UNIT 1: INCOME TAX CONCEPT:

What is Tax?

Let us being by understanding the meaning of tax. Tax is considered to be the

‘cost of living in the society’ Tax is levied by the government to meet the
common welfare expenditure of the society.

Tax is a compulsory contribution to state revenue, levied by the

government on income and business profits or added to the cost of goods
and services and transactions.

Everyone who earning in India has to income tax. The income could be
pension, salary or could be earning from a saving account. Income tax is a tax
you pay directly to the government basis your income or profit. There are two
types of taxes direct taxes and indirect taxes.

Direct Tax is levied directly on the income of the person. Income Tax,
corporate tax, gift tax and Wealth Tax are the part of Direct Tax.

Indirect taxes are levied on the production or consumption of goods and

services or on transactions, including imports and exports.

Before 2017 the Indirect Tax comprises of various taxes and duties like Service
Tax, Sales Tax, Value Added Tax, Customs Duty, Excise Duty and etc. From
July 1st, 2017 all such Indirect Taxes are submerged in one tax law which was
named as ‘The Goods and Services Tax Act, 2017”.

The present law of income tax is contained in the income tax act 1961. The
income tax act contains the provisions for determination of taxable income,
determination of tax liability, procedure for assessment, appeal, penalties and
prosecutions. It is also lays down the power and duties of various income tax
authorities.

The law of Income Tax in India governed by the Income Tax Act of 1961 and the
gaps are being filled by the Income Tax Rules, Notifications, Circulars and
judicial pronouncement including rulings by the Tribunal (a court of justice).
The Income Tax law in India consists of the following components:

1. Income Tax Act, 1961: The Act contains the major provisions related
to Income Tax in India. It come into force on 1 st April 1962. It contains
section 1 to 298.
2. Income Tax Rules, 1962: Central Board of Direct Taxes (CBDT) is the
body which looks after the administration of Direct Tax. The CBDT is
empowered to make rules for carrying out the purpose of this Act.
3. Finance Act: Every year Finance Minister of Government of India
presents the budget to the parliament. Once the finance bill is
approved by the parliament and get the clearance from President of
India, it became the Finance Act. Amendment is made every year to
the income tax and other tax law by finance act.
4. Circulars and Notifications: Sometimes the provisions of an act may
need clarification and that clarification usually in a form of circulars
and notifications which has been issued by the CBDT from time to
time. It includes clarifying the doubts regarding the scope and
meaning of the provisions.

Income Tax concept:

Assessee (Section 2(7))

An assessee is a person or entity who is entitled to pay the taxes. It could be an

individual, an HUF or Hindu Undivided Family, partnership firm, company,
Body of Individuals or AOP (association of persons).

Assessment Year (Section 2(9)):

“Assessment Year” means the year in which income of the previous year of an
assessee is taxed. The timed lap of assessment year is of twelve months
beginning from the 1st April every year. The period starts from 1st April of one
year and ending on 31st March of next year. Broadly, assessment year is
defined under section 2 (9) of the Act.
 Income (Section 2(24))

Starting with income tax basics, the most important term to understand is
what is defined as income. Income, as per the Income Tax Act is set in five
categories that anyone who has a source of earning is liable to pay.

1 Income from Salary

This head essentially includes any remuneration, which is received by an

individual on terms of services provided by him based on a contract of
employment. This amount qualifies to be considered for income tax only if
there is an employer-employee relationship between the payer and the payee
respectively. Salary also  include the basic wages, advance salary, pension,
commission, gratuity, perquisites as well as annual bonus.

The important point to note here is that salary is taxable on due basis or
received basis whichever is earlier. Let me explain this with the help of an
example. If you receive salary for the month of march 2020 in April 2020, it will
still be taxable in previous year 2019-20. This is because it was due in march.
Similarly if your employer has given you salary of April and May in advance in
the month of March, then it will be taxable again in the month of march itself.

Therefore, salary income will be taxable on due basis or received basis

whichever is earlier.

2 Income from House Property

According to the Income Tax Act 1961, Sections 22 to 27 is dedicated to the

provisions for the income tax computation of the total standard income of a
person from the house property or land that he or she owns.

In simple terms, this head includes rental income received from the properties. 
For tax computation purposes, the property in which you are staying and not
earning any rental income can give you benefit. This benefit is in the form of
deductions of interest paid on home loan.

However, if the property is utilized  for letting out the normal course of
business, then the income from the rent will be considered.

