Unit 1

Taxation System in India - I

Structure
1.1 Introduction
Objectives
1.2 Tax Structure in India: A Brief History
1.3 Basic Concepts
Tax Management
Assessment Year: Section 2(9)
Previous Year: Section 3
Person: Section 2(31)
Assessee: Section 2(7)
Income: Section 2(24)
Gross Total Income and Total Income
Agricultural Income

1.4 Capital and Revenue

Capital Receipts vs. Revenue Receipts
Capital Expenses vs. Revenue Expenses
Capital Losses vs. Revenue Losses

1.5
1.6
1.7
1.8
1.9
1.10
1.11

Basis of ChargeResidential Status

Direct and Indirect Taxes
Summary
Glossary
Terminal Questions
Answers
Case Study

Caselet
Indias Changing Tax Structure
The vibrancy in Indias economy challenges investors to assess their return
on investment from time to time. In the recent past, there has been a visible
change in the modus operandi of tax administrators. Enforcement with the
aid of Permanent Account Number (PAN) as a tracking tool, strengthening
reporting and disclosure from taxpayers (such as remittance certificates in
Form 15CB/CA), codification of laws dealing with commercial substance
(such as GAAR, payment to notified jurisdictional area), and heavy penalty
for defaulters testify to this change.
Repatriation requires a commercial approach, as any scheme of profit
extraction is always under the taxmans scanner. Let us examine the impact

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of the recent tax amendments on some of the traditional methods of profit

extraction from India.
Indian companies with surplus cash and accumulated profits have been
buying back their shares. This typically entails capital gains, which is taxable.
Budget 2013 proposed 20 per cent tax on the distributed income to
shareholders through buyback, which is computed as the difference between
the amount paid for buying back the unlisted shares and the consideration
received by the company for issuing such shares. With this proposal, the
government has imposed a flat 20 per cent tax on all such transfers, which
could have been either nil or 10 per cent in the case of foreign shareholders,
depending on their country of residence, and less than 20 per cent (subject
to indexation benefits) for domestic shareholders.
Indian companies enter into various arrangements with overseas entities
for use of brand name, software licensing, technical know-how and
processes, technology collaboration and so on, for which remunerations,
more often termed as royalty, is paid. Likewise, various services are also
sourced from overseas companies, for which there is Fees for Technical
Services (FTS).
Indian companies are required to demonstrate commercial expediency and
benefits derived for paying royalty/ FTS and undertake appropriate tax
withholding to ensure their tax deductibility is not challenged.
In the 2013 Budget, the government proposed enhancing this tax on royalty
and FTS from 10 per cent to 25 per cent, which is higher than the rates
provided in most tax treaties with India. This proposal makes PAN and TRC
an absolute must for preferential treatment under tax treaties.
Taxpayers and, now, tax auditors are being closely monitored for adherence
to reporting obligation. These changing tax laws are testimony to the fact
that the rules of the game have changed.
Source: Adapted from http://www.thehindubusinessline.com/industry-andeconomy/taxation-and-accounts/profits-flying-overseas-cant-escape-thetaxmans-net/article4564615.ece. (Retrieved on 28 March 2013)

1.1 Introduction
Tax refers to the fee charged by the government on product, income or activity.
Our taxation structure provides two types of taxesdirect and indirect. If tax is

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levied directly on the income or wealth of a person, then it is a direct tax. If tax is
levied on the price of product or service then it is an indirect tax. In todays
economy, the income tax structure plays a vital role as it is a source of revenue
and a measure of removing economic disparity.
Before one can embark on a study of the law of income tax, it is important
to understand some of the expressions used in the Income Tax Act, 1961. The
purpose of this unit is to enable you to comprehend basic expressions such as
income, capital and revenue.

Objectives
After studying this unit, you should be able to:
explain the basic concepts related to the tax structure in India
identify the various features of income and the tax treatment procedure of
income
discuss gross total income and total income
differentiate between capital receipts/expenses/losses and revenue
receipts/expenses/losses

1.2 Tax Structure in India: A Brief History

The taxation structure of a country plays an important role in the working of its
economy. In India, earlier, the emphasis was on higher rates of tax and provision
of more incentives. Now the emphasis has shifted towards decreasing the rates
of taxes and withdrawing incentives. In our present day economy, the structure
of the income tax plays a vital role as it is a source of revenue and a measure of
removing economic disparity. Our tax structure provides two types of taxes
direct and indirect. Income tax, wealth tax and gift tax are direct taxes whereas
sales tax and excise duties are indirect taxes.
History
Income Tax (I-T) was introduced in India in February 1860. In 1886, the first I-T
Act came into existence. The pattern laid down in it for levying taxes continues
even today though some changes have taken place. In 1918, the Act was passed
but it was short-lived and was replaced by another in 1922. This Act was in
operation till 31st March 1961.

