Income tax

1. Chargeability of income tax

  • Article 265 of the Constitution of India provides that "no tax shall be levied or collected except by the authority of law". Therefore, no tax can be levied or collected in India, unless it is explicitly and clearly authorised by way of legislation. The Income-tax Act, 1961 (ITA) was enacted to provide for levy and collection of tax on income earned by a person.
  • According to the ITA, every person, whose total income exceeds the maximum amount not chargeable to tax, shall be chargeable to income tax at the rate or rates prescribed in the Finance Act. The ITA defines the term "person" to include an individual, an HUF, a company, a firm (including LLP), an AOP or a BOI; a local authority and every other artificial juridical person.
  • The ITA provides an inclusive definition of the expression "income". Therefore, income includes not only those things which this definition explicitly declares, but also all such things as the word signifies according to its natural import.1 Therefore, before arriving at a conclusion as to the tax implications of a receipt of money, it is imperative to determine whether or not such a receipt amounts to income under the ITA. There will be no incidence of income tax if a receipt of money does not amount to income. For instance, it is important to distinguish a capital receipt from a revenue receipt because, while all revenue receipts are taxable under the ITA, unless specifically exempted, a capital receipt cannot be taxed as income, 2 unless otherwise provided for by the statute. 3

2. Residential status

  • Section 6 of the ITA defines the term "resident", and contains different criteria to determine the residence of various entities such as a company, a firm and an individual, etc. A company is regarded as resident in India if it is an Indian company; or the place of its effective management4 is in India in the relevant financial year. 5 The expression "place of effective management" has been defined to mean a place where key management and commercial decisions that are necessary for the conduct of the busness of an entity as a whole are, in substance made. 6 An AOP, a firm or HUF is considered resident in India, except where during that financial year, the control and management of its affairs is situated wholly outside India. An individual's residential status is dependent on the duration of stay in India.
  • A person resident in India is liable to tax on his global income. A non-resident is liable to tax on income which is received or is deemed to be received in India or which accrues or arises or is deemed to accrue or arise to him in India.

3. Scope of income

  • The total income of an assessee is determined on the basis of his residential status in India. According to s 5 of the ITA, Indian residents 7are liable to be taxed on their global income, whereas non-residents are taxed only on income that has its source in India. 8
  • The scope of s 5 is expanded by the legal fiction contained in s 9, which deems certain incomes to be of Indian source. Section 9 provides for circumstances when various types of incomes are deemed to be Indian sourced and hence are liable to tax in India. It specifically provides that all incomes accruing or arising, whether directly or indirectly, through or from any business connection9 in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situated in India, are deemed to be taxable in India to the extent attributable to Indian operations. It has been clarified in the ITA that an asset or capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from assets located in India. Such asset can be said to be deriving its value substantially from assets located in India, where the value of such asset exceeds Rs 10 crores (Indian Rupees Ten Million) and the same represents atleast 51% of the value of all the assets owned by the company/entity10.

4. Tax year

  • The financial year in which the income is earned is called the "Previous Year" and which is the year ending on the 31st day of March each year. The year immediately succeeding the previous year is referred to as the "assessment year". The income of the previous year is taxed in the assessment year. The term "Assessment Year" refers to a period of 12 months commencing on the 1st day of April every year and ending on 31st day of March of the following year.

5. Rates of income tax

  • Applicable tax rates vary depending on the type of entity and the residential status of the taxpayer. For example, income of a resident company is taxed at the rate of 30%,11 whereas a non-resident company is taxed at the rate of 40%.12 However, the applicable rates of income tax are amended every financial year by the corresponding Finance Act. For the tax rates applicable to the assessment year 2016-2017, please refer to Annexure 1.
  • In computation of the income of a non-resident, the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and the country of residence of the nonresident are required to be examined, since the ITA provides that its provisions shall be applicable only insofar as they are more beneficial to the taxpayer. 13 Thus, if the provisions of the DTAA are more beneficial as compared to the provisions of the ITA, the non-resident can opt to be taxed with reference to the provisions of the DTAA. Please refer Annexure 2 for a list of countries with whom India has signed DTAA.

The only exception where beneficial provisions of DTAA are not available to a non-resident is in case of applicability of General Anti Avoidance Rules14 or non-furnishing of Tax Residency Certificate by the non-resident. 15

6. Heads of income

  • Income liable to tax in the hands of a person under the ITA has been classified into five mutually exclusive heads of income, namely:
    • Salaries,
    • Income from house property,
    • Profits and gains from business or profession,
    • Capital gains, and
    • Income from other sources.
  • The ITA details the manner of computation for each head of income. Various exemptions and deductions are provided under each head of income and the net amount (net of exemptions and deductions) is included in computing a person's total taxable income. Ad hoc deductions and exemptions are provided for, insofar as salaries and income from house property are concerned. No expenditure other than as prescribed can be deducted while computing income under the head "salaries" and "income from house property".

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1. Kanga Palkhivala and Vyas, The Law and Practice of Income Tax, Ninth Edition at p. 142

2. Padmaraje R. Kadambande v CIT [1992] 195 ITR 877

3. For example, capital gains under s 45 of the ITA

4. As substituted by the Finance Act, 2015, w.e.f., 1.4.2016 

5. A period of 12 months commencing on the 1st day of April

6. As defined in Explanation to s 6(3) of the ITA

7. Defined in s 6 of the ITA

8. Income is said to have its source in India if it is "income which accrues or arises in India, is deemed to accrue or arise in India or is received in India".

9. The expression "business connection" as used in this provision was not originally defined in the ITA. The Supreme Court in the case of R.D. Aggarwal [56 ITR 20] laid down the definition of the term as:

"Business connection means something more than business. It presupposes an element of continuity between the business of the non-resident and his activity in the taxable territory, rather than a stray or isolated transaction".

The ITA was amended by the Finance Act, 2003, and an inclusive definition of the expression was inserted with effect from April 1, 2004. As per this definition, a business connection includes "any business activity carried out through a person who, acting on behalf of the nonresident, (a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident, unless his activities are limited to the  purchase of goods or merchandise for the non-resident; or (b) has no such authority, but habitually maintains in India a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the non-resident; or (c) habitually secures orders in India, mainly or wholly for the non-resident or for that non-resident and other non-residents controlling, controlled by, or subject to the same common control, as that non-resident."

10.Refer Explanations 5, 6 and 7 in cl (i) of s 9(1) of the ITA

11. exclusive of applicable surcharge and education cess

12.exclusive of applicable surcharge and education cess 

13.Section 90(2) of the ITA

14.Section 90(2A) of the ITA

15.Section 90(4) of the ITA 

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