LAW OF TAXATION

Tax is a fee charged by a government on a product, income or activity.

There are two types of taxes. Direct taxes and indirect taxes.

Direct tax
If tax is levied directly on the income or wealth of a person, then it is a direct tax e.g. income-tax, wealth tax.

Indirect tax
Taxes that are indirectly imposed on the public through goods and services are called indirect taxes.

Various indirect taxes which were imposed by the central and state government are incorporated by GST.

Constitutional provisions relating to Taxation

Article 265 of the Constitution of India says that "No tax shall be levied or collected except by authority of law".

Distribution of powers of taxation

 List 1 in the 7th schedule to the constitution has the powers of the Central Government listed in Entries 82-92B.
 List 2 in the schedule has the powers of the State Government listed in Entries 45-63.
 Entry 97 of List 1 in the 7th Schedule contains residuary powers of taxation belonging only to the centre.

Nature and Scope of Income Tax

The definition of income as per the Income-tax Act begins with the words “Income includes”.

Therefore, it is an inclusive definition and not an exhaustive one.

Such a definition does not confine the scope of income but leaves room for more inclusions within the ambit of the term.

The CBDT administers the Income Tax Department, which is a part of the Department of Revenue under the Ministry of
Finance, Govt. of India.

The Income Tax Law consists of :

 Income Tax Act 1961,

 Income Tax Rules 1962,
 Notifications and Circulars issued by (CBDT),
 Annual Finance Acts and
 Judicial pronouncements by the Supreme Court and High Courts.
Definitions-
Section 2 of the Income Tax Act:

(31) "person" includes—

i. an individual,
ii. a Hindu undivided family,
iii. a company,
iv. a firm,
v. an association of persons or a body of individuals, whether incorporated or not,
vi. a local authority, and
vii. every artificial juridical person, not falling within any of the preceding sub-clauses.

Explanation— For the purposes of this clause, an association of persons or a body of individuals or
a local authority or an artificial juridical person shall be deemed to be a person, whether or not
such person or body or authority or juridical person was formed or established or
incorporated with the object of deriving income, profits or gains;

(7) "assessee" means a person by whom any tax or any other sum of money is payable under this Act, and
includes—
(a) every person in respect of whom any proceeding under this Act has been taken for the
assessment of his income or assessment of fringe benefits or of the income of any other
person in respect of which he is assessable, or of the loss sustained by him or by such other
person, or of the amount of refund due to him or to such other person;
(b) every person who is deemed to be an assessee under any provision of this Act;
(c) every person who is deemed to be an assessee in default under any provision of this Act (for
eg- employer should deduct tax from the salary of the employee before giving the salary)

(9) "assessment year" means the period of twelve months commencing on the 1st day of April every year
Assessment year is the financial year (commencing on the 1st April and ending on 31st March) following the previous
year.

"Previous year" defined.

Section 3. For the purposes of this Act, "previous year" means the financial year immediately preceding the
assessment year:
Provided that, in the case of a business or profession newly set up, or a source of income newly coming into
existence, in the said financial year, the previous year shall be the period beginning with the date of setting up
of the business or profession or, as the case may be, the date on which the source of income newly comes into
existence and ending with the said financial year.
Assessment Year: 2023 – 2024
Financial Year: Period: April 1, 2023 – March 31, 2024

Previous year 2022 – 2023

Financial Year: Period: April 1, 2022 – March 31, 2023
Income earned in a previous year is chargeable to tax in the assessment year.
Income normally refers to revenue receipts.

Capital receipts are generally not included within the scope of income.

However, certain capital receipts are considered as income and taxable under the head Capital gains.
e.g. gains on sale of commercial land

The Income Tax Act has not discussed the concept of capital and revenue therefore we have to depend upon the
accounting principles and judicial pronouncements.

What Are Capital Receipts?

Capital receipts are payments received by a company that are not income in nature and enhance the company's overall
capital. These are funds generated by a company's non-operating operations and appear on the balance sheet rather than
the income statement.