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On the recommendations of the Law Commission and Direct Taxes

Enquiry Committee and in consultation with the law ministry, a bill was framed,
which was referred to a select committee and finally passed in September 1961.
This Act is a comprehensive one and consists of 298 Sections, XIV schedules,
thousands of sub-sections, rules and sub-rules. This Act came into force on 1
April 1962 and has undergone several amendments.

Self Assessment Questions

1. The Indian tax structure provides for two types of taxes: ___________
and __________ tax.
2. Sales tax and excise duties are direct taxes. (True/False)

1.3 Basic Concepts

Let us discuss some of the basic concepts of taxation.

1.3.1 Tax Management

Tax Management is an integral part of business management. It involves not
only due compliance of law in a timely and regular manner, it also refers to
arranging the affairs in such a manner that it reduces the tax liability burden.
Specifics of tax management are:
(i) Filing of return (Section 139)
(ii) Maintenance of accounts (Section 44AA)
(iii) Getting the accounts audited (Section 44 AB)
(iv) Complying with the notices of Income Tax Department
(v) Payment of advance tax (Section 207 to 211)
(vi) Timely deduction of tax at source and timely payment of tax deduction
(Section 192 to 206C)
(vii) Self-assessment tax should be paid before filing of resource of income
(Section140)

1.3.2 Assessment Year: Section 2(9)

Assessment year means the period of twelve months which begins from the
first day of April every year and ends on March 31 of the next year. In India, the

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government maintains its accounts for twelve months, i.e., 1st April to 31st March.
This period is known as the financial year. The Income Tax (I-T) department has
also selected the same year for its assessment procedure.
The assessment year is the financial year of the government during which
a persons income relating to the relevant previous year is assessed to tax.
Every person who is liable to pay tax under this Act, files return of income by
prescribed dates. These returns are processed by I-T officials. This processing
is called assessment. Under this, income returned by the assessee is checked
and verified. The year in which this whole process is undertaken is called the
assessment year.

1.3.3 Previous Year: Section 3

Previous means coming before, it can simply be said that previous year is the
financial year preceding the assessment year, e.g., for assessment year 2011
2012 the previous year would be the financial year ending 31st March 2011.
(i) Previous year in case of a continuing business: It is the financial year
proceeding the assessment year. As such for the assessment year 2011
2012, the previous year for continuing business is 20102011, i.e., 1st
April 2010 to 31st March 2011.
(ii) Previous year in case of newly set up business: The previous year in
case of newly started business will be the period between the
commencement of business and the following 31st March, e.g., in case of
a newly started business commencing its operations on Diwali 2011, the
previous year in relation to the assessment year 2012-2013 shall be the
period between Diwali 2011 and 31st March 2012.
(iii) Previous year in case of newly created source of income: In such
cases, the previous year shall be the period between the day on which
such source came into existence and the following 31st March.

1.3.4 Person: Section 2(31)

The term person includes:
(i) Individual: Individuals, minors
(ii) Hindu Undivided Family (HUF): The manager of HUF is called a karta
and its members are called coparceners.
(iii) Company: An artificial person registered under the Indian Companies Act,
1956, or any other law. Also included under this head is a foreign company
[Section 2 (23A)].
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(iv) Firm: An entity that comes into existence as a result of a partnership

agreement.
(v) Association of Persons (AOP) or Body of Individuals (BOI):
Cooperative societies such as MARKFED, NAFED are examples of such
persons. When persons come together to carry out a joint enterprise and
they do not constitute a partnership under the ambit of law, they are
assessable as an association of persons.
(vi) Local authority
(vii) Artificial judicial person: Statutory corporations such as Life Insurance
Corporation and a university are called artificial judicial persons.

1.3.5 Assessee: Section 2(7)

Assessee is person who is liable to pay tax. They come under three categories:
(i) Ordinary assessee
(a) Any person against whom some proceedings under this Act are going on.
It is immaterial whether any tax or other amount is payable by him or not;
(b) Any person who has sustained loss and has filed return of loss u/s 139(3).
(c) Any person by whom some amount of interest, tax or penalty is payable
under this Act; or
(d) Any person who is entitled to refund of tax under this Act.
(ii) Representative assessee or deemed assessee
A person may not be liable only for his own income or loss but also on the
income or loss of other persons e.g., guardian of minor or lunatic, agent of a
non-resident, etc. In such cases, the persons responsible for the assessment
of income of such persons are called representative assessees. Such person
is deemed to be an assessee.
(iii) Assessee-in-default
Any individual who fails to carry out his or her legal duties is termed assesseein-default. For example, when an employer pays salary to his employee or when
one pays interest, it is mandatory to subtract the amount of tax and submit it to
the government. In case the person fails to submit the tax to the government, he
becomes assessee-in-default.

