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INCOME TAX

MODULE 2

INTRODUCTION:
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:

Heads of Income: Salary


Heads of Income: House Property
Heads of Income: Profit In Business/ Profession
Heads of Income: Capital Gains
Heads of Income: Other Sources

HEADS OF INCOME: 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 In order to understand the meaning of expression "salary", one has to keep in
mind the following norms:

Relationship between payer and payee


Salary and wages - Conceptually not different
Salary front former employer, present employers or prospective employer
Salary income must be real and not fictitious
Foregoing of salary
Voluntary payments
Salary paid tax-free

Under section 17(1), salary is defined to include the following:


a. wages ;
b. any annuity or pension ;
c. any gratuity;
d. any fees, commission, perquisites or profits in lieu of or in addition to any salary or wages ;
e. any advance of salary ;
f. any payment received by an employee in respect of any period of leave not availed by him ;
g. the portion of the annual accretion in any previous year to the balance at the credit of an
employee participating in a recognized provident fund to the extent it is taxable ;
h. transferred balance in a recognized provident fund to the extent it is taxable; and
i. the contribution made by the Central Government or any other employer to the account of an
employee under a notified pension scheme referred to in section 80CCD.

BASIS OF CHARGE OF SALARY INCOME


Basis of charge as per section 15 - As per section 15, salary consists of :
Any salary due from an employer (or a former employer) to an assessee in the

previous year, whether actually paid or not;

Any salary paid or allowed to him in the previous year by or on behalf of an

employer (or a former employer), though not due or before it became due; and

Any arrears of salary paid or allowed to him in the previous year by or on

behalf of an employer (or a former employer), if not charged to income-tax for


any earlier previous year.

ALLOWANCE
Allowance is generally defined as a fixed quantity of money or other substance

given regularly in addition to salary for the purpose of meeting some particular
requirement connected with the services rendered by the employee or as
compensation for unusual conditions of that service.

Perquisite: Perquisite may be defined as any Casual Emolument or Benefit

attached to an office or position in Addition to Salary or Wages. It also denotes


something that benefits a man by going in to his own pocket. Perquisites may
be provided in cash or in kind. Perquisites are included in salary income only
if they are received by an employee from his employer.

THE TAX FREE PERQUISITES


Medical

facility, Medical reimbursement

Refreshments Subsidized Lunch/ 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

TAXABLE PERQUISITES
Rent-free accommodation
Concessional rent accommodation
Gifts given by employer exceeding Rs.50000
Interest free loan exceeding Rs.20000.

House Rent Allowance:- Provided that expenditure on rent is


actually incurred, exemption available shall be the least of the
following :
(i) HRA received.
(ii) Rent paid less 10% of salary.
(iii) 40% of Salary (50% in case of Mumbai, Chennai, Kolkata,
Delhi) Salary here means Basic + Dearness Allowance, if
dearness allowance is provided by the terms of employment.

What is included in fringe benefits and how are they taxed?


The Finance Act 2005 has introduced a new tax called Income-tax on fringe benefits w.e.f.

01.04.2006. This shall be in the form of additional income tax levied on fringe benefits provided
or deemed to have been provided by an employer to his employees during the previous year.

Rate of Tax : The tax on fringe benefits shall be levied at the rate of 30% on the value of fringe benefits

provided.

Liability to Pay: The liability to pay this tax is to be borne by the employer including

i) a company
ii) a firm
iii) an association of persons or body of individuals excluding any fund or trust or institution
eligible for exemption u/s 10(23C) or 12AA.
iv) a local authority
v) an artificial juridical person

INCOME FROM 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 2227 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.

CONCEPT OF BUSINESS AND PROFESSION

(1) Business: According to Section 2(13), Business includes any


Trade - It means purchase and sale of goods carried on with

profit motive
Commerce - It means trade carried on a large scale.
Manufacture- Making of new and different article out of input
material by Physical or mechanical labour.
Any adventure or concern in the nature of trade, commerce or
manufacture-

The expression adventure in nature of trade clearly suggests that the

transaction cannot be properly regarded as trade or business. A single isolated


transaction outside the assessees line of business may constitute adventure in
nature of trade and commerce.
Whether an activity is an adventure or concern in the nature of trade,

commerce or manufacture is to be decided on the basis of cumulative effect


of the facts and circumstances of each case.
An example of such adventure or concern is where the assessee purchases a

plot of land and builds a complex on it and divides it into office spaces and
sells each of these, thereby making a profit from the entire activity.

ESSENTIAL FEATURES OF A BUSINESS ARE :


(a) Regularity of transactions or continuity of activities;
(b) Objective of earning profits;
(c) Application of labour and skill

(2) PROFESSION: AS PER SECTION 2(36), PROFESSION INCLUDES


VOCATION.
Profession- It involves occupation requiring purely intellectual or

manual skill, which is based on continuous learning and experience.


It is exercised to earn a living. E.g. Politics is a profession.
Vocation - It means any work performed on the strength of ones
natural ability for that work. It need not be for making an income
nor need it involve any systematic and organized activity.

INCOMES CHARGEABLE TO TAX UNDER THE HEAD PROFITS


AND GAINS OF BUSINESS OR PROFESSION [SECTION 28]
(1) Profits and gains of any business or profession carried on by assessee at any

time during previous year.


