Notes: - Direct & Indirect Taxes (Taxation)

Lecture 1

Introduction

What is Tax?

‘Tax’ is a charge levied by the government on its subject (i.e. individual, company and firm) for the purpose of meeting its expenses. Tax is used to meet the following expenses

- Defence- Salaries of Staff- Interest on Loan- Maintaining and Developing Infrastructure- Recurring Expenses- Maintenance of Roads, Sanitation and Health

Types of Tax

Direct Tax

A Direct tax is a kind of charge, which is imposed directly on the taxpayer and paid directly to the government by the persons (juristic or natural) on whom it is imposed. A direct tax is one that cannot be shifted by the taxpayer to someone else.

Types of Direct Taxes are

Income Tax: Income Tax Act, 1961 imposes tax on the income of the individuals or Hindu undivided families or firms or co-operative societies (other tan companies) and trusts (identified as bodies of individuals associations of persons) or every artificial juridical person. The inclusion of a particular income in the total incomes of a person for income-tax in India is based on his residential status. There are three residential status, viz., (i) Resident & Ordinarily Residents (Residents) (ii) Resident but not Ordinarily Residents and (iii) Non Residents. There are several steps involved in determining the residential status of a person. All residents are taxable for all their income, including income outside India. Non residents

are taxable only for the income received in India or Income accrued in India. Not ordinarily residents are taxable in relation to income received in India or income accrued in India and income from business or profession controlled from India

Corporation Tax: The companies and business organizations in India are taxed on the income from their worldwide transactions under the provision of Income Tax Act, 1961. A corporation is deemed to be resident in India if it is incorporated in India or if it’s control and management is situated entirely in India. In case of non resident corporations, tax is levied on the income which is earned from their business transactions in India or any other Indian sources depending on bilateral agreement of that country.

Gift Tax: Gift tax in India is regulated by the Gift Tax Act which was constituted on 1st April, 1958. It came into effect in all parts of the country except Jammu and Kashmir. As per the Gift Act 1958, all gifts in excess of Rs. 25,000, in the form of cash, draft, check or others, received from one who doesn't have blood relations with the recipient, were taxable. However, with effect from 1st October, 1998, gift tax got demolished and all the gifts made on or after the date were free from tax. But in 2004, the act was again revived partially. A new provision was introduced in the Income Tax Act 1961 under section 56 (2). According to it, the gifts received by any individual or Hindu Undivided Family (HUF) in excess of Rs. 50,000 in a year would be taxable.

Indirect Tax

An indirect tax is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer). An indirect tax is one that can be shifted by the taxpayer to someone else. An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products.

Customs Duty: The Customs Act was formulated in 1962 to prevent illegal imports and exports of goods. Besides, all imports are sought to be subject to a duty with a view to affording protection to indigenous industries as well as to keep the imports to the minimum in the interests of securing the exchange rate of Indian currency. Duties of customs are levied on goods imported or exported from India at the rate specified under the customs Tariff Act, 1975 as amended from time to time or any other law for the time being in force.

Service Tax: The service providers in India except those in the state of Jammu and Kashmir are required to pay a Service Tax under the provisions of the Finance Act of 1994. The provisions related to Service Tax came into effect on 1st July, 1994. Under Section 67 of this Act, the Service Tax is levied on the gross or aggregate amount charged by the service provider on the receiver. However, in terms of Rule 6 of Service Tax Rules, 1994, the tax is permitted to be paid on the value received. The interesting thing about Service Tax in India is that the Government depends heavily on the voluntary compliance of the service providers for collecting Service Tax in India.

Sales Tax: Sales Tax in India is a form of tax that is imposed by the Government on the sale or purchase of a particular commodity within the country. Sales Tax is imposed under both, Central Government (Central Sales Tax) and State Government (Sales Tax) Legislation. Generally, each State follows its own Sales Tax Act and levies tax at various rates. Apart from sales tax, certain States also imposes additional charges like works contracts tax, turnover tax and purchaser tax. Thus, Sales Tax Acts as a major revenue-generator for the various State Governments. From 10th April, 2005, most of the States in India have supplemented sales tax with a new Value Added Tax (VAT).

Value Added Tax (VAT): The practice of VAT executed by State Governments is applied on each stage of sale, with a particular apparatus of credit for the input VAT paid. VAT in India classified under the tax slabs are 0% for essential commodities, 1% on gold ingots and expensive stones, 4%

on industrial inputs, capital merchandise and commodities of mass consumption, and 12.5% on other items. Variable rates (State-dependent) are applicable for petroleum products, tobacco, liquor, etc. VAT levy will be administered by the Value Added Tax Act and the rules made there-under and similar to a sales tax. It is a tax on the estimated market value added to a product or material at each stage of its manufacture or distribution, ultimately passed on to the consumer. Under the current single-point system of tax levy, the manufacturer or importer of goods into a State is liable to sales tax. There is no sales tax on the further distribution channel. VAT, in simple terms, is a multi-point levy on each of the entities in the supply chain. The value addition in the hands of each of the entities is subject to tax. VAT can be computed by using any of the three methods: (a) Subtraction method: The tax rate is applied to the difference between the value of output and the cost of input. (b) The Addition method: The value added is computed by adding all the payments that is payable to the factors of production (viz., wages, salaries, interest payments etc). (c) Tax credit method: This entails set-off of the tax paid on inputs from tax collected on sales.

Additional Concepts

Income: The definition of the term “income” in section 2(24) is inclusive and not exhaustive. Therefore, the term “income” not only includes those things that are included in section 2(24) but also includes those things that the term signifies according to its general and natural meaning.

Income includes

Profit & Gains from Business & Profession.

