INTRODUCTION

The taxes are the basic source of revenue for the Government. Revenue raised from the taxes

are utilized for meeting the expense of Government like, provision of education,

infrastructure facilities such as roads, dams etc.

Tax is the financial charge imposed by the Government on income, commodity or activity.

Government imposes two types of taxes namely Direct taxes and Indirect taxes. Under direct

taxes, person who pays the tax bears the burden of it example: Income tax, Wealth Tax etc.

while in Indirect Taxes the person who consumes the goods or services example: Service

Tax, Value Added Tax, Excise Duty etc.

The first Income Tax Act in India was introduced in 1860. The present law of income tax is

contained in Income Tax Act, 1961. This Act is the charging Statute of Income Tax in India.

It provides for levy, administration, collection and recovery of Income Tax. The Income Tax

Law comprises The Income Tax Act 1961, Income Tax Rules 1962, Notifications and

Circulars issued by Central Board of Direct Taxes (CBDT), Annual Finance Acts and Judicial

pronouncements by Supreme Court and High Courts.

Direct Taxes, as the name suggests, are taxes that are directly paid to the government by the

taxpayer. It is a tax applied on individuals and organizations directly by the government e.g.

income tax, corporation tax, wealth tax etc.

DIRECT TAXES

Income Tax

Income Tax is paid by an individual based on his/her taxable income in a given financial

year. Under the Income Tax Act, the term ‘individual’ also includes Hindu Undivided

Families (HUFs), Co-operative Societies, Trusts and any artificial judicial person. Taxable

income refers to total income minus applicable deductions and exemptions.

Tax is payable if the taxable income is above the minimum taxable limit and is paid as per the

differing rates announced for each tax slab for the financial year.

 

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Corporation Tax

Corporation Tax is paid by Companies and Businesses operating in India on the income

earned worldwide in a given financial year. The rates of taxation vary based on whether the

company is incorporated in India or abroad.

 

Wealth Tax

Wealth tax is applicable on individuals, HUFs or companies on the value of their assets in a

given financial year on the date of valuation. It is taxed at the rate of 1% of the net wealth of

any assesse exceeding Rs 30,00,000.

‘Net wealth’ here includes, unproductive assets like cash in hand above Rs 50,000, second

residential property not rented out, cars, gold jewellery or bullion, boats, yachts, aircrafts or

urban land. It does not include productive assets like commercial property, stocks, bonds,

fixed deposits, mutual funds etc.

 

Capital Gains Tax

The profits made on sale of property are taxable under Capital Gains Tax. Property here

includes stocks, bonds, residential property, precious metals etc. It is taxed at two different

rates based on how long the property was owned by the taxpayer – Short Term Capital Gains

Tax and Long Term Capital Gains Tax. This deciding period of ownership varies greatly for

different classes of property.

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DEFINITION

DEFINITION of 'Direct Tax’

A tax that is paid directly by an individual or organization to the imposing entity. A taxpayer

pays a direct tax to a government for different purposes, including real property tax, personal

property tax, income tax or taxes on assets. Direct taxes are different from indirect taxes,

where the tax is levied on one entity, such as a seller, and paid by another, such a sales tax

paid by the buyer in a retail setting.

BREAKING DOWN 'Direct Tax’

A direct tax cannot be shifted to another individual or entity. The individual or organization

upon which the tax is levied is responsible for the fulfillment of the tax payment. Indirect

taxes, on the other hand, can be shifted from one taxpayer to another.

DEFINITION of 'Income Tax'

A tax that governments impose on financial income generated by all entities within their

jurisdiction. By law, businesses and individuals must file an income tax return every year to

determine whether they owe any taxes or are eligible for a tax refund. Income tax is a key

source of funds that the government uses to fund its activities and serve the public

BREAKING DOWN 'Income Tax'

Most countries employ a progressive income tax system in which higher income earners pay

a higher tax rate compared to their lower earning counterparts.

The first income tax imposed in America was during the War of 1812. Its original purpose

was to fund the repayment of a $100 million debt that was incurred through war-related

expenses. After the war, the tax was repealed, but income tax became permanent during the

early 20th century.

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DIFFERENCE BETWEEN DIRECT TAX AND

INDIRECT TAX

Basis of Comparison Direct Tax Indirect Tax

Meaning

Direct tax is referred to as the tax, which is paid by the person to the government to whom it is levied and charged on the income and wealth of persons.

Indirect Tax is referred to as the tax, which is paid by the taxpayer to the government indirectly, charged on goods and services.

Burden The person on whom it is levied bears its burden.

The burden of tax can be shifted to another person.

TypesWealth Tax, Income Tax, Property Tax, Corporate Tax, Import and Export Duties.

Central Sales tax, VAT (Value Added Tax), Service Tax, STT (Security Transaction Tax), Excise Duty, Custom Duty.

Evasion Tax evasion is possible.Tax evasion is hardly possible because it is included in the price of goods and services.

Inflation Direct tax helps in reducing inflation. Indirect taxes promotes inflation.

Levied onPersons, i.e. Individual, HUF (Hindu Undivided Family), Company, Firm etc.