They are non-recurring, meaning they do not occur regularly. They end up increasing a company's obligations or
decreasing its assets. These types of receipts have no impact on an organization's total profit or loss. Capital receipts are of
long-term in nature.

Capital Receipts Examples-

 Amount received from the sale of fixed assets.

 Amount received from Shareholders holders
 Borrowings include loans, insurance claims, etc.:- These loans create liability for the company. These loans are
non-recurring in nature.

CASE = CIT V Rajaram Maize Products 2002

What are Revenue Receipts?

Revenue receipts are funds a company receives due to its primary business operations. It leads to an increase in the
company's total revenue. Because a company's operating activities create these funds, they are recorded in the trade and
profit and loss account rather than the balance sheet. They are recurrent and can be seen frequently and used for profit
distribution. Revenue receipts are of short-term nature

Revenue Receipts Examples:

Some instances of revenue receipts in an organization are:

 Money received for services provided to customers

 Rent received
 Discounts received from suppliers, vendors, or creditors
 Interest earned
 Commission received
 Revenue earned by the sale of scrap material or waste, etc.

CASE = CIT V Saurashtra Cement Ltd 2010

Income means net receipts and not gross receipts.

Net receipts are arrived at after deducting the expenditure incurred in connection with earning such receipts.
WHAT IS EXEMPT INCOME AND TAXABLE INCOME?
An exempt income is not charged to tax, i.e., Income-tax Law specifically grants exemption from tax to such
income. (Incomes which are chargeable to tax are called as taxable incomes.)

Agricultural income

Agricultural income is not taxable. However, if you have non-agricultural income too, then while calculating tax on
non-agricultural income, your agricultural income will be taken into account for rate purpose.

 Under the Constitution Parliament has no power to levy tax on agricultural income.
 Only the State Governments are empowered to levy tax on agricultural income.
 Therefore, Acc to Sec 10(1) of the I.T Act agricultural income is exempt from central income tax.
 But w.e.f assessment year 1974-75 agricultural income become a factor in determination of tax on non
agricultural income.
 Sec 2 (1A) defines agricultural income.

3 basic conditions which must be satisfied before a particular income may be treated as agricultural income are as
follows:

 any rent or revenue derived from land

 which is situated in India and
 is used for agricultural purposes

CASE = CIT V Raja Benoy Kumar Sahas Roy 1957

Definition of Income Sec 2(24)

 The definition of income as per the Income-tax Act begins with the words “Income includes”. Therefore, it is an
inclusive definition of income and not an exhaustive one.
 Such a definition does not confine the scope of income but leaves room for more inclusions within the ambit of
the term.
 The word income includes not only those things which are included in Sec 2(24) but will also include
within its import such things as the word signifies according to its natural or literal meaning.

Universal Radiators VS CIT; 1993

CIT VS G R KARTHIKEYAN; 1993

 It was held that even if a receipt does not fall within the ambit of any of the sub clauses in S 2(24) it still be
income if it partakes of the nature of income.
 The idea behind providing inclusive definition in Sec 2(24) is not to limit its meaning but to widen its net.
 The word income is of widest amplitude and it must be given its natural and grammatical meaning.
 Its ambit should be the same as that of the word income occurring in entry 82 of list 1 of the 7th schedule to the
constitution.
Thus, the following general principles emerge regarding the concept of income

1. Regularity of income
 Income is a periodical monetary return coming with some sort of regularity or expected regularity from
definite sources.
 However recurring nature is not an absolute necessity in order that an item may be designated as income for
the purposes of income tax.
 Thus income may not necessarily be recurring in nature though it is generally of that character.

2. Form of income
 It is not necessary that the income must be received in the form of money.
 Receipts in kind or service having money equivalent can also be income.
 The income arises either on receipt basis or accrual basis but the substance of the matter is income.
 If an assessee has earned income but has not actually received it it will be treated as income of assessee
because he is entitled to receive it.

3. Illegal income
 Income earned by unlawful means is also assessable if it satisfies the prescribed conditions of receipt or
deemed receipt, accrual or deemed accrual as the case may be.
 However, any expense or loss incurred by an assessee in carrying on such business is not deductible as per
Sec 37(1).