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1.3.6 Income: Section 2(24)

The definition given u/s 2 (24) is inclusive and not exhaustive. The dictionary
explains the term income as periodical monetary return coming from definite
sources like ones business, land, work and investments. It is nowhere mentioned
that income refers only to monetary return. It includes value of benefits and
perquisites. The term income includes not only what is received by using the
property but also the amount saved. Income includes:
(i) Profit and gain: For instance, profit generated by a businessman is taxable
as income.
(ii) Dividend: For instance, dividend declared/paid by a company to a
shareholder is taxable as income in the hands of shareholders.
(iii) Voluntary contribution received by a trust: For example, ABC Trust is
created for public charitable purposes. On 15th December 2008, it received
a sum of `2 lakhs as voluntary contribution from a business house. `2
lakh would be included in the income of the trust.
(iv) Value of perquisite or profit: The value of any perquisites or profit in lieu
of salary in the hand of employee is taxable.
(v) Special allowance or benefit: Any special allowance provided to an
assessee to meet expenses for the duties he discharged at his place of
employment, will be termed income.
(vi) Benefit on amenity: Value of any benefit or amenity, whether convertible
into money or not. For example, Mr Larry is employed by XYZ Ltd. Apart
from his salary, he has been provided a rent-free house by the employer.
The value of this perquisite is taxable income for Mr Larry.
(vii) Capital gain: Any capital gain taxable u/s 45 is treated as income. For
example, Mr Singh owns a house as property. On its transfer, a capital
profit of `1,20,000 is generated. This profit is treated as income, even
though it is a capital profit.
(viii) Gain from lotteries, crossword puzzles, horse races, card games,
gambling or betting. For e.g., Mr Chopra wins a sum of `50,000 from
gambling, which would be treated as his income.
(ix) Amount exceeding `50,000 by way of gift from non- relatives are treated
as income.

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Tax treatment of income

Treatment of income for tax purposes can be divided into three categories. They
are:
(i) Taxable income: These incomes form a part of the total income and are
fully taxable. These are treated u/s 14 to 69 of the Act. These are salaries,
rent, business profits, professional gain, capital gain, interest, dividend,
winning from lotteries, races, etc.
(ii) Exempted incomes: These incomes do not form a part of the total income
either fully or partially. Hence, no tax is payable on such incomes. These
incomes are given u/s 10(1) to 10(32) of the Act.
(iii) Rebateable (tax free) incomes: These incomes form a part of the total
income and are fully taxable. Tax is calculated on the total income out of
which a rebate of tax at an average rate is allowed. The rebate incomes
given under Section 86 of the Act are:
Share of income received by a member of an association of persons
provided the total income of such AOP is assessed to tax at the
rates applicable to an individual.
Share of income received by a partner of a firm assessed as an
association of persons provided the total income of such PFAOP is
assessed to tax at the rates applicable to an individual.

1.3.7 Gross Total Income and Total Income

Under Section 14, the term Gross Total Income (GTI) means aggregate of
incomes computed under the following five heads:
(i) Income under salaries
(ii) Income under house property
(iii) Income under profit and gains of business or profession
(iv) Income under capital gain
(v) Income under other sources
After aggregating income under various heads, losses are adjusted and
the resultant figure is called Gross Total Income (GTI). From GTI, deductions u/
s 80 is allowed. The resultant figure is called total income on which rates of
taxes are applied. The following chart explains it:

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Less: Adjustment on account of set-off and carry forward of losses

Gross Total Income ______
Less: Deductions u/s 80C to 80U
Total Income or Net Income ______
COMPUTATION OF TAX LIABILITY
Tax on net Income
Add : Surcharge
Tax and Surcharge
Add : Education cess
Add : Secondary and higher education cess
Less : Rebate u/s 86,89,90, 90A and 91
TAX
Add: Interest payable under Sections 234A, 234B and 234C ...........
Total
Less: Pre-paid taxes
Tax paid on self assessment
Tax deducted or collected at source
Tax paid in advance
Tax Liability ______

1.3.8 Agricultural Income

Section 10(1) exempts agricultural income from income tax. Under Section 2(1A)
the expression agricultural income means:
1. Any rent or revenue derived from land which is situated in India and is
used for agricultural purposes. [Section 2(1A) (a)]
2. Any income derived from land:
(i) Used for agricultural purposes; or
(ii) Used for agricultural operations, such as irrigating and harvesting,
sowing, weeding, digging, cutting, etc. It involves employment of
some human skill, labour and energy to get some income from land.