Consumers of goods and services.

Nature Progressive Regressive

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MERITS OF DIRECT TAX

Following are the important advantages or merits of Direct Taxes:-

Equity

There is social justice in the allocation of tax burden in case of direct taxes as they are

based on the principle of ability to pay. Persons in a similar economic situation are taxed

at the same rate. Persons with different economic standing are taxed at a different rate.

Hence, there is both horizontal and vertical equity under direct taxation. Progressive

direct taxation can reduce income inequalities and bring about adequate social &

economic justice.

Certainty

As far as direct taxes are concerned, the tax payer is certain as to how much he is

expected to pay, as the tax rates are decided in advance. The Government can also

estimate the tax revenue from direct taxes with a fair accuracy. Accordingly, the

Government can make adjustments in its income and expenditure.

Relatively Elastic

The direct taxes are relatively elastic. With an increase in income and wealth of

individuals and companies, the yield from direct taxes will also increase. Elasticity also

implies that the government's revenue can be increased by raising the rates of taxation.

An increase in tax rates would increase the tax revenue.

Creates Public Consciousness

They have educative value. In the case of direct taxes, the taxpayers are made to feel

directly the burden of taxes and hence take keen interest in how public funds are spent.

The taxpayers are likely to be more aware about their rights and responsibilities as

citizens of the state.

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Economical

Direct taxes are generally economical to collect. For instances, in the case of personal

income tax, the tax can be deducted at source from the income or salaries of the

individuals. Therefore, the government does not have to spend much in tax collection as

far as personal income tax is concerned. However, in the case of indirect taxes, the

government has to set up an elaborate machinery to collect taxes.

Anti-inflationary

The direct taxes can help to control inflation. During inflationary periods, the government

may increase the tax rate. With an increase in tax rate, the consumption demand may

decline, which in turn may reduce inflation.

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DEMERITS OF DIRECT TAX

Though direct taxes possess above mentioned merits, the economist have criticised them on

the following grounds:-

Tax Evasion

In India, there is good amount of tax evasion. The tax evasion is due to High tax rates,

Documentation and formalities, Poor and corrupt tax administration. It is easier for the

businessmen to evade direct taxes. They invariable suppress correct information about

their incomes by manipulating their accounts and evade tax on it.

In less developed countries like India, due to high rate of progressive tax evasion &

avoidance are extensive and led to rise in black money.

Arbitrary Rates

The direct taxes tend to be arbitrary. Critics point out that there cannot be any objective

basis for determining tax rates of direct taxes. Also, the exemption limits in the case of

personal income tax, wealth tax, etc., are determined in an arbitrary manner. A precise

degree of progression in taxation is also difficult to achieve. Therefore direct taxes may

not always fulfill the canon of equity.

Inconvenient

Direct taxes are inconvenient in the sense that they involve several procedures and

formalities in filing of returns. For most people payment of direct tax is not only

inconvenient, it is psychological painful also. When people are required to pay a sizeable

part of their income as a tax to the state, they feel very much hurt and their propensity to

evade tax remains high. Further everyone who is required to pay a direct tax has to

furnish appropriate evidence in support of the statement of his income & wealth & for

this he has to maintain his accounts in proper form. Direct tax is considered inconvenient

by some people because they have to make few lump sum payments to the governments,

whereas their income receipts are distributed over the whole year.

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Narrow Coverage

In India, there is a narrow coverage of direct taxes. It is estimated that only three percent

of the population pay personal income tax. Due to low coverage, the government does not

get enough funds for public expenditure. Estate duty & wealth tax are equally narrow

based and thus revenue proceeds from these taxes are invariably small.

Affects Capital Formation

The direct taxes can affect savings and investment. Due to taxes, the net income of the

people gets reduced. This in turn reduces savings. Reduction in savings results in low

investment. The low investment affects capital formation in the country.

Effect on Willingness and Ability to Work

Highly progressive direct taxes reduce people's ability and willingness to work and save.

This in turn may have a negative impact on investment and productive capacity in the

economy. If tax burden is high, people's consumption level gets adversely affected and

this has an impact on their ability to work and save. High taxes also discourage people

from working harder in order to earn and save more.

Sectoral Imbalance

In India, there is Sectoral imbalance as far as direct taxes are concerned. Certain sectors

like the corporate sector is heavily taxed, whereas, the agriculture sector is 100% tax free.

Even the large rich farmers are exempted from payment of personal income tax.

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SCOPE OF TOTAL INCOME

The following points should be noted in regard to scope of income:

While S. 4 makes the total income of the previous year chargeable to tax, S. 5 defines the

scope of the total income so chargeable to tax. It determines the extent and scope of income

which is chargeable to tax. The term “scope of income” means which items of income are

included and which are excluded while computing tax liability.

The scope of income depends upon the residential status of the person. There are three broad

categories of persons:

a) Resident and ordinary resident

b) Non- resident and

c) Resident but not ordinarily resident.

Section 5 lays down what types of income would be taxable in the case of assessees

belonging to each of these categories.

It should be noted that section 5 specifically states that the income is to be computed “subject

to the provisions of this act”. Thus, if any item of income is exempt under the provisions of

the act, it is to be excluded from the scope of income.