4. Connection with outside agency

Money received by a woman from husband for private use or household expenses shall not be considered as
her income for the purposes of income tax.
Any property acquired with such money or savings would be the capital asset belonging to woman.
RBNJ Naidu V CIT 1956.

Compensation from insurance company against injuries sustained in a road accident is not income.

5. Diversion of income by overriding title and application of income

 Where by an obligation income is diverted by an overriding title of another person to the income before
it reaches the assessee it is Diversion of income and not taxable.
 Where the income is required to be applied to discharge an obligation after such income reaches the
assessee it is an application of income and is taxable.
 In order to decide whether a particular income is a Diversion of income or application of income it has to
be determined whether it reaches the assessee as his own income or not.

CIT V Sunil J Kinariwala 2003

 Court observed that the determinative factor is the nature and effect of assessee’s obligation in regard to the
amount in question.
 Where such obligation entitles a third person to receive the amount before the assessee could lay a claim to
receive the same as his income there is Diversion of income by an overriding title.
  But where after the receipt of income by the assessee the same is passed on to a third person in discharge of
an obligation that would be a case of application of income not Diversion of income.

Section 6 of the Income Tax Act deals with the Residential status

The taxability of an individual in India depends upon his residential status in India for any
particular financial year.

The term residential status has been coined under the income tax laws of India and must not be
confused with an individual’s citizenship in India.

An individual may be a citizen of India but may end up being a non-resident for a particular year.

Residential status under Income Tax Act 1961

Resident Non-resident (NR)

Resident And Resident but not-

ordinary resident ordinary resident
(ROR) (RNOR)

HOW TO DETERMINE THE RESIDENTIAL STATUS OF AN INDIVIDUAL?

To determine the residential status of an individual, the first step is to ascertain whether he is resident or non-
resident.

If he turns to be a resident, then the next step is to ascertain whether he is resident and ordinarily resident or is a
resident but not ordinarily resident.

Step 1: Determining whether resident or non-resident

Resident- an individual will be treated as a resident in India for a year if he satisfies any of the following
conditions:

(1) He is in India for a period of 182 days or more in that year; or

(2) Alternatively, the person has to stayed in India for at least 60 days in the preceding year and has also lived in
India for a total of 365 days or more during the four years immediately preceding the relevant financial year (PY).

Exceptions to Residential Status

In respect of an Indian citizen and a person of Indian origin who leaves India in any previous year as a crew member
or for the purpose of employment outside India, the period of 60 days as mentioned in (2) above shall be substituted
with 182 days.
 Same provisions are applicable for a citizen of India, or a person of Indian origin within the meaning of Explanation
to clause (e) of section 115C, who, being outside India, comes on a visit to India in any previous year

The Finance Act, 2020, w.e.f., Assessment Year 2021-22 has amended the above exception to provide that the
period of 60 days as mentioned in (2) above shall be substituted with 120 days, if an Indian citizen or a person of
Indian origin whose total income, other than income from foreign sources, exceeds Rs. 15 lakhs during the previous
year.

Income from foreign sources means income which accrues or arises outside India (except income derived from a
business controlled in or a profession set up in India).

However, such individual shall be deemed to be Indian resident only when he is not liable to tax in any country or
jurisdiction by reason of his domicile or residence or any other criteria of similar nature.

Thus, from Assessment Year 2021-22, an Indian Citizen earning total income in excess of Rs. 15 lakhs (other than
from foreign sources) shall be deemed to be resident in India if he is not liable to pay tax in any country.

Note: The Finance Act, 2020 has introduced new Section 6(1A) to the Income-tax Act, 1961. The new provision
provides that an Indian citizen shall be deemed to be resident in India if his total income, other than income from
foreign sources, exceeds Rs. 15 lakhs during the previous year.

Step 2: Determining whether resident and ordinarily resident or resident but not ordinarily resident

If an individual qualifies as a resident, the next step is to determine if he is a Resident ordinarily resident (ROR) or
an RNOR.