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According to [Section 2(1A)(a)], if the following two conditions are satisfied,

income derived from land can be termed as agricultural income.
Income derived from land: It is essential that for any income to be termed
as agricultural, land must be an effective and immediate source of income and
not indirect and secondary.
Land is used for agricultural purposes: To term any income as agricultural
income, it is necessary that income must be the result of agricultural operations
performed on agricultural land.

Self Assessment Questions

3. Match the following:
(a) Section 44 AB

(i) Filing of Return

(b) Section 139

(ii) Self assessment tax should be paid before

filing of resource of income

(c) Section 44AA

(iii) Getting the accounts audited

(d) Section 140

(iv) Maintenance of accounts.

4. ___________ is a person who is liable to pay tax.

5. Taxable income can be divided into three categories _________, ________
and __________.
6. Savings is part of income. (True/False)
7. A person is deemed to be an assessee-in-default if he fails to fulfill his
statutory obligations. (True/False)
Activity 1
What will be the previous year in relation to the assessment year 2011
2012 in the following cases:
(i) A business keeping its accounts on financial year basis
(ii) A newly-started business commencing its operation on 1st January 2011
(iii) A person giving `1,00,000 as loan @18 per cent p.a. interest (on monthly
basis) on 1st September 2007

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1.4 Capital and Revenue

Income Tax is levied on income of the assessee and not on every receipt that he
receives. The method of charging tax on different types of receipts is different.
Income Tax Act, 1961, provides a separate head capital gains for levying tax
on capital receipts. Similarly, while calculating net taxable income of an assessee,
only revenue expenses are allowed to be deducted out of revenue receipts.
While calculating business profit or professional gain, only revenue receipts
and revenue expenses are considered. This makes the distinction between capital
and revenue very important. For this distinction, capital and revenue items can
be further divided into three parts:

1.4.1 Capital Receipts vs. Revenue Receipts

It is a normal practice with a government to divide its receipts into revenue and
capital categories. Broadly speaking, revenue receipts include routine and
earned ones. For this reason, they do not include borrowings and recovery of
loans from other parties, but they do include tax receipts, donations, grants,
fees, etc. Capital receipts, on the other hand, cover those items, which are
basically non-repetitive and non-routine and change the governments financial
liabilities/assets.
Capital receipts are to be charged to tax under capital gains and revenue
receipts are taxable under other heads. It is vital to understand which receipt is
a capital receipt and which one is revenue. Some tests, however, can be applied
in particular cases. These tests are:
(i) On the basis of nature of assets: If a receipt is referred to fixed asset, it
is a capital receipt and if it is referred to circulating asset it is a revenue
receipt. Fixed asset is that with the help of which the owner earns profit by
keeping it in his possession, e.g., plant, machinery, building or factory,
etc. Circulating asset is that the property through which with the help of
which the owner earns profit by parting with it and letting others become
its owner, e.g. stock-in-trade.
(ii) Termination of source of income: Any sum received in compensation
for the termination of source of income is capital receipt, e.g.,
compensation received by an employee from his employer on termination
of his services.
(iii) Amount received in substitution of income: Any sum received in
substitution of income is revenue receipt. For e.g., A company purchasesd
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the right to produce a film from its earlier producer on the condition that no
other producer will be given the films rights. Later, it was found that the
rights for producing this film had already been sold.
(iv) Compensation received on termination of lease or surrender of a
right: Any amount received as compensation on surrendering a right or
termination of any lease is capital receipt whereas any amount received
for loss of future income is a revenue receipt.
For e.g., An author gives up his right to publish a book and receives
`1,00,000 as compensation. It is capital receipt but if he receives it as advance
royalty for five years it is revenue receipt.

1.4.2 Capital Expenses vs. Revenue Expenses

To distinguish revenue expenditure from capital expenditure, the following tests
can be applied:
(i) Nature of the assets: The amount incurred to purchase or gain fixed
assets or due to the installation of fixed assets is called capital expenditure.
while
When a person incurs expenses due to purchasing of goods for resale as
well as other costs in connection with the purchase, it is termed as revenue
expense.
(ii) Nature of liability: A payment made by an individual to clear a capital
liability is capital expenditure.
while
Any expense incurred to clear a revenue liability is revenue expenditure.
For e.g., the amount paid to a contractor for cancelling a contract to
construct a factory building will be called capital expenditure.
(iii) Nature of transaction: If an expense is incurred to obtain a source of
income it is capital expenditure, e.g., purchase of patents to produce picture
tubes of TV sets.
while
Any expense incurred to earn an income is revenue expenditure, e.g.,
salary to staff, advertisement expenses etc.
(iv) Nature of payment in the hands of payer: If any expenditure is incurred
by an assessee as a capital expenditure, it will remain a capital expenditure
even if the amount may be revenue receipt in the hands of receiver, e.g.,
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purchase of motor car by a businessman is capital expenditure in his

hands although it is revenue receipt in the hands of the car dealer.