RESIDENT AND ORDINARY RESIDENT

A resident and ordinary resident is taxable in respect of any income, from whatever source

derived, which:

(a) Is received, or deemed to be received in India, in the previous year, by or on behalf of

such person; or

(b) Accrues or arises, or is deemed to accrue or arise to him, in India, during the previous

year; or

(c) Accrues or arises to him outside India, during the previous year.

Thus, in the case of a ‘resident and ordinary resident’, his total income includes any income

received, or accruing or arising in India, and any income accruing or arising outside India (or 9

deemed to be so received, or accruing or arising, as the case may be). In short, the entire

‘World Income’ (Indian Income+ Foreign Income) of an ordinary resident is to be included in

his total income.

RESIDENT BUT NOT ORDINARY RESIDENT

A person not ordinary resident in India, is taxable in respect of any income, from whatever

source derived, which-

(a) Is received, or deemed to be received, in India, in the previous year, by or on behalf of

such person: or

(b) Accrues or arises, or is deemed to accrue or arise to him, in India, during the previous

year; or

(c) Accrues or arises to him, outside India, from a business controlled from or a profession set

up in India.

Thus, in the case of a not ordinary resident, while the Indian Income is to be included in the

total income, the foreign income is to be included only if it is derived from a business

controlled in or a profession set up in India. So, the liability of a ‘Not-Ordinary Resident’ in

respect of the Foreign Income is much less as compared with that of the ‘Ordinary Resident’.

NON-RESIDENTA resident who is a non-resident, is taxable in respect of any income, from whatever source

derived, which-

(a) Is received in India, or is deemed to be received in India, in the previous year, by or on

behalf of such person; or

(b) Accrues or arises, or is deemed to accrue or arise to him, in India, during the previous

year.

Thus, in the case of a ‘non-resident’ his taxable income includes only his Indian income

during that year. The Foreign Income of a non-resident is not taxable under The Indian

Income-Tax Act. So, the liability of a non-resident is the lowest among all the types of

residents under The Income Tax Act.

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RESIDENTIAL STATUS AND TAXABILITY OF INCOME

NATURE OF

INCOME

RESIDENT &

ORDINARY

RESIDENT

RESIDENT BUT

NOT ORDINARY

RESIDENT

NON RESIDENT

Income received in

IndiaTaxable Taxable Taxable

Income which

accrues or arises in

India

Taxable Taxable Taxable

Income deemed to

be received in IndiaTaxable Taxable Taxable

Income deemed to

accrue in IndiaTaxable Taxable Taxable

Income which

accrues and arises

outside India from a

business controlled

from India/

profession set up in

India.

Taxable Taxable Not Taxable

Any other income

which accrues or

arises outside India

Taxable Not Taxable Not Taxable

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NOTE:

1) Indian income is taxable in all cases, whether of an ordinary resident, or a not-ordinary

resident, or a non-resident. Indian income includes income received or accruing or arising

in India, or deemed to be received in India.

2) Foreign income of an ordinary resident is wholly taxable.

3) Foreign income of a not-ordinary resident is taxable only if derived from a business

controlled or profession set up in India.

4) Foreign income of a non-resident is not taxable at all.

[As per S.1, the Act extends to whole of India i.e. it applies to all residents of India and to all

income arising in India. hence all income earned by a resident (whether arising in or outside

India), while all income arising in India is taxable (whether earned by a resident or a non-

resident).]

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Illustration

From the following income of Mr. Rohit for the previous year 2014-15, compute his gross

total income for the assessment year 2015-16 if he is-

(a) Resident and ordinary resident

(b) Resident but not ordinary resident

(c) Non-resident

Income

1. Dividend received from Mac-Donalds Ltd. a USA Company in USA 18000

2. Rent received from house in Kolkata 60000

3. Income from agriculture in Sri Lanka 50000

4. Income from business in Dhaka, controlled from Mumbai 60000

5. Rent from office property in UK credited to bank account in Switzerland 20000

6. Income from profession in Nairobi received in Nairobi which was set up

in India30000

7. Past untaxed foreign income brought to India, during the previous year 10000

8. Royalties from Indian Companies 40000

Solution:

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Name: Mr. Rohit

Previous Year: 2014-15 Assessment Year: 2015-16

Computation Of Total

Income Income R&OR

R but

NOR NR1.Dividend received from Mac-

Donalds Ltd. USA Company in

USA

2.Rent received from house in

Kolkata

3.Income from Agriculture in Sri

Lanka

4.Income from business in Dhaka

controlled from Mumbai

5.Rent from office property in UK

credited to bank account in

Switzerland

6.Income from profession in

Nairobi received in Nairobi

which was set up in India

7.Past untaxed foreign income

brought to India during the

previous year

8.Royalties from Indian

Companies

Gross Total Income

Foreign

Indian

Foreign

Foreign

Foreign

Foreign

Remittance

(Not Income)

Indian

18000

60000

50000

60000

20000

30000

-

40000

278000

-

60000

-

60000

-

30000

-

40000

190000

-

60000

-

-

-

-

-

40000

100000

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INCOME FROM SALARY

MEANING

The meaning of the term ‘salary’ for purposes of income tax is much wider than what is

normally understood. Every payment made by an employer to his employee for service

rendered would be chargeable to tax as income from salaries. The term ‘salary’ for the

purposes of Income-tax Act, 1961 will include both monetary payments (e.g. basic salary,

bonus, commission, allowances etc.) as well as non-monetary facilities (e.g. housing

accommodation, medical facility, interest free loans etc).