He will be a ROR if he meets both of the following conditions:

1. Has been a resident of India in at least 2 out of 10 years immediately previous years and

2. Has stayed in India for at least 730 days in 7 immediately preceding years

Therefore, if any individual fails to satisfy even one of the above conditions, he would be an RNOR.

From FY 2020-21, a citizen of India or a person of Indian origin who leaves India for employment outside India
during the year will be a resident and ordinarily resident if he stays in India for an aggregate period of 182 days or
more.

However, this condition will apply only if his total income (other than foreign sources) exceeds Rs 15 lakh.

Also, a citizen of India who is deemed to be a resident in India (w.e.f FY 2020-21) will be a resident and ordinarily
resident in India.

 If the individual does not satisfy any of the conditions specified at step one, then he will become non-resident.
Taxability
Resident:

A resident will be charged to tax in India on his global income i.e. income earned in India as well
as income earned outside India.

NR and RNOR:

Their tax liability in India is restricted to the income they earn in India.

They need not pay any tax in India on their foreign income.

Income Tax Exemption on Gratuity

Basics of Gratuity
Gratuity is a monetary benefit given by the employer

The provisions of gratuity are governed by the Payment of Gratuity Act, 1972.

Eligibility to Get Gratuity

The employer will pay gratuity when the employee satisfies the following conditions:

 The employee should be drawing wages as a full-time employee of an organisation.

 An apprentice is not eligible to receive gratuity.

 The employee should be in continuous service for a minimum of 5 years.

 The employee can also get gratuity upon resignation, superannuation, disablement due to
accident or disease, or death.

 The condition of 5 years is not applicable in the case of disablement or death.

Employees Covered Under the Payment of

Gratuity Act
Every individual – working in a factory, mine, oil field, port, railways, plantation, shops &
establishments, or educational institution having 10 or more employees on any day in the preceding
12 months – is entitled to gratuity.

Once the Act becomes applicable to an employer, even if the number of employees goes below 10,
gratuity is still applicable.

Exemptions on Gratuity
For the purposes of exemption under Section 10(10) of the Income Tax Act the employees have
been divided into the following 3 categories –

Exemptions on gratuity received by government sector employees

The gratuity given to employees working in a government sector upon their termination, retirement
or superannuation are fully exempted from paying tax under Section 10(10) (i).

It is applicable to employees of the central government, state government, defense sector, members
of civil services and other local authorities.
Exemptions on gratuity received by private sector employees

The income tax exemption on gratuity given to employees working in the private sector depends on
whether they are covered under the Payment of Gratuity Act or not.

When private sector employees are covered under the Act under Section 10(10) (ii)

under the Payment of Gratuity Act The least of the following is exempt from tax:

 Last salary (basic + DA)* number of years of employment* 15/26;

 Rs. 20 lakhs (which has been hiked from Rs. 10 Lakh as per the amendment);

 Gratuity Actually received

Sr.
Particulars As Amended
No.

1 Last drawn salary (Basic + DA) 1 lakh

Number of years of employment 20 (will be rounded off)

1,00,000*20*15/26 =
Gratuity
11,53,846

2 Maximum exemption allowed 20 lakhs (as amended)

3 Gratuity actually received 11 lakh

 Amount of exemption (least of the
11 lakh
above)

Taxable gratuity –

When private sector employees are not covered under the Act

There is no law that restricts an employer from paying gratuity to his employees, even if the
organization is not covered under the Payment of Gratuity Act.

under Section 10(10)(iii) of the Income Tax Act

The least of the following are exempt from tax:

 Last 10 month’s average salary (basic + DA)* number of years of employment* 1/2;

 Rs. 10 lakhs (the hike to Rs 20 lakhs is not applicable for employees not covered under
the Payment of Gratuity Act)

 Gratuity actually received

Sr. No. Particulars Amount (Rs.)

1 Average of last 10 month’s salary 90,000

Number of years of employment 25 (will be rounded off)

Gratuity 90,000*25*1/2 = 11,25,000

2 Maximum exemption allowed 10 lakhs

3 Gratuity actually received 11 Lakhs

Amount of exemption (least of the three) 10 Lakhs

Taxable Gratuity 1 Lakh