Basic Concepts of Income Tax

Table of Contents:

1. Income Tax Law

2. Charge of Income-tax: [Sec. 4]

3. Assessment year: [Sec. 2(9)]

4. Previous year: [Sec. 3]

5. Person: [Sec. 2(31)]

6. Assessee: [Sec. 2(7)]

7. Certain Principles relating to Income under Income-tax Act

8. Income: [Sec. 2(24)]

9. Heads of Income: [Sec. 14]

10. Total Income and Computation of Tax Liability

11. Exemption and Deduction in respect of income

12. Rounding off of Income: [Sec. 288A]

13. Rounding off of Tax: [Sec. 288B]

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1. Income Tax Law

Income-tax is a tax levied on the total income of an assessee, being a person charged under the provisions of this Act, for the relevant previous year.

For understanding Income tax law in India, the following components need to be studied carefully:

(1) Income-tax Act, 1961

(2) Annual Finance Acts

(3) Income-tax Rules, 1962

(4) Notification and Circulars, issued from time to time

(5) Judicial Decisions

1.1 Income-tax Act, 1961

The levy of income-tax in India is governed by the Income-tax Act, 1961 which extends to whole of India and came into force on 1^st April, 1962. The Act contains 298 sections and XIV schedules. It contains provisions for determination of taxable income, tax liability, assessment procedures, appeals, penalties and prosecutions. These undergo changes every year with additions and deletions brought by the Annual Finance Act passed by the Parliament.

1.2 Annual Finance Acts

Every year, Finance Bill is introduced by the Finance Minister of the Government of India in the Parliament’s Budget Session. When the Finance Bill is passed by both the Houses of the Parliament and gets the assent of the President, it becomes the Finance Act. Amendments are made every year to the Income-tax Act, 1961 and other tax laws by the Finance Act. Finance Bill also mentions the Rates of Income tax and other taxes given in various schedules which are attached to it. Therefore, though Income-tax Act is a settled law, the operative effect is given by the Annual Finance Act.

1.3 Income-tax Rules, 1962

Central Board of Direct Taxes (CBDT) looks after the administration of direct taxes and is empowered u/s 295 of the Income Tax Act, to make rules for carrying out the purposes of the Act and thereby it frames various rules from time to time for the proper administration of the Income-tax Act, 1961. These rules were first framed in 1962 and are thereby collectively called Income-tax Rules, 1962. It is important to read these rules along with the Income-tax Act, 1961. The power to make rules under this section shall also include the power to give retrospective effect, but not earlier than the date of commencement of this Act. However, such retrospective effect shall not be given so as to prejudicially affect the interests of the assessees.

1.4 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 provisions. These circulars are issued for the guidance of the officers and/or assessees. These circulars are binding on the department and not on the assessee and therefore the assessee can take advantage of beneficial circulars.

Notifications are issued by the Central Government to give effect to the provisions of the Act. For example, u/s 10(15)(iv)(h), interest on bonds and debentures are exempt by the Central Government subject to such conditions through Notifications. The CBDT is also empowered to make and amend rules for the purposes of the Act by issue of notifications. For example, u/s 35CCD, the CBDT is empowered to prescribe guidelines for notification of skill development project.

1.5 Judicial Decisions

Judicial decisions are an important and unavoidable part of the study of income-tax law. For the Parliament, it is not possible to provide for all possible issues that may arise in the implementation of any Act and hence the judiciary will have to consider various cases 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. In case, where the apparently contradictory decisions are given by benches having similar number of judges, the principle of the later decision would be applicable. The decisions given by various High Courts will apply in the respective states in which such High Courts have jurisdiction.

2. Charge of Income-tax: [Sec. 4]

Tax cannot be levied or collected in India except under the authority of Law. Section 4 of the Income- tax Act, 1961 gives authority to the Central Government for charging income tax. This is the charging section in the Income-tax Act, 1961 which provides that:

(i) Tax shall be charged at the rates prescribed for the year by the Annual Finance Act;

(ii) The charge is on every person specified under section 2(31);

(iii) Tax is chargeable on the total income earned during the previous year and not the assessment year. (There are certain exceptions provided by sections 172, 174, 174A, 175 and 176);

(iv) Tax shall be levied in accordance with and subject to the various provisions contained in the Act.

This section is the backbone of the law of income-tax insofar as it serves as the most operative provision of the Act. The tax liability of a person springs from this section.