(1) Employer-employee relationship:

Before an income can become chargeable under the head ‘salaries’, it is vital that there

should exist between the payer and the payee, the relationship of an employer and an

employee. Consider the following examples:

(a) Sujatha, an actress, is employed in Chopra Films, where she is paid a monthly

remuneration of `2 lakh. She acts in various films produced by various producers. The

remuneration for acting in such films is directly paid to Chopra Films by the different

producers. In this case, `2 lakh will constitute salary in the hands of Sujatha, since the

relationship of employer and employee exists between Chopra Films and Sujatha.

(b) In the above example, if Sujatha acts in various films and gets fees from different

producers, the same income will be chargeable as income from profession since the

relationship of employer and employee does not exist between Sujatha and the film

producers.

(c) Commission received by a Director from a company is salary if the Director is an

employee of the company. If, however, the Director is not an employee of the company,

the said commission cannot be charged as salary but has to be charged either as income

from business or as income from other sources depending upon the facts.

(d) Salary paid to a partner by a firm is nothing but an appropriation of profits. Any salary,

bonus, commission or remuneration by whatever name called due to or received by

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partner of a firm shall not be regarded as salary. The same is to be charged as income

from profits and gains of business or profession. This is primarily because the

relationship between the firm and its partners is not that of an employer and employee.

(2) Full-time or part-time employment:

It does not matter whether the employee is a full-time employee or a part-time one. Once the

relationship of employer and employee exists, the income is to be charged under the head

“salaries”. If, for example, an employee works with more than one employer, salaries

received from all the employers should be clubbed and brought to charge for the relevant

previous years.

(3) Foregoing of salary:

Once salary accrues, the subsequent waiver by the employee does not absolve him from

liability to income-tax. Such waiver is only an application and hence, chargeable to tax.

Example: Mr. A, an employee instructs his employer that he is not interested in receiving the

salary for April 2013 and the same might be donated to a charitable institution. In this case,

Mr. A cannot claim that he cannot be charged in respect of the salary for April 2013. It is

only due to his instruction that the donation was made to a charitable institution by his

employer. It is only an application of income. Hence, the salary for the month of April 2013

will be taxable in the hands of Mr. A. He is however, entitled to claim a deduction under

section 80G for the amount donated to the institution.

(4) Surrender of salary:

However, if an employee surrenders his salary to the Central Government under section 2 of

the Voluntary Surrender of Salaries (Exemption from Taxation) Act, 1961, the salary so

surrendered would be exempt while computing his taxable income.

(5) Salary paid tax-free:

This, in other words, means that the employer bears the burden of the tax on the salary of the

employee. In such a case, the income from salaries in the hands of the employee will consist

of his salary income and also the tax on this salary paid by the employer.

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DEFINITION OF SALARY

The term ‘salary’ has been defined differently for different purposes in the Act. The

definition as to what constitutes salary is very wide. As already discussed earlier, it is an

inclusive definition and includes monetary as well as non-monetary items. There are different

definitions of ‘salary’ say for calculating exemption in respect of gratuity, house rent

allowance etc.

‘Salary’ under section 17(1), includes the following:

(i) Wages,

(ii) Any annuity or pension,

(iii) Any gratuity,

(iv) Any fees, commission, perquisite or profits in lieu of or in addition to any salary or

wages,

(v) Any advance of salary,

(vi) Any payment received in respect of any period of leave not availed by him i.e. leave

salary or leave encashment,

(vii) The portion of the annual accretion in any previous year to the balance at the credit of an

employee participating in a recognised provident fund to the extent it is taxable and

(viii) Transferred balance in recognized provident fund to the extent it is taxable,

(ix) The contribution made by the Central Government or any other employer in the previous

year to the account of an employee under a pension scheme referred to in section

80CCD.

BASIS OF CHARGE

1. Section 15 deals with the basis of charge. Salary is chargeable to tax either on ‘due’ basis

or on ‘receipt’ basis, whichever is earlier.

2. However, where any salary, paid in advance, is assessed in the year of payment, it cannot

be subsequently brought to tax in the year in which it becomes due. 17

3. If the salary paid in arrears has already been assessed on due basis, the same cannot be

taxed again when it is paid.

Examples:

i. If A draws his salary in advance for the month of April 2014 in the month of March 2014

itself, the same becomes chargeable on receipt basis and is to be assessed as income of the

P.Y.2013-14 i.e., A.Y.2014-15. However, the salary for the A.Y.2015-16 will not include

that of April 2014.

ii. If the salary due for March 2014 is received by A later in the month of April 2014, it is still

chargeable as income of the P.Y.2013-14 i.e. A.Y.2014-15 on due basis. Obviously, salary

for the A.Y.2015-16 will not include that of March 2014.