(2) Compensation or other payment due to or received by any person.

(3) Income derived by trade, professional or other similar association from


specific services rendered to its members.
(4) Profits on sale of import licence;
(5) Cash assistance against exports from Government of India and Duty
Drawback;

(6) Value of any benefit or perquisite, whether convertible into money or not
arising from exercise of business or profession;
(7) Interest, salary, bonus, commission or remuneration due to or received by
partner from the firm. Such income is taxable in hands of partners to the extent
it is allowed as deduction in hands of firm. Any amount not allowed as
deduction to firm under Section 40(b), is not taxable in the hands of partner.

(8) Any sum received or receivable, in cash or in kind, under an agreement for
(a) Non-competition i.e. not carrying out any activity in relation to any business; or
(b) Exclusivity i.e. not sharing any know-how, patent, copyright, trademark, license,
franchise or any other business or commercial right of similar nature or information or
technique likely to assist in the manufacture or processing of goods or provision of services.
Exceptions : However, sum received for transfer of business, or transfer of right to
manufacture, produce or process any article/thing, which is chargeable under Capital Gains
is not taxable under this Section.
(9) Any sum (including bonus) received under Keyman Insurance Policy.

GENERAL CONDITIONS TO BE FULFILLED FOR CHARGING AN INCOME


UNDER THE HEAD PROFITS AND GAINS OF BUSINESS OR PROFESSION

(1) There should be profits and gains: Only real profits and gains are liable to
income tax and not mere gross receipts. However, there is an exception; stock- intrade is valued at lower of cost or market price.
(2) Profits and gains may be of any business or profession: Profits and gains from
an illegal business are also chargeable to tax under this head. However, the
following incomes are not taxable under this head :
(a) Rent of house property is taxable under Section 22 even if property constitutes
stock in trade of recipient of rent or the recipient of rent is engaged in the business
of letting properties on rent.
(b) Dividends are taxable under the head Income from Other Sources even if
securities are held as stock-in-trade or assesee is a dealer in shares.

(3) Business or profession must be carried on by assessee:


The profits and gains from business or profession are taxable in the hands of

the person who has the right to carry on the business.

A company becomes a legal entity in the eye of law only when it is

incorporated. Therefore, the pre-incorporation profits cannot be included in


the assessment of the assessee-company. For such profits, only the promoters
can be held liable.

(4) Business or profession should be carried on at any time during

previous year: The business or profession must have been carried on


for some time during the previous year. However, a temporary
suspension of activities of the business does not necessarily amount
to discontinuance of the business.

What is the scheme of business deductions/ allowance:

Before studying the nature and amount of permissible and non permissible
deductions under sections 30 to 43D, it will be useful if one keeps in view the
following principles governing admissibility of these deductions:
(1) The allowances laid down under Section 30 to 37 are cumulative and not
alternative.
(2) Expenditure should have been incurred in connection with assessees own
business.
(3) Expenditure should relate to the previous year in which business has been
carried on.

(4) Onus to proof it is the responsibility of the assessee to prove that a


particular deduction is admissible in his case.
(5) No allowance in respect of expenditure incurred before date of setting-up
of business: In case of newly set up business or profession, previous year
commences on the date of its setting-up. So, any expenditure incurred before
setting up of business or profession is not deductible. It is only when the unit
has been put into such a shape that it can start functioning as a business or
manufacturing organization that it can be said to be set up.

6. No allowance in respect of non-assessable business.


7. Expenditure relating to illegal business.
8. no allowance in respect of anticipated losses.
9. no deduction in respect of depreciation of investment
10. benefit of expenditure may extend to somebody else.
11. no allowance in respect of exhaustion of wasting assets.

WHAT ARE THE SPECIFIC DEDUCTIONS UNDER THE


ACT?
Sections 30 to 37 cover expenses which are expressly allowed as

deduction while computing business income, sections 40, 40A &


43B cover expenses which are not deductible.
The following expenses are expressly allowed as deductions against
profits and gains of business or profession

DEDUCTION IN RESPECT OF RENT, RATES, TAXES, REPAIRS AND


INSURANCE FOR BUILDING, ETC. [SECTION 30 ]
The following are allowable as deduction in computing the income under the

head Profits and Gains of Business or Profession

(1) Rent paid for premises occupied by assessee as tenant and used for his
Business or Profession.
(2) Expenditure on repairs of premises paid by owner thereof or tenant.
However, capital expenditure on repairs shall not be eligible for deduction, but
depreciation can be claimed thereon.

(3) Land revenue, local rates or municipal taxes paid for premises,
(4) Insurance premium paid for premises, plant and machinery or furniture
against risk of damage or destruction thereof.
for plant and machinery and furniture [section 31]
(5) Current repairs (excluding capital expenditure) paid for plant and machinery
or furniture used for business purposes is allowable as deduction under sec.31.

CONDITIONS TO BE FULFILLED IN ORDER TO CLAIM


DEPRECIATION UNDER SECTION 32
In order to claim depreciation under Section 32, the following conditions are

required to be fulfilled:

1. asset must be owned by the assessee.


2. it must be used for the purpose of business or profession
3. It should be used during the relevant previous year.
4. Depreciation is available on tangible as well as intangible assets.