3. Assessment year: [Sec. 2(9)]

Assessment year means a period of 12 months commencing on 1^st April every year. The total income earned by the assessee during the previous year shall be chargeable to tax in the next year; which is termed as the assessment year. For example, for the previous year 2022-23, the relevant assessment year shall be 2023-24 (1.4.2023 to 31.3.2024).

4. Previous year: [Sec. 3]

The year in which income is earned, i.e. the financial year immediately preceding the assessment year, is called the previous year and the tax shall be paid on such income in the next year which is called the assessment year. This means that the tax is levied on the income in the year in which it is earned; referred as previous year and the tax on such income will be paid in the assessment year. All assessees are required to follow a uniform previous year i.e. the financial year starting from 1^st April and ending on 31^st March.

5. Person: [Sec. 2(31)]

As the income tax is levied on the total income of the previous year of every ‘person’, it becomes important to understand the term ‘Person’. The term ‘person’ includes the following seven categories:

(i) an individual,

(ii) a Hindu Undivided Family (HUF),

(iii) a company,

(iv) a firm,

(v) an Association of Persons (AoP) or a Body of Individuals (BoI), whether incorporated or not,

(vi)  a local authority, and

(vii) every artificial juridical person not falling within any of the preceding sub-clauses e.g., a university or deity.

As per Explanation to Sec. 2(31), an AoP/BoI/Local authority or any artificial juridical person shall be deemed to be a person, irrespective of whether they were formed or established with the purpose of earning or deriving profits or not.

6. Assessee: [Sec. 2(7)]

Assessee means a person by whom any tax or any other sum of money is payable under this Act. It also includes the following:

(i) Every person in respect of whom any proceeding under this Act has been taken for the assessment of his income;

(ii) Every person who is deemed to be an assessee under any provisions of this Act. Sometimes, a person becomes assessable in respect of the income of some other persons. In such case also, he is considered as an assessee. For example, legal representative of a deceased person;

(iii) Every person who is deemed to be an assessee in default under any provision of this Act. For example, where a person making any payment to other person is liable to deduct tax at source, and if he has not deducted tax at source or has deducted but not deposited the tax with the government; he shall be deemed to be an assessee in default.

7. Certain Principles relating to Income under Income-tax Act

The following are the important principles relating to income:

• • Income generally refers to revenue receipts, but however under the Income-tax Act, 1961, certain capital receipts have also been specifically included within the definition of income for example capital gains i.e. gains on sale of a capital assets like land.
  • The income to be considered for tax purpose shall be net receipts and not gross receipts.
    Net receipts are arrived at after deducting the expenditure incurred in connection with earning such receipts.
  • Income is taxable either on due basis or receipt basis, as provided under the respective head of income. For the purpose of computing income under the heads ‘Profits and gains of business or profession’ and ‘Income from other sources’, the method of accounting which is regularly followed by the assessee should be considered, which can be either cash system or mercantile system.
  • Income earned during the year i.e. the previous year shall be chargeable to tax in the next year i.e. the assessment year e.g. the income of the P.Y. 2022-23 shall be chargeable in the A.Y. 2023-24. But, there are certain exceptions to this principle (i.e. Accelerated assessment u/s 172, 174, 174A and 175) which are discussed in the Chapter ‘Liability in Special Cases’.

8. Income: [Sec. 2(24)]

The definition of ‘Income’ given under section 2(24) is inclusive and not exhaustive and therefore it may be possible that certain items may be considered as income under this Act according to its general and natural meaning, even if it is not included under section 2(24). The term ‘Income’ includes the following:

• • Profits and gains;
  • Dividend;
  • Voluntary contributions received by a trust which is created wholly or partly for charitable or religious purposes; or by educational institutions, hospitals or electoral trust;
  • The value of any perquisite or profit in lieu of salary taxable u/s 17;
  • Any special allowance granted to the assessee to meet expenses wholly, necessarily and exclusively for the performance of office or employment duties;
  • The value of any benefit or perquisite, whether converted into money or not, obtained from a company either by a director or by a person who has substantial interest in the company or by a relative of the director or such person, and any sum paid by any such company in respect of any obligation which, otherwise, would have been payable by the director or other person aforesaid;
  • The value of benefit or perquisite to a representative assessee like a trustee appointed under a trust;
  • Any sum chargeable to income-tax under clauses (ii) and (iii) of sec. 28 or sec. 41 or sec. 59;
  • Any sum chargeable to income-tax under clauses (iiia), (iiib), (iiic), (iv), (v), (va) and (via) of sec. 28;
  • Any capital gains chargeable u/s 45;
  • The profits and gains of any insurance business carried on by a mutual insurance company or by a co-operative society, computed in accordance with section 44 or any surplus taken to be such profit and gains by virtue of provisions contained in the First Schedule;
  • The profits and gains of any of banking business (including providing credit facilities) carried on by a co-operative society with its members;
  • Winnings from lottery, crossword puzzles, races (including horse races), card games or other games of any sort or from gambling or betting;
  • Any sum received by the assessee from his employees as contributions to any provident fund or superannuation fund or any fund set up under Employees’ State Insurance Act, 1948 or any fund for the welfare of such employee; [Sec. 2(24)(x)]
  • Any amount received under the Keyman insurance policy including the sum allocated by way of bonus; [Sec. 2(24)(xi)]
  • Any sum chargeable to income-tax u/s 56(2)(v), (vi);
  • Any sum of money or specified movable or immovable properties received without consideration or inadequate consideration as provided u/s 56(2)(vii), (via);
  • Any consideration received for issue of shares as exceeds the FMV of shares referred to in section 56(2)(viib);
  • Any sum of money received as advance in the course of negotiation for transfer of a capital asset, if such sum is forfeited as the negotiation do not resulted in transfer of the asset 56(2)(ix);
  • Any sum chargeable to income-tax u/s 56(2)(x);
  • Any compensation or other payment referred to in Sec. 56(2)(xi);
  • Income shall include assistance received in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) from the Central Government or a State Government or any other authority or body or agency in cash or kind to the assessee other than:

(a) the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43,

(b) the subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or the State Government, as the case may be.

9. Heads of Income: [Sec. 14]

For the purpose of computation of total income under the Income-tax Act, 1961, all the incomes shall be classified under the following 5 heads of income:

(i) Salaries [Secs. 15 to 17]

(ii) Income from House Property [Secs. 22 to 27]

(iii) Profits and Gains of Business or Profession [Secs. 28 to 44DB]

(iv) Capital Gains [Secs. 45 to 55A]

(v) Income from Other Sources [Secs. 56 to 59]

Gross Total Income means aggregate of income computed under the above five heads, after making clubbing provisions and adjustments of set off and carry forward of losses.

10. Total Income and Computation of Tax Liability

Total income of an assessee means the Gross Total Income (GTI) as reduced by the amount of deduction available under sections 80C to 80U.

11. Exemption and Deduction in respect of income

• • • Exemption in respect of any income means that such income shall not form part of any head of income and therefore not to be included in computation of total income. Whereas, deduction in respect of any income means that such income shall be first included under the respective head of income for the computation of gross total income and thereafter deduction can be claimed on such income under the respective head or from the gross total income. Deduction may also be allowed for making certain specified payments or contributions.
    • For e.g. Section 10 provides exemption in respect of certain incomes; sections 54, 54b, 54d, 54ec, 54f, 54g, 54ga, 54gb, 54H provides exemption in respect of capital gains of the assessee.
      Section 16 [i.e. standard deduction, entertainment allowance and professional tax] provides deduction from gross salary, section 24 provides standard deduction and deduction for interest of loan borrowed under the head ‘Income from House Property’. Further, Chapter VI-A [i.e. sections 80C to 80U] provides deduction from gross total income of the assessee.
    • Exemption cannot exceed the taxable income; but deduction can exceed taxable income.

12. Rounding off of Income: [Sec. 288A]

The total income computed in accordance with the provisions of this Act shall be rounded off to the nearest multiple of ` 10.

If the last figure in that amount is five or more, the amount shall be increased to the next higher amount which is multiple of 10 and if the last figure is less than five, the amount shall be reduced to the next lower amount which is multiple of 10.

13. Rounding off of Tax: [Sec. 288B]

The total amount of income tax payable and the amount of refund due, computed in accordance with the provisions of this Act shall be rounded off to the nearest multiple of ` 10.

If the last figure in that amount is five or more, the amount shall be increased to the next higher amount which is multiple of 10 and if the last figure is less than five, the amount shall be reduced to the next lower amount which is multiple of 10.

Dive Deeper:
Certain Definitions Under the Income Tax Act, 1961