ADVANCE SALARY

Advance salary is taxable when it is received by the employee irrespective of the fact whether

it is due or not. It may so happen that when advance salary is included and charged in a

particular previous year, the rate of tax at which the employee is assessed may be higher than

the normal rate of tax to which he would have been assessed. Section 89(1) provides for relief

in these types of cases.

LOAN OR ADVANCE AGAINST SALARY

Loan is different from salary. When an employee takes a loan from his employer, which is

repayable in certain specified installments, the loan amount cannot be brought to tax as salary

of the employee.

Similarly, advance against salary is different from advance salary. It is an advance taken by

the employee from his employer. This advance is generally adjusted with his salary over a

specified time period. It cannot be taxed as salary.

ARREARS OF SALARY

Normally speaking, salary arrears must be charged on due basis. However, there are

circumstances when it may not be possible to bring the same to charge on due basis. For

example if the Pay Commission is appointed by the Central Government and it recommends

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revision of salaries of employees, the arrears received in that connection will be charged on

receipt basis. Here, also relief under section 89(1) is available.

PROVIDENT FUNDProvident fund scheme is a scheme intended to give substantial benefits to an employee at the

time of his retirement. Under this scheme, a specified sum is deducted from the salary of the

employee as his contribution towards the fund. The employer also generally contributes the

same amount out of his pocket, to the fund. The contribution of the employer and the

employee are invested in approved securities. Interest earned thereon is also credited to the

account of the employee. Thus, the credit balance in a provident fund account of an employee

consists of the following:

(i) Employee’s contribution

(ii) Interest on employee’s contribution

(iii) Employer’s contribution

(iv) Interest on employer’s contribution.

The accumulated balance is paid to the employee at the time of his retirement or resignation.

In the case of death of the employee, the same is paid to his legal heirs. The provident fund

represents an important source of small savings available to the Government. Hence, the

Income-tax Act, 1961 gives certain deductions on savings in a provident fund account. The

following are the types of provident funds:

(i) Statutory Provident Fund (SPF)

(ii) Recognised Provident Fund (RPF)

(iii) Unrecognised Provident Fund (URPF)

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The tax treatment is given below:

PARTICLUARSSTATUTORY

PF

RECOGNOSED

PF

UNRECOGNISED

PF

EMPLOYEE’S

CONTRIBUTIONIgnore Ignore Ignore

EMPLOYER’S

CONTRIBUTIONFully Exempt

Exempt Upto

12% [Basic

Salary+ DA (In

Terms)+

Turnover

Commission]

Fully Exempt

INTEREST

CREDITEDFully Exempt

Exempt Upto

9.5%Fully Exempt

LUMPSUM

RECEIVED

Exempt u/s

10(11)

Exempt u/s

10(12)

Taxable

(Divided In 4 Parts)

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LUMPSUM RECEIVED FROM UNRECOGNISED PF

CONTRIBUTION INTEREST

Employee’s Employer’s On On

Contribution Contribution Employer’s Employee’s

Contribution Contribution

IGNORE TAXABLE AS IFS TAXABLE

AS IFOS

LUMPSUM RECEIVED FROM RECOGNISED PROVIDENT

FUND

AFTER 5 YEARS WITHIN 5 YEARS

EXEMPT DUE TO: OTHERWISE

Ill health of employee

Discontinuation of business

by employer TAXABLE

Any other reason beyond

control of employee

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GRATUITYGratuity is a voluntary payment made by an employer in appreciation of services rendered by

the employee. Now-a-days gratuity has become a normal payment applicable to all

employees. In fact, Payment of Gratuity Act, 1972 is a statutory recognition of the concept of

gratuity. Almost all employers enter into an agreement with employees to pay gratuity

GRATUITY

Government POGA Other

Employees Employees Employees

Fully Exempt 1526 X Last Salary X Completed

12 X Average X completed

pm. years of salary years of service service

Actual Received Actual received

Maximum Rs. 1000000 Maximum Rs. 1000000

(WHICHEVER IS LESS) (WHICHEVER IS LESS)

Last Salary pm. Average Salary

= Basic salary = Average basic salary

+ +

DA (all) Average DA (in terms)

+

Average Turnover

Commission

Average of last 10 months

preceding the month

of retirement

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DEDUCTIONS FROM SALARY

The income chargeable under the head ‘Salaries’ is computed after making the following

deductions:

1) Entertainment allowance [Section 16(ii)]

2) Professional tax [Section 16(iii)]

(1) Entertainment allowance –

Entertainment allowance received is fully taxable and is first to be included in the salary and

thereafter the following deduction is to be made: However deduction in respect of

entertainment allowance is available in case of Government employees. The amount of

deduction will be lower of:

i. One-fifth of his basic salary or

ii. 5,000 or

iii. Entertainment allowance received.

Deduction is permissible even if the amount received as entertainment allowance is not

proved to have been spent.

