedule VII to
Constitution of India. This entry deals with Tax on income other than agricultural income. This
task is achieved by the enactment of the Income Tax Act, 1961 [The Act].
The Act provides for the scope and machinery for levy and collection of Income Tax in India. It is
supported by Income Tax Rules, 1962 and several other subordinate rules and regulations. Besides,
circulars and notifications are issued by the Central Board of Direct Taxes (CBDT) and sometimes
by the Ministry of Finance, Government of India dealing with various aspects of the levy of Income
tax. Unless otherwise stated, references to the sections will be the reference to the sections of the
Income Tax Act, 1961.
Section 4, which is the charging section, provides that Income tax is a tax on the total income of a
person called the assessee of the previous year relevant to the assessment year at the rates prescribed in the relevant Finance Act.
This phrase sets the tone and agenda of any study on Income Tax Law This comprises of the understanding of the following:
Concept of assessment year and previous year,
Meaning of person and assessee,
How to charge tax on income,
What is regarded as income under the Income-tax Act,
What is gross total income,
What is total income or taxable income and
Income-tax rates

HEADS OF INCOME
Income tax is payable by an assessee on his total income from all the source of income. Each source
has its own unique features and requires specific treatment for correct computation of income from
that particular source. Naturally, rules and method for computation of income from each such
source are different according to the nature of the source.
Under chapter 4 of Income Tax Act, 1961 (Section 14), income of a person is calculated under various defined heads of income. The total income is first assessed under heads of income and then it is
charged for Income Tax as under rules of Income Tax Act. According to Section 14 of Income Tax
Act, 1961, there are following heads of income under which total income of a person is calculated:

1.

Income under the head salaries (Section 15 17)

2.

Income from house property (Section 22 27)

3.

Profits and gains from business or profession (Section 28 44)

4.

Capital gains (Section 45 55)

5.

Income from other sources (Section 56 59)

Importance of different heads

Each head of income provides a different scheme of computation of taxable income under that head
depending upon the nature of income and the complexities attached with that head of income. For
this reason, each of the head of income has its own deeming provisions and provisions for exclusions and deductions and deductions of expenses etc.

It is therefore, necessary that an income belonging to a specific head must be computed under that
head only. If an income cannot be placed under any of the first four heads, it will be taxed under the
head Income from other sources.
Aggregate of net income under various heads gives total income of the assessee person , from
which deductions are made under chapter VIA . The net result is called the total income or sometimes taxable income. Therefore, computation of income under different heads provides the starting
point of determining the tax liability.

Heads to be mutually exclusive

All the heads of income are mutually exclusive. If any income is considered under a particular head
e.g. Income from house property, it will not be taken into consideration for another head e.g. Profits
and Gains from business and profession.
The nature of income is such that at times, it may not be possible to have water-tight compartmentalisation.

Tax on aggregate income under all the heads

Although the income is computed under five different heads of income, tax will be computed on the
aggregate or total income from all the sources taken together at the prescribed rates. However, different tax treatment is given to different items. For instance, Long term Capital gains (LTCG) are
generally taxed at 20%. But LTCG on listed securities is exempt from tax. Similarly, short term
capital gain on sale of equity shares is taxed at 18%. The amount of such short term capital gains
would be deducted from the aggregate total income and accordingly tax rates are applied. Similarly,
shipping companies are taxed on the basis of tonnage of the shipping fleet. Lotteries, horse races etc

are taxed at the maximum rate of tax @ 30% All such incomes are excluded and tax is computed on
rest of the total income.

Common residential status for all the heads

S. 6 provides that where a person is resident for the purpose of any particular head of income, he
will also be considered as resident for the purposes of computation of income under all the heads of
income.

Salary Income Tax - Heads of Income: Salary

What is Salary ?
Income under heads of salary is defined as remuneration received by an individual for services rendered by him to undertake a contract whether it is expressed or implied. According
to Income Tax Act there are following conditions where all such remuneration are chargeable
to income tax:
When due from the former employer or present employer in the previous year, whether paid
or not
When paid or allowed in the previous year, by or on behalf of a former employer or present
employer, though not due or before it becomes due.
When arrears of salary is paid in the previous year by or on behalf of a former employer or
present employer, if not charged to tax in the period to which it relates.

What Income Comes Under Head of Salary?

Under section 17 of the Income Tax Act, 1961 there are following incomes which comes under
head of salary:
Salary (including advance salary)
Wages
Fees
Commissions
Pensions

Annuity
Perquisite
Gratuity
Annual Bonus
Income From Provident Fund
Leave Encashment
Allowance
Awards

What is Leave Encashment?

Leave encashment is the salary received by an individual for leave period. It is a chargeable
income whether he is a government employee or not. Under section 10(10AA) (i) there is also
a provision of exemption in case of leave encashment depending upon whether he is a government employee or other employees.

What is Annuity?
It is an annual income received by the employee from his employer. It may be paid by the
employer as voluntarily or on account of contractual agreement. It is not taxable until the
right to receive the same arises. Under section 56, Income Tax Act, 1961 other annuities come
under a will or granted by a life insurance company or accruing as a result of contract which
comes as income under from other sources.