3 Income from Profits of Business

 The income tax computation of the total income will be attributed from
the income earned from the profits of business or profession. The difference
between the expenses and revenue earned will be chargeable. Here is a list of
the income chargeable under the head:
 Profits earned by the assessee during the assessment year
 Profits on income by an organisation
 Profits on sale of a certain license
 Cash received by an individual on export under a government scheme
 Profit, salary or bonus received as a result of a partnership in a firm
 Benefits received in a business

4 Income from Capital Gains

Capital Gains are the profits or gains earned by an assessee by selling or

transferring a capital asset, which was held as an investment.

Capital asset can be real estate, stocks, Mutual funds, Bonds, Gold etc.

So whenever you sell a capital asset and earn gains. This is considered as your
income which will be taxable under the head Capital Gain.

Just to clarify, please note that rental income from property is taxed under
“Income from house Property” but if you sell the property and experience gain,
it will be taxed under “capital gain”.

5 Income from Other Sources

This is the last head of income. Any other form of income, which is not
categorized in the above mentioned 4 heads, can be sorted in this category.

Some of the examples can be interest income from bank deposits, lottery
awards, card games, gambling or other sports awards are included in this
category.

These incomes are attributed in the Section 56(2) of the Income Tax Act and
are chargeable for income tax.

Person (section 2 (31)):

The income tax is charged in respect of total income of the previous year of
every person. Here persons include:

1. an Individual;
2. a Hindu Undivided Family (HUF) ;
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.
8. Association of Persons (AOP) or Body of Individuals or a Local authority
or Artificial Juridical Persons shall be deemed to be a person whether or
not, such persons are formed or established or incorporated with the
object of deriving profits or gains or income.

Individual. It refers to a natural human being whether male or female, minor

or major.

Hindu Undivided Family. It is a relationship created due to operation of

Hindu Law. The manager of HUF is called “Karta” and its members are called
‘Coparceners’.

Company. It is an artificial person registered under Indian Companies Act

1956 or any other law.

Firm. It is an entity which comes into existence as a result of partnership

agreement between persons to share profits of the business carried on by all or
any one of them. Though, a partnership firm does not have a separate legal
entity, yet it has been regarded as a separate entity under Income Tax Act.
Under Income Tax Act, 1961, a partnership firm can be of the following two
types

1. a firm which fulfil the conditions prescribed u/s 184.

2. A firm which does not fulfil the conditions prescribed u/s 184.

It is important to note that for Income Tax purposes, a limited liability

partnership (LLP) constituted under the LLP Act, 2008 is also treated as a firm.

Association of Persons or Body of Individuals. Co-operative societies,

MARKFED, NAFED etc. are the examples of such persons. When persons
combine together to carry on a joint enterprise and they do not constitute
partnership under the ambit of law, they are assessable as an association of
persons. Receiving income jointly is not the only feature of an association of
persons. There must be common purpose, and common action to achieve
common purpose i.e. to earn income. An AOP. can have firms, companies,
associations and individuals as its members.
A body of individuals (BOl) cannot have non-individuals as its members. Only
natural human beings can be members of a body of individuals.

Whether a particular group is AOP. or BOl. is a question of fact to be decided in

each case separately.

Local Authority. Municipality, Panchayat, Cantonment Board, Port Trust etc.

are called local authorities.

Artificial Juridical Person. A public corporation established under special Act

of legislature and a body having juristic personality of its own are known to be
Artificial Juridical Persons. Universities are an important example of this
category.

Previous Year (Section 3)

Income earned during the year is taxable in the next year. The definition of
“Previous Year” is given under section 3 of the Act. Previous Year is the year in
which income is earned. Previous year is the financial year immediately
proceeding the relevant assessment year. From 1989-90 onwards, every
taxpayer is obliged to follow financial year (i.e., April 1st of one year to March
31st of next year) as the previous year.

For a newly set up business or profession, the first previous year will start from
the day from which that business or profession has commenced, but the period
of ending will remains same (i.e., 31st March).

Illustration 1: X set up business on July 20, 2016. What is the previous year
for the assessment year 2017-18?

Solution: Previous year for the assessment year 2017-18 is the period

commencing from the date of setting up of business/ profession (i.e., July 20,
2016) and ending on March 31, 2017.