1.4.3 Capital Losses vs. Revenue Losses

A distinction has to be made between revenue losses and capital losses of the
business because under the provisions of this Act, capital losses can be set off
against the income from capital gain only, whereas the revenue losses are
business losses and as such can be set off against any other income of the
assessee. On the basis of court judgment, following decisions have become
distinguishing points between the two:
(i) Loss due to sale of assets: Where there is loss on selling capital assets,
it is a capital loss whereas any loss incurred during the sale of stock-intrade is a revenue loss.
(ii) Loss due to embezzlement: Where there is embezzlement by an
employee and this causes loss to the business, it is revenue loss.
(iii) Loss due to withdrawal of money from bank: Once the amount is
deposited in a bank and then it is withdrawn by an employee and is
misappropriated, it is a capital loss.
(iv) Loss due to liquidation of company: Amount deposited by a person
with manufacturing industry to get its agency and loss due to company
being liquidated is a capital loss.
(v) Loss due to theft by an employee: Losses occurring due to theft or
embezzlement or misappropriation by an employee is revenue loss.
Example: State whether the following are capital or revenue receipts. Give
reasons for your answers: (i) Compensation received for compulsory vacation
of place of business. (ii) Bonus shares received by a dealer of shares. (iii) Money
received by a tyre manufacturing company for sale of technical know-how
regarding manufacture of tyres. (iv) Dividend and interest for investment.
Solution: (i) Revenue receipt as it is in compensation of assessees profit,
which he would have earned.(ii) If the assessee has also converted the bonus
shares into stock-in-trade then it is a revenue receipt otherwise it is an accretion
in the capital assets.(iii) Revenue receipt. But in case the sale of technical knowhow results in substantial reduction in value of the tyre company or company
closes down its business in that particular line then the receipt would be a Capital
Receipt. (iv) Revenue receipt. Assessee gets the income of dividend and interest
regularly and forms a definite source and it is a return for the use of his asset by
somebody else.
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Self Assessment Questions

8. While calculating net taxable income of an assessee, only ________ are
allowed to be deducted of revenue receipts.
9. To calculate business profit or professional gain, only _________ and
__________ are considered.
10. Tax can be levied on capital receipts under capital gains. (True/False)
11. Any amount received for loss of future income is a capital receipt. (True/
False)

1.5 Basis of ChargeResidential Status

The computation of total income of a person and incidence of tax depends on
his residential status. The residential status has nothing to do with the citizenship
of a person. The residential status of an assessee is determined with reference
to his residence (stay or physical presence) in India during the previous year. To
determine the taxable income of a person the residential status is required to be
determined for each assessment year.
Why to determine residential status?
Since the total income of an assessee varies according to his residential status
in India, the incidence of tax shall also very according to such residential status
in India. The basic rules for determining residential status of an assessee are:
(i) Determine residential status for each category of persons separately e.g.
there are separate set of rules for determining the residential status of an
individual, firm, AOP, companies, etc.
(ii) Determine residential status for the previous year and not the assessment
year because the total income is determined of the previous year only.
(iii) Determine every year the residential status of a person on the basis of
number of days stay in India. It may change from year to year.
(iv) Residential status of a person is applicable to all source of income.
(v) Citizenship of a country and residential status are separate concepts. A
person may be an India citizen, but may not be a resident in India. On the
other hand, a person may be a foreign national / citizen, but he may be a
resident of India.

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Residential Status of an Individual

(On the basis of Basic Conditions)

Resident

Non-Resident

(On the basis of additional Conditions)

Ordinary Resident
In India

Resident but Not Ordinary

Resident
In India

Rules for determining residential status of individuals

There are two conditions to determine the residential status of an individual viz.
(i) Basic conditions and
(ii) Additional conditions
(i) Basic conditions
There are two basic conditions. They are:
(a) An individual has been in India for 182 days or more during the previous
year (P.Y) or
(b) An individual has been in India for 60 days or more during the previous
year and 365 days or more during four years preceeding the relevant
previous year.
Exceptions to the above basic conditions (b):
o In case of an Indian citizen who leaves India during the previous year
for the purpose of employment or as a member of crew of Indian
ship or,
o In case of an Indian citizen or a person of Indian origin who comes
on a visit to India during the previous year. The presence of 60 days
required, is extended to 182 days or more in India during the previous
year. In other words basic conditions (b) referred above is not
applicable for such individuals mentioned above.
[A person of Indian origin means himself or any one of his parents or any
one of his grandparents should have been born in India or undivided India.]
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(ii) Additional conditions