Dividend

Voluntary Contribution received by a trust

Perquisite or Profit in Lieu of Salary

Any special allowance or benefit granted to meet expenses in performance of duty

Export Incentives.

Value of any Benefit or Perquisite to businessman or professional.

Interest, Salary, Bonus, Commission or Remuneration received by partner or partnership firm

Capital Gains

Profits of Insurance Business.

Winning of Lottery, Crossword puzzles, horse races and card games.

Sum received under Keyman Insurance Policy

Sum received under an agreement for not carrying out an activity

Gifts exceeding Rs. 50,000 received by Individual

The Components of Gross Total Income are

As per section 14, the income of a person is computed under the following five heads:

1. Salaries.

2. Income from house property.

3. Profits and gains of business or profession.

4. Capital gains.

5. Income from other sources.

The aggregate income under these heads is termed as “gross total income”.

Financial Year : The year starting from April 1 and ending on March 31 of the next year is known as a financial year.

Assessment Year: AY is a financial year in which the income earned during the previous year is taxed.

Previous Year (sec 3): The year in which the income is earned is called the previous year.

E.g.:

1. Income earned by XYZ Ltd in the year 2007-2008 will be taxed in the year 2008-2009. The same would be taxable irrespective of the accounting year followed by the assessee. In the aforesaid the year 2007-08 is the previous year and the year 2008-09 is the assessment year.

Income earned during the previous year is taxed during the assessment year. Therefore a year is an assessment year and previous year simultaneously. However in certain

cases the income is taxed in the year in which it is earned. The exceptions to the rule are as under:

1. Income of non-resident from shipping. (sec172) 2. Income of persons leaving India either permanently or for long period of time

(sec174)3. Income of bodies formed for short duration. (sec174A)4. Income of persons trying to alienate his assets with view to avoiding payment of

his tax. (sec 175)5. income of discontinued business.(sec176)

“Person “sec 2(31):

The term persons include:

a) an individualb) a Hindu undivided familyc) a companyd) a firme) an association of persons and a body of individuals whether incorporated or

notf) a local authorityg) Every artificial jurisdictional person not falling under any of the preceding

category.

The aforesaid is an inclusive list and the last category covers all those that do not fall in any of the preceding classification.

Assessee [sec2 (7)]:

Assessee means a person by whom any tax or any other sum of money (i.e. penalty or interest is payable under the act. It includes:

1. Every person in respect of whom any proceeding under the act has been taken for the assessment of his income or loss or the amount of refund due to him.

2. any person who is deemed to be an assessee.(representative assessee)3. an assessee in default ( advance tax and TDS not deducted)

company" means—

 (i)  any Indian company, or

(ii)  any body corporate incorporated by or under the laws of a country outside India, or

(iii)  any institution, association or body which is or was assessable or was assessed as a company for any assessment year under the Indian Income-tax Act, 1922 (11 of 1922), or which is or was assessable or was assessed under this Act as a company for any assessment year commencing on or before the 1st day of April, 1970, or

(iv)  any institution, association or body, whether incorporated or not and whether Indian or non-Indian, which is declared by general or special order of the Board to be a company :

Provided that such institution, association or body shall be deemed to be a company only for such assessment year or assessment years (whether commencing before the 1st day of April, 1971, or on or after that date) as may be specified in the declaration ;]

(18)  "company in which the public are substantially interested"—a company is said to be a company in which the public are substantially interested—

[(a)  if it is a company owned by the Government or the Reserve Bank of India or in which not less than forty per cent of the shares are held (whether singly or taken together) by the Government or the Reserve Bank of India or a corporation owned by that bank ; or]

[(aa)  if it is a company which is registered under section 25 of the Companies Act, 1956 (1 of 1956); or

(ab)  if it is a company having no share capital and if, having regard to its objects, the nature and composition of its membership and other relevant considerations, it is declared by order of the Board to be a company in which the public are substantially interested :

Provided that such company shall be deemed to be a company in which the public are substantially interested only for such assessment year or assessment years (whether commencing before the 1st day of April, 1971, or on or after that date) as may be specified in the declaration ; or]

[(ac)  if it is a mutual benefit finance company, that is to say, a company which carries on, as its principal business, the business of acceptance of deposits from its members and which is declared by the Central Government under section 620A of the Companies Act, 1956 (1 of 1956), to be a Nidhi or Mutual Benefit Society ; or]

[(ad)  if it is a company, wherein shares (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) carrying not less than fifty per cent of the voting power have been allotted unconditionally to, or acquired unconditionally by, and were throughout the relevant previous year beneficially held by, one or more co-operative societies ;]

[(b)  if it is a company which is not a private company as defined in the Companies Act, 1956 (1 of 1956), and the conditions specified either in item (A) or in item (B) are fulfilled, namely :—

(A)  shares in the company (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) were, as on the last day of the relevant previous year, listed in a recognised stock exchange in India in accordance with the Securities Contracts (Regulation) Act, 1956 (42 of 1956), and any rules made there under ;

[(B)  shares in the company (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) carrying not less than fifty per cent of the voting power have been allotted unconditionally to, or acquired unconditionally by, and were throughout the relevant previous year beneficially held by—

(a)  the Government, or

(b)  a corporation established by a Central, State or Provincial Act, or

(c)  any company to which this clause applies or any subsidiary company of such company 79[if the whole of the share capital of such subsidiary

company has been held by the parent company or by its nominees throughout the previous year.]

Explanation.—In its application to an Indian company whose business consists mainly in the construction of ships or in the manufacture or processing of goods or in mining or in the generation or distribution of electricity or any other form of power, item (B) shall have effect as if for the words "not less than fifty per cent", the words "not less than forty per cent" had been substituted;]]