(2) Professional tax on employment –

Professional tax or taxes on employment levied by a State under Article 276 of the

Constitution is allowed as deduction only when it is actually paid by the employee during the

previous year. If professional tax is reimbursed or directly paid by the employer on behalf of

the employee, the amount so paid is first included as salary income and then allowed as a

deduction under section 16.

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INCOME FROM BUSINESS AND PROFESSION

MEANING OF ‘BUSINESS’, ‘PROFESSION’ AND ‘PROFITS’

(i) The tax payable by an assessee on his income under this head is in respect of the profits

and gains of any business or profession, carried on by him or on his behalf during the

previous year. The term “business” has been defined in section 2(13) to “include any trade,

commerce or manufacture or any adventure or concern in the nature of trade, commerce or

manufacture”. But the term “profession” has not been defined in the Act. It means an

occupation requiring some degree of learning. Thus, a painter, a sculptor, an author, an

auditor, a lawyer, a doctor, an architect and, even an astrologer are persons who can be said

to be carrying on a profession but not business. The term ‘profession’ includes vocation as

well [Section 2(36)]. However, it is not material whether a person is carrying on a ‘business’

or ‘profession’ or ‘vocation’ since for purposes of assessment, profits from all these sources

are treated and taxed alike.

(ii) Business necessarily means a continuous exercise of an activity; nevertheless, profit from

a single venture in the nature of trade would also be assessable under this head if the venture

had come to an end or after the entire cost had been recouped. For example, where a person

had purchased a piece of land, got it surveyed, laid down a scheme of development, divided it

into a number of building plots and sold some of the plots from time to time, though he

would not be charged tax on a notional profit made on the individual sale of plots, he would

be liable to pay tax on the surplus after all the plots have been sold and the venture has come

to an end or after he has recovered the cost of all the plots and expenditure incidental thereto

and has a surplus left.

(iii) Profits may be realised in money or in money’s worth, i.e., in cash or in kind. Where

profit is realised in any form other than cash, the cash equivalent of the receipt on the date of

receipt must be taken as the value of the income received in kind. Capital receipts are not

generally to be taken into account while computing profits under this head. Payment

voluntarily made by persons who were under no obligation to pay anything at all would be

income in the hands of the recipient, if they were received in the course of a business or by

the exercise of a profession or vocation. Thus, any amount paid to a lawyer by a person who 24

was not a client, but who has been benefited by the lawyer’s professional service to another

would be assessable as the lawyer’s income.

(iv) Application of the gains of trade is immaterial. Gains made even for the benefit of the

community by a public body would be liable to tax. To attract the provisions of section 28, it

is necessary that the business, profession or vocation should be carried on at least for some

time during the accounting year but not necessarily throughout that year and not necessarily

by the assessee-owner personally, but it should be under his direction and control.

(v) The charge is not on the gross receipts but on the profits and gains in their natural and

proper sense. Profits are ascertained on ordinary principles of commercial trading and

commercial accounting. According to section 145, income has to be computed in accordance

with the method of accounting regularly and consistently employed by the assessee. The

assessee may account for his receipts on the cash basis or mercantile basis.

(vi) The Act, however, contains certain provisions for determining how the income is to be

assessed. These must be followed in every case of business or profession. The illegality of a

business, profession or vocation does not exempt its profits from tax: the revenue is not

concerned with the taint of illegality in the income or its source. Income is taxable even if the

assessee is carrying on the business, profession or vocation without any profit motive. The

liability to tax arises once income arises to the assessee; the motive or purpose of earning the

income is immaterial. Thus, profit motive is not essential for describing the income from that

activity as income from business or profession.

(vii) The profits of each distinct business must be computed separately but the tax chargeable

under this section is not on the separate income of every distinct business but on the

aggregate profits of all the business carried on by the assessee. Profits should be computed

after deducting the losses and expenses incurred for earning the income in the regular course

of the business, profession, or vocation unless the loss or expenses is expressly or by

necessary implication, disallowed by the Act.

(viii) Income arising from business assets which are temporarily let out e.g., an oil mill,

cinema theatre, hotel, ginning or textile factory, rice mill or jute press would be assessable as

business income. But if the commercial asset is permanently let the income is taxable as

income from house property or income from other sources, depending on the facts and

circumstances of the case. 25

INCOME CHARGEABLE UNDER THIS HEAD [SECTION 28]

The various items of income chargeable to tax as income under the head ‘profits and gains of

business or profession’ are as under:

(i) Income arising to any person by way of profits and gains from the business, profession or

vocation carried on by him at any time during the previous year.

(ii) Any compensation or other payment due to or received by:

(a) Any person, by whatever name called, managing the whole or substantially the whole of

(i) The affairs of an Indian company or

(ii) The affairs in India of any other company at or in connection with the termination of his

management or office or the modification of any of the terms and conditions relating thereto;

(b) any person, by whatever name called, holding an agency in India for any part of the

activities relating to the business of any other person at or in connection with the termination

of the agency or the modification of any of the terms and conditions relating thereto ;

(c) any person, for or in connection with the vesting in the Government or any corporation

owned or controlled by the Government under any law for the time being in force, of the

management of any property or business; By taxing compensation received on termination of

agency or on the takeover of management (which is a capital receipt) as income from

business, section 28(ii) provides exception to the general rule that capital receipts are not

income taxable in the hands of the recipient.