There are two additional conditions which are as follows:
(a) He has been resident in India for at least two out of ten years immediately
preceeding the relevant previous year and,
(b) He has been in India for at least 730 days or more, during seven years
immediately preceeding the relevant previous year.
Important points to be considered while calculating number of days for
the residential status of an individual are as follows:
1. The day of leaving and arriving to India both days are inclusive.
2. Day starts from midnight 12.01 hour, i.e. at zero hours.
3. Any fraction of a minute is also treated as one day i.e. 0.0001 hour is also
taken as one day.
4. Sundays and holidays are inclusive.
5. The stay may be at any place or places in India.
6. The stay need not be continuous during the previous year.
When an individual is said to be:
1. Resident and ordinarily resident: If an individual satisfies any one of
the basic conditions and fulfills both the additional conditions, then he is
said to be ordinarily resident.
2. Resident but not ordinarily resident: After satisfying one or both of the
basic conditions if an individual satisfies one or none of the additional
conditions then he is said to be resident but not ordinarily a resident.
3. Non-Resident: If an individual does not satisfy any one of the basic
conditions then he said to be non-resident.
Rules for determining the residential status
Ordinarily Resident
Must satisfy at least one
of the basic conditions
and both the additional
conditions.

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Not Ordinarily Resident

Must satisfy at least one
of the basic conditions
and none or one of the
additional conditions.

Non Resident
None of the basic
conditions are satisfied.
So the additional
conditions are
immaterial.

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Residential Status of a Hindu Undivided Family [HUF] Sec.6(2)

An HUF may be like individual ordinarily resident, or resident but not ordinarily
resident or non-resident. It may be shown as under:
Residential Status of Hindu Undivided Family
(on the basis of Control and Management of HUF)

Non-Resident

Resident
(On the basis of Kartas stay in India)

Ordinary Resident
In India

Resident but Not

Ordinary Resident
In India

Rules for determining residential status of HUF

Basic conditions
The control and management of the affairs of HUF must be wholly or partly in
India. Control and management is said to be situated in a place where directing
power is situated and decision making functions are performed.
If HUF satisfies the basic condition it is resident in India otherwise treated
as non-resident in India.
Additional conditions
Once an HUF satisfies basic condition it becomes Resident. To decide whether
it is ordinarily resident or not ordinarily resident in India one has to apply the
additional conditions concerned with Kartas (head of the family) stay in India.
(a) Karta has been resident in India in at least two out of ten previous years
immediately preceding relevant previous year.
(b) Karta has been present in India for a period of 730 days in seven previous
years immediately proceeding the previous year.
If Karta of the HUF satisfies both the additional conditions, HUF is ordinarily
resident in India; otherwise it is not ordinarily resident in India.
[It is should be noted that the additional conditions can be fulfilled only in the
individual capacity of karta.]
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Rules for determining residential status of firm and associations [Sec.6(2)]

A firm or an association of persons can be either resident or non-resident in the
relevant previous year. The status is determined on the basis of the place from
where control and management is exercised by the partners of the firm or
principal officer in case of association of persons. So to determine the status
one has be apply the rules stated below:
(a) The residential status is resident in India if the control and management
or the firm / association of persons is situated wholly or partly in India.
(b) The residential status is non-resident in India if the control and management
of the firm / association of persons is situated wholly outside India.
Rules for determining residential status of company [Sec.3]
The rules are as follows:
1. An Indian company (domestic company) is always a resident in India.
2. (a) A foreign company is resident in India if its control and management
is situated wholly in India.
(b) A foreign company is non-resident in India if its control and
management is wholly or partly situated outside India.
Rules for determining residential status of every other person [Sec.6(4)]
In case of every other person there are two type of residence:
1. Resident: Every other person is resident in India if control and
management of his affairs are wholly or partly situated within India during
the relevant previous year.
2. Non-resident: Every other person is Non-resident in India if control and
management of his affairs are wholly situated outside India.
The incidence of tax and residential status
A. Incidence of tax on resident (ordinarily resident in India in case of
individual and HUFs):
The Indian income as well as foreign income of a person (i.e. individual,
HUF, Firm, Association of persons, Company or every other person) during
the previous year is taxable in the hands of a person who is a resident in
India (an ordinarily resident in case of individuals and HUFs)
B. Incidence of tax on non-ordinarily resident in India:
This status can be seen only in case of individuals and HUFs. In this case
all Indian incomes are taxable. In addition, any foreign income connected
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with business controlled from India or profession set up in India is also