What is Gratuity?
It is salary received by an individual paid by the employee at the time of his retirement or by
his legal heir in the case of death of the employee.

What is Allowance?
It is the amount received by an individual paid by his/her employer in addition to salary. Under section 15 of the Income Tax Act, 1961 these allowance are taxable excluding few condition where they are entitled of deduction/ exemptions.

Under Income Tax Act following types of allowance are defined

House Rent Allowance:
Under sections 10(13A) of Income Tax Act, 1961 allowance is defined as an amount received
by an employee paid by his/ her employer as a rent of his/her house. It is a taxable income.
There is no exemption in tax if he is living in his own house or house for which he is not paying rent. There are following amount which are exempt from tax:
Actual house rent paid by that individual
Rent paid for the accommodation over 10% of the salary
50% of the salary if house is placed at Delhi, Mumbai, Kolkata, Chennai or 40% of the salary
in it is placed in any other city
Entertainment Allowance:
It is the amount paid by employer for availing entertainment services. Under section 16(ii) of
Income Tax Act, 1961 it is entitled to deduction in tax from is salary. But in this case deduction is given to his gross salary which also includes entertainment allowance. Deduction in tax
against this allowance can be divided into two parts :
In case of Government employee entitled to minimum deduction of
Entertainment allowance received
20% of basic salary excluding any other allowance
Rs. 5000 In case of other employee entitled to minimum deduction of
(a) Entertainment allowance received
20% of basic salary excluding any other allowance

Rs. 7500
Entertainment allowance received during 1954-1955
Other Special Allowances
Children Education Allowance
Tribal Area Allowance
Hostel Expenditure Allowance
Remote Area Allowance
Compensatory Field Area Allowance
Counter Insurgency Allowance
Border Area Allowance
Hilly Area Allowance

Allowances for there is a provision of exempt in income tax are:

Allowance given to a citizen of India, who is a government employee, for rendering services
outside India
Allowances given to Judges of High Courts
Allowance given Judges of Supreme Court
Allowances received by an employee of UNO

What is Perquisite?
Under section 17(2) of Income Tax Act, 1961 perquisite is defined as:
Amount paid for the rent-free accommodation provided to the assessee by his employer
Any concession in the matter of rent respecting any accommodation provided to the assessee
by his employer
Any benefit or amenity granted or provided free of cost or at concessional rate in any of the
following cases:
1. By a company to an employee, who is a director thereof
2. By a company to an employee being a person who has a substantial interest in the company
3. By any employer to an employee whose income under the head 'Salaries' exceeds Rs.24000
excluding the value of non monetary benefits or amenities
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 recognised provident fund or EPF, to effect an assurance on the life of the assessee or to effect a
contract for an annuity

There are following perquisites which are tax free:

Medical facility
Medical reimbursement

Refreshments
Subsidised Luch/ Dinner provided by employer
Facilities For Recreation
Telephone Bills
Products at concessional rate to employee sold by his/ her employer
Insurance premium paid by employer
Loans to employees by given by employer
Transportation
Training
House without rent
Residence Facility to member of Parliament, judges of High Court/ Supreme Court
Conveyance to member of Parliament, judges of High Court/ Supreme Court
Contribution of employers to employee's pension, annuity schemes and group insurance

Deductions from Salary income

Certain deductions are available while determining the taxable salary income.

A) Standard Deduction
Income tax slabs 2009-2010 (for Men) in India:

Income Tax Slab (in Rs.)

Tax

0 to 1,60,000 No Tax
1,60,001 to 3,00,000 10%
3,00,001 to 5,00,000 20%
Above 5,00,000

30%

Income tax slabs 2009-2010 (for Women) in India:

Income Tax Slab (in Rs.)

Tax

0 to 1,90,000 No Tax
1,90,001 to 3,00,000 10%
3,00,001 to 5,00,000 20%
Above 5,00,000

30%

Income tax slabs 2009-2010 (for Senior Citizens) in India:

Income Tax Slab (in Rs.)
0 to 2,40,000 No Tax
2,40,001 to 3,00,000 10%
3,00,001 to 5,00,000 20%
Above 5,00,000

30%

Tax

B) Professional Tax
Professional tax, which is paid, is allowed as deduction.

C) Arrears salary
If salary is received in arrears or in advance, it can be spread over the years to which it relates and be taxed accordingly as per section 89(1) of the Income tax Act.

Disclaimer : This is an information based website, meant for providing assistance to it's readers. The information has been gathered from a number of secondary sources, we do not hold
any responsibility for mis-information or mis-communication.

Heads of Income: House Property

What Is Heads of House Property?

According to Chapter 4, Section 22 - 27 of Income Tax Act, 1961 there is a provision of
income under head of house property. In every section from 22-27 there are detail specification of house property income. It is defined as income earned by a person through his house
or land.

What Income Comes Under Head of House Property?

Annual value of building or land owned by assessee. There is a charge on the potential
of property to generate income not on the rent received. But if property is used for making
profit in business then it will be taxable not under this head but will be taxable under head of
profit in business/ profession.