(iii) Income derived by any trade, professional or similar associations from specific services

rendered by them to their members. It may be noted that this forms an exception to the

general principle governing the assessment of income of mutual associations such as

chambers of commerce, stock brokers’ associations etc. As a result a trade, professional or

similar association performing specific services for its members is to be deemed as carrying

on business in respect of these services and on that assumption the income arising there from

is to be subjected to tax. For this purpose, it is not necessary that the income received by the

association should be definitely or directly related to these services.

26

(iv) Profits on sale of a licence granted under the Imports (Control) Order, 1955 made under

the Imports and Exports (Control) Act, 1947.

(v) Cash assistance (by whatever name called) received or receivable by any person against

exports under any scheme of the Government of India.

(vi) Any Customs duty or Excise duty drawback repaid or repayable to any person against

export under the Customs and Central Excise Duties Drawback Rules, 1971.

(vii) Any profit on the transfer of the Duty Entitlement Pass Book Scheme, being Duty

Remission Scheme, under the export and import policy formulated and announced under

section 5 of the Foreign Trade (Development and Regulation) Act, 1992.

(viii) Any profit on the transfer of Duty Free Replenishment Certificate, being Duty

Remission Scheme, under the export and import policy formulated and announced under

section 5 of the Foreign Trade (Development and Regulation) Act, 1992.

(ix) The value of any benefit or perquisite whether convertible into money or not, arising

from business or the exercise of any profession.

(x) Any interest, salary, bonus, commission or remuneration, by whatever name called, due to

or received by a partner of a firm from such firm will be deemed to be income from business.

However, where any interest, salary, bonus, commission or remuneration by whatever name

called, or any part thereof has not been allowed to be deducted under section 40(b), in the

computation of the income of the firm the income to be taxed shall be adjusted to the extent

of the amount disallowed. In other words, suppose a firm pays interest to a partner at 20%

simple interest p.a. The allowable rate of interest is 12% p.a. Hence the excess 8% paid will

be disallowed in the hands of the firm. Since the excess interest has suffered tax in the hands

of the firm, the same will not be taxed in the hands of the partner.

(xi) Any sum received under a Keyman insurance policy including the sum allocated by way

of bonus on such policy will be taxable as income from business. “Keyman insurance policy”

means a life insurance policy taken by a person on the life of another person who is or was

the employee of the first mentioned person or is or was connected in any manner whatsoever

with the business of the first mentioned person.

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(xii) Any sum received or receivable, in cash or kind, on account of any capital asset (in

respect of which deduction has been allowed under section 35AD) being demolished

destroyed, discarded or transferred.

ADMISSIBLE DEDUCTIONS

RENT, RATES, REPAIRS AND INSURANCE FOR BUILDINGS [SECTION 30]

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RENT, RATES, REPAIRS AND INSURANCE FOR BUILDINGS USED FOR BUSINESSALLOWEDNOT USED FOR BUSINESSNOT ALLOWED

REPAIRS AND INSURANCE OF MACHINERY, PLANT AND FURNITURE

[SECTION 31]

DEPRECIATION [SECTION 32]

29

REPAIRS AND INSURANCE OF MACHINERY, PLANT AND FURNITURE USED FOR BUSINESSALLOWEDNOT USED FOR BUSINESSNOT ALLOWEDASSET ELLIGIBLETANGIBLEBUILDINGFURNITURE & FIXTURESPLANT & MACHINERYINTANGIBLEKNOWHOW PATENTS COPYRIGHTS TRADEMARKS LICENSE FRANCHISE

PLANT & MACHINERY

Plant & Machinery includes Motor Vehicle, Ship, Aircraft, Surgical Equipment, Scientific

Apparatus but does not include Livestock, Tea Bushes, Building, Furniture & Fixtures

RATE OF DEPRICIATION

A.

B. FURNITURE& FIXTURES = 10%

C. PLANT & MACHINERY

i.

30

BUILDINGTEMPORARY STRUCTURE100%RESIDENTIAL BUILDING5%NORMAL10%MOTOR CARHIRING BUSINESS30%NORMAL15%

ii. SHIP = 20%

iii. AIRCRAFT = 40%

iv. GLASS CONTAINER = 50%

v. COMPUTER & SOFTWARE = 60%

vi.

vii. ENERGY SAVING DEVICES = 80%

viii. POLLUTION CONTROL EQUIPMENT = 100%

ix. GENERAL RATE = 15%

D. INTANGIBLE ASSET = 25%

31

BOOKSANNUAL PUBLICATION100%LIBRARY BUSINESS100%NORMALLY60%

32

METHOD OF DEPRECIATIONFIMINDIVIDUAL ASSETPOWER UNITSOPTIONALWDVBLOCK OF ASSET SYSTEMMANDATORY FOR ALL ASSESSEEOTHER METHODSNOT ALLOWEDASSET PURCHASED & PUT TO USEFOR 180 DAYS OR MOREFULL DEPRECIATIONLESS THAN 180 DAYSHALF DEPRECIATION

(VIII) EXPENDITURE ON SCIENTIFIC RESEARCH [SECTION 35]

33

DONATION/ CONTIBUTION FOR SCIENTIFIC RESEARCHTO A COMPANY APPROVED FOR SCIENTIFIC RESEARCH125%TO NATIONAL LABORATORY FOR SCIENTIFIC RESEARCH200%TO SCIENTIFIC RESEARCH UNIVERSITYSCIENTIFIC REASEARCH COLLEGE175%FOR SOCIAL AND STATISTICAL REASEARCH125%

ILLUTRATIONMr. More gives following P & L A/c for the year ending 31-3-2015:

Particulars Rs. Particulars Rs.