taxable in the hands of Not Ordinarily Resident in India.
C. Incidence of tax on non-resident:
A non-resident in India is liable to pay tax on Indian income. However, he is
not liable to pay tax on foreign income.
Table which highlights the tax liability (in brief)
Income
A. Indian Income (All are taxable):
1. Income received in India
2. Income deemed to be received in
India
3. Income accrued or earned in India
4. Income deemed to be accrued or
earned in India
B. Foreign Income:
5. Income received and accrued or
arisen outside India from a
business controlled from or
profession set up in India
6. Income received and accrued or
arisen from a business controlled
or profession set up outside India
7. Income received and accrued or
arisen from any other source
(salary, HP, Capital gain and other
sources) outside India
C. Exempted Incomes:
8. Past untaxed foreign income
brought into India during the
previous year
9. Income received and accrued or
arisen outside India in earlier years
but later on remitted to India.

Ordinarily
Resident

Non
Ordinarily
Resident

NonResident

Yes
Yes

Yes
Yes

Yes
Yes

Yes
Yes

Yes
Yes

Yes
Yes

Yes

Yes

No

Yes

No

No

Yes

No

No

No

No

No

No

No

No

Self Assessment Questions

12. Every other person is _________ in India if control and management of
his affairs are wholly or partly situated within India during the relevant
previous year.
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13. The computation of total income of a person and incidence of tax depends
on his _________.
14. A person may be an India citizen, but may not be a resident in India. (True/
False)
15. Citizenship of a country and residential status are not separate concepts.
(True/False)

1.6 Direct and Indirect Taxes

Broadly, there are two types of taxes: direct and indirect. A direct tax is one that
is paid directly to the government by the persons on whom it is imposed. An
indirect tax is one which is collected by intermediaries (such as a retailer) who
turn over the proceeds to the government. So, if a tax is levied directly on personal
or corporate income or wealth, then it is a direct tax; if it is levied on the price of
a good or service, it is called an indirect tax. Income tax, wealth tax and gift tax
are direct taxes whereas sales tax, custom duty, service tax, value added tax
and excise duties.
Taxes are categorized on the basis of their incidence. Incidence of a tax is
said to fall upon the group that, at the end of the day, bears the burden of the
tax. A person who pays tax to the government may not actually bear the burden;
he may pass it on to someone else (perhaps customers). Direct taxes are ones
where the person who pays the tax also bears its burden. Indirect taxes are
ones where the person who pays the tax shifts the burden to his customers.

Self Assessment Questions

16. Indirect tax is collected by ___________.
17. A direct taxes payee bears its burden. (True/False)
Activity 2
Prashant Kulkarni took a loan from a bank to purchase a house. Compute
the income from the house property for the year 1st April 2011 to 31st March
2012. The following details are available:
Interest payable on loan up to 31 March 2010

`1,80,000

Installment paid towards the loan

`70,000

Municipal taxes due but not paid

`10,000

Insurance premium

`4,000

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1.7 Summary
Let us recapitulate the important concepts discussed in this unit:
The first Income Tax Act was introduced in 1886.
Assessee is defined as a person who is liable to pay tax under the provision
of the income tax law.
Income is taxable under the Income Tax law, regardless of whether it is
received in cash or in kind, and whether it is capital or revenue income.
According to Section 14, Gross Total Income is the aggregate of incomes
computed from salaries, house property, profits or gains of business
profession, capital gain and other sources.
As per the amended Finance Act, 2010, maximum marginal rate means
the rate of income-tax (including surcharge on income-tax, if any) applicable
in relation to the highest slab of income in the case of an individual
[association of persons or, as the case may be, body of individuals] as
specified in the Finance Act of the relevant Capital receipts are to be
charged to tax under capital year. gains and revenue receipts are taxable
under other heads. If a receipt is referred to fixed asset, it is a capital
receipt and if it is referred to circulating asset it is a revenue receipt.
Any sum received in compensation for the termination of source of income
is capital receipt, e.g., compensation received by an employee from his
employer on termination of his services. Any sum received in substitution
of income is revenue receipt.
Payment made by an individual to clear a capital liability is capital
expenditure. Any expense incurred to clear a revenue liability is revenue
expenditure.

1.8 Glossary
Assessee: A person by whom any tax or any other sum of money is payable.
Income: Periodical monetary return coming in regularly from definite
sources like ones business, land, work, investments etc.
Assessment year: The period of 12 months commencing on the first day
of April every year.