How to calculate annual value of property?

According to annual value, house property is calculated as
Annual value of a house is zero if property is in the occupation of the owner for his residence
for the whole year & if no other benefit is availed by owner from his property. There will be
no deductions as given under section 24 except deduction interest on borrowed capital
If the owner lets out the house or a part thereof for any period of time during the previous
year the annual value of the property or part has to be calculated for the whole year and the
proportionate annual value of the period for which the house or any part thereof was in the

occupation of the owner for his own residence shall be deducted from the gross annual value.
The assessee in such cases cannot claim deduction under section 24 in excess of the annual
value so determined
The assessee occupies more than one house for his residence, the above exemption is applicable only to one such house at the option of the assessee. The annual value of the other house or
houses shall be computed as if the house or houses are let
In case where the assessee has only one residential house but it cannot be occupied by the
owner by reason of that owing to his employment, business or profession carried out on at any
other place, he has to reside at that other place in a building not belonging to him, the annual
value of such house shall be taken to be nil if the house is not actually let and no other benefit
is derived by the owner from such house. The assessee cannot claim any deduction in such
case as allowable under section 24 of the Act except for interest on borrowed capital subject to
a maximum of Rs. 15,000/-

Heads of Income: Profit in Business/ Profession

According to Income Tax Act, 1961 income under this head is defined as the income earned
by assessee as a profit or gain in his business or profession. Income under this head must follow these conditions:
There must be a business/ profession
Business/ profession is being carried by assessee
Business/ profession have been carried out by assessee in assessment year for which income
tax is filling
What Income Comes Under Head of Profit in Business?
Profits and gains of assessee from any business or profession during assessment year
Any payment or compensation due or received by a person for his services to organization as
a part of his business
Making profit in trade Income of professional or organization against services provided by
that professional/ organization
Profits on sale of a license granted under the Imports (Control) Order, 1955, (EXIM control
Act, 1947)
Cash received or due by any person against exports under government schemes
Any benefit whether it is not in cash coming from business/ profession
Any profit, salary, bonus or commission received by company partners.

Heads of Income: Capital Gains

What is Capital Gain?
According to Income Tax Act,1961 heads of capital gain is defined as gains derived on transfer of capital asset. Capital Gain is the profit or gain of an assessee coming from the transfer
of a capital asset effected during the previous year or assessment year. "Capital Asset" and
transfer are predefined in income tax act.

What is Capital Asset?

Under section 2(14) of the Income Tax Act,1961 Capital Asset is defined as property of any
kind held by assesse including property held for his business or profession. It includes all type
real property as well as all rights in property. It is also defined as gains on transfer of assets in
which there in no cost of acquisition like:
Goodwill of business generated by assessee
Tenacy rights
Stage carriage permits
Loom hours
Right to manufacture
Processing & production of any article or things
Assets Which Don't Come Under Heads of Capital Assets
According to Income Tax Act,1961 there are few assets which don't form a part of Capital Assets, which are as follows:

Stock of goods and raw materials used by assessee for his business or profession
Those property which are movable like wearing apparel, furniture, automobile, phone,
household goods etc. Held by assessee. But Jewelry which is also an movable assets comes under heads of Capital Assets
Agricultural property in India. But agriculture land coming under municipal limits (in area
having population ore than 10,000) comes under Capital Assets. Agriculture lands within 8
Km from municipal limit also comes under Capital Assets if it is notified by the central government of India
Agricultural property in India. But agriculture land coming under municipal limits (in area
having population ore than 10,000) comes under Capital Assets. Agriculture lands within 8
Km from municipal limit also comes under Capital Assets if it is notified by the central government of India
Few Gold Bonds issued by government
Few special bonds issued by central government like Special Bearer Bonds, 1991
Transfer of Capital Assets
Under Section 2(47) of The Income Tax Act,1961 transfer of capital assets is defined as:
Sale, exchange and relinquishment of assets
Extinguishment of any rights in capital assets
Acquisition of capital assets or rights
Conversion of capital asset by its owner as stock in trade of his business, it may also be a term
of transfer

Transfer of immovable property under Section 53A of Transfer of Property Act, 1882
Any transaction by which an assessee become enable to act as a member of cooperative society
Any transaction by which an assessee acquire shares in cooperative society.

Heads of Income: Other Sources

Every type of income comes under a specified heads. But there are few incomes, which don't
come under any of following heads:
Salary
House Property
Profit In Business/ Profession
Capital Gains

So under Section 56(2) of Income Tax Act,1962 all such income comes in this heads of income.
There are following incomes which are taxed under this heads
Income coming as a dividend paid by a company to an assessee
Income coming from winning in lottery, crossword puzzles, races, card games, gambling or
other such sports
Income coming as an amount received by assessee from his employer as a fund for welfare of
employee
Income as an interest on securities
Income coming by letting on hire machinery, plant, furniture, building or other goods Income
coming from insurance policy

Disclaimer : This is an information based website, meant for providing assistance to it's readers. The information has been gathered from a number of secondary sources, we do not hold
any responsibility for mis-information or mis-communication.