Illustration 2: Mr X joins an Indian company on January 21, 2016. Prior to

joining this company, Mr X was not in employment anywhere nor does he have
any other source of earning. Determine the previous year of Mr X for the
assessment year 2016-17 and 2017-18?
Solution: Previous year for the assessment year 2016-17 and 2017-18 are as
follows:

Previous Year Assessment Year

Jan. 20, 2016 to March 31, 2016 2016-17

April 1, 2016, to March 31, 2017 2017-18

Agriculture income (Section 2(1-A)):

Agriculture income earned by a taxpayer in India is exempt under Section 10(1)
of the Income Tax Act, 1961. Agricultural income is defined under section 2(1A)
of the Income-tax Act.
As per section 2(1A), agricultural income generally means 
(a) Any rent or revenue derived from land which is situated in India and is used
for agricultural purposes.
(b) Any income derived from such land by agriculture operations including
processing of agricultural produce so as to render it fit for the market or sale of
such produce.
(c) Any income attributable to a farm house subject to satisfaction of certain
conditions specified in this regard in section 2(1A). Any income derived from
saplings or seedlings grown in a nursery shall be deemed to be agricultural
income.
Meaning of Agricultural Income:
Section 2 (1A) of the Income Tax Act, 1961 defines “agricultural income” as an
income under the following three sources:
(i) Any rent or revenue derived from land which is situated in India and
is used for agricultural purposes: The assessee will not be liable to pay tax
on the rent or revenue arising from agricultural land subject to the conditions:
(a) The land should either be assessed to land revenue in India or be subject to
a local rate assessed and collected by officers of the Government.
(b) In instances where such a land revenue is not assessed or not subject to
local rate, the land should not be situated within the jurisdiction of a
 municipality (whether known as a municipality, municipal corporation, notified
area committee, town area committee, town committee or by any other name)
or a cantonment board, and which has a population of more than ten thousand
(according to the last preceding census which has been published before the
first day of the previous year in which the sale of land takes place); or it should
not be situated:

 More than 2kms. from the local limits of any municipality or cantonment
board and which has a population of more than 10,000 but not exceeding
1,00,000; or
 not being more than 6kms. from the local limits of any municipality or
cantonment board and which has a population of more than 1,00,000 but not
exceeding 10,00,000; or
 not being more than 8kms. from the local limits of any municipality or
cantonment board and which has a population of more than 10,00,000.
(c) The revenue must not include any income arising out of transfer of such
land.

Further, a direct nexus between the agricultural land and the receipt of income
by way of rent or revenue is essential. (For instance, a landlord could receive
revenue from a tenant.)
(ii) Any income derived from such land by agricultural operations including
processing of agricultural produce, raised or received as rent in kind or any
process ordinarily employed by cultivator or receiver of rent-in-kind so as to
render it fit for the market, or sale of such produce.
(iii) Any income derived from any building owned and occupied by the
assessee, receiving rent or revenue from the land, by carrying out
agricultural operations: The building must be on or in the immediate vicinity
of the land. It must be used by the assesee as a dwelling house or store-house
or an out-building, in connection with the land.

The following are some of the examples of agricultural income:

 Income derived from sale of replanted trees.
 Income from sale of seeds.
 Rent received for agricultural land.
 Income from growing flowers and creepers.
  Profits received from a partner from a firm engaged in agricultural
produce or activities.
 Interest on capital that a partner from a firm, engaged in agricultural
operations, receives.

The following are some of the examples of non-agricultural income:

 Income from poultry farming.
 Income from bee hiving.
 Any dividend that an organization pays from its agriculture income.
 Income from the sale of spontaneously grown trees.
 Income from dairy farming.
 Income from salt produced after the land has flooded with sea water.
 Purchase of standing crop.
 Royalty income from mines.
 Income from butter and cheese making.
 Receipts from TV serial shooting in farm house.

Gross total income

Gross total income (GTI) is the sum of incomes computed under the five heads
of income i.e. salary, house property, business or profession, capital gain and
other sources after applying clubbing provisions and making adjustments of
set off and carry forward of losses.

GTI = Salary Income + House Property Income + Business or Profession

Income + Capital Gains + Other Sources Income + Clubbing of Income -
Set-off of Losses

Residential status and their incidence of tax:

Tax incidence on an assessee depends on his residential status.

For instance, whether an income, accrued to an individual outside india, is

taxable in india depends upon the residential status of the individual in india.
Similarly, whether an income earned by a foreign national in india (or outside
india) is taxable in india, depends on the residential status of the individual,
rather than on his citizenship. Therefore, the determination of the residential
status of a person is very significant in order to find out his tax liability.