To Rent: By Gross Profit 4,38,000

Factory 45,000 By Dividend On Shares 6,000

Godown 18,000 By Sale Of Import License 30,000

Showroom 25,000By Cash Compensatory Subsidy

For Export15,000

Proprietor House 36,000 By Custom Duty Drawback 8,000

To Insurance:By Gifts & Presents From

Business Associates7,000

Factory 5,000 By Gifts From Father- In- Law 2,000

Godown 8,000By Interest From Customers For

Late Payment15,000

Showroom 1,00,000

By Amount Received Under

Endowment Life Insurance

Policy (Including Bonus Rs.

60,000)

1,00,000

To Municipal Tax: By Salary From Partnership Firm 2,00,000

Godown 41,000By Interest On Capital From

Partnership Firm85,000

Proprietor House 6,000 By Salary From ABC Ltd. 50,000

To Repairs: By Gift From ABC Ltd. 40,000

Factory 8,000 By Rent From Subletting 4,000

Proprietor House 30,000 By Income From Lottery Prize 20,000

34

To Insurance Of P&M 7,000 40,000

To Insurance Of Furniture 1,000

To Repairs Of P&M 3,000

To Depreciation 35,000

To Scientific Research Expense 20,000

To Sundry Expenses 20,000

To Salary 1,30,000

To Net Profit 5,22,000

Total 10,60,000 Total 10,60,000

Additional information:

1. Depreciation allowed according to income tax amounted to Rs. 40000

2. Salary to son reasonable Rs. 100000

You are required to prepare statement of income from business for the AY 2015-16

SOLUTION:

Name of Assessee: Mr. More35

Previous Year: 2014-15

Assessment year 2015-16

Statement of income from business

PARTICULARS Rs. Rs.Net Profit As Per P& L 5,22,000

Add: Non- Business Expenses

1. Rent: Proprietor’s House 36000

2. Municipal Tax: Proprietor House 6000

3. Repairs: Proprietor House 30000

4. Depreciation 35000

5. Salary To Son 30000 137000

657000

Less: Non- Business Income

1. Dividend On Shares 6000

2. Gift From Father In Law 2000

3. Endowment Life Insurance Policy 100000

4. Share In Net Profit From Partnership Firm 50000

5. Salary From ABC Ltd. 40000

6. Gift From ABC Ltd. 4000

7. Rent From Sub-Letting 20000

8. Income From Lottery Prize 40000 (262000)

395000

Less: Unrecorded Business Expenses

1. Depreciation As Per IT (40000)

Taxable Income From Business 355000

CONCLUSION

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The taxes are the basic source of revenue for the Government. Revenue raised from the taxes

are utilized for meeting the expense of Government like, provision of education,

infrastructure facilities such as roads, dams etc.

Direct Taxes are taxes that are directly paid to the government by the taxpayer. It is a tax

applied on individuals and organizations directly by the government e.g. income tax,

corporation tax, wealth tax etc.

The term scope of income means which items of income are included and which are excluded

while computing tax liability.

Every payment made by an employer to his employee for service rendered would be

chargeable to tax as income from salaries. The term salary for the purposes of tax will include

both monetary payments (e.g. basic salary, bonus, commission, allowances etc.) as well as

non-monetary facilities (e.g. housing accommodation, medical facility, interest free loans

etc). The tax payable by an assessee on his income under the head of income from business

and profession is in respect of the profits and gains of any business or profession, carried on

by him or on his behalf during the previous year.

BIBLIOGRAPHY

37

Direct Tax-Manan Prakashan

https://in.finance.yahoo.com/news/basics-explained--what-are-direct-and-indirect-

taxes-064840748.html

http://www.investopedia.com/terms/d/directtax.asp#ixzz3lXLBu3hV

http://www.investopedia.com/terms/i/incometax.asp#ixzz3lXNaWKEk

http://keydifferences.com/difference-between-direct-tax-and-indirect-tax.html

http://kalyan-city.blogspot.in/2010/12/direct-taxes-meaning-merits-and.html

http://www.dvsca.net/admin/pdffiles/13597250832-Scope%20of%20Total

%20Income%20and%20Residential%20status.pdf

http://www.icaiknowledgegateway.org/littledms/folder1/chapter-4-income-from-

salaries.pdf

http://www.icaiknowledgegateway.org/littledms/folder1/chapter-6-profits-and-gains-

of-business-or-profession.pdf

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