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Previous year: The Financial Year in which the income is earned is known
as the previous year. Any financial year begins from 1st of April and ends
on subsequent 31st March. The financial year beginning on 1st of April
2010 and ending on 31 st March 2012 is the previous year for the
assessment year 2011-2012
Person: The income tax is charged in respect of the total income of the
previous year of every person. Here the person means:
(i) An individual: A natural human being i.e., male, female minor or
aperson of sound or unsound mind
(ii) A Hindu undivided family (HUF)
(iii) A company: Any Indian company, any institution, association or body
whether Indian or non Indian, which is declared by general or special
order of the board to be a company 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, 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
(iv) A firm i.e.,a partnership firm. An association of persons or a body of
individuals whether incorporated or not
(v) Association of person or body of individuals.
(vi) A local authoritymeans a municipal committee, district board, body
of port commissioners, or other authority legally entitled to or
entrusted by the government with the control and management of a
municipal or local fund.
(vii) Every artificial, juridical person, not falling within any of the above
categories.
Capital Receipts: It is proceeds from the sale of capital assets. They
may be used to finance new capital expenditure or repay existing loan
debt
Revenue Receipts: It is proceeds from the sale of circulating assets.

1.9 Terminal Questions

1. Explain these conceptstax management, assessee, assessment and
previous year and person.
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2. Define income and its various aspects with examples.

3. Define the terms gross total income and total income. Explain the
procedure to calculate the total income.
4. What do you understand by agricultural income?
5. Distinguish between revenue expenditure and capital expenditure. Explain
the distinction between capital losses and revenue losses.
6. What are capital receipts? What are its characteristics?
7. What are the factors that would determine the residential status of an
individual?
8. Write a comprehensive note on direct and indirect taxes.

1.10 Answers
Self Assessment Questions
1. Direct, indirect
2. False
3. (a) (iii), (b) (i), (c) (iv), (d) (ii)
4. Assessee
5. Taxable, exempted and rebateable incomes
6. True
7. True
8. Revenue expenses
9. Revenue receipts, revenue expenses
10. True
11. False
12. Resident
13. Residential status
14. True
15. False
16. Intermediaries
17. True

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Terminal Questions
1. Tax management is an integral part of business management. For more
details, refer section 1.3.
2. The definition of income given under Section 2 (24) is inclusive and not
exhaustive. For more details, refer section 1.3.6.
3. Under Section 14, the term gross total income means aggregate of
incomes computed under five heads. For more details, refer section 1.3.7.
4. Any rent or revenue derived from land which is situated in India and is
used for agricultural purposes. For more details, refer section 1.3.8.
5. To distinguish revenue expenditure from capital expenditure, a few tests
should be conducted. For more details, refer section 1.4.2.
6. Capital receipts cover items, which are basically non-repetitive and nonroutine and change the governments financial liabilities/assets. For more
details, refer section 1.4.1.
7. To find out whether a person is resident, we need to follow a couple of
steps. For more details, refer section 1.5.
8. A direct tax is one that is paid directly to the government by the persons on
whom it is imposed. For more details, refer section 1.6.

1.11 Case Study

Indirect Taxes Pack Direct Punch
Goa has mostly spared the populace any direct taxes, but the aam admi is
going to have to shell out more, thanks to the state finance minister
increasing indirect taxes, including the levy of an entry tax on products
purchased online, a cess on products packed in non-biodegradable material,
and an up in the cost of various government forms and services.
Reading out the tax proposals in his budget, Goa chief minister Manohar
Parrikar emphasized that revenue enhancement by means of taxation is
proposed to be achieved without taxing the people, who are already burdened
with rising prices, but by rationalization of various available resources.
He then went on to notice the increasing trend of online shopping, where
the web becomes the market place and goods are purchased and sold in
virtual space and the same can be delivered at the homes or designated
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address of the purchaser, through various courier services, where billing is

not done locally and hence the state loses sizeable revenue.
To protect this revenue, the government will now levy an entry tax on such
courier services or agents or interstate stage carriages, who deliver these
goods locally. The CM said it would be their (courier services and stage
carriages) responsibility to obtain registration under the Entry Tax Act and to
pay the tax at applicable rates.
He then proposed a levy of cess, at the rate of 2 per cent of the sale value,
on all products sold in non-biodegradable material as identified by the state
constituted high-level task force on solid waste management. The levy of
15 per cent VAT on lubricating oil will add to the burden of vehicle owners,
while the proposal to revise the costs of various forms available in government
offices and charges of government services, during this year, will pinch
pockets dearly.
Discussion Questions
1. How will Goa increase its revenue through these proposed indirect taxes?
2. What other option does the government have to increase revenue?
Hint: Indirect taxes are provided by the consumers for the product they buy.
This indirectly reaches the government.
Source: http://www.goacom.com/goa-news-highlights/7296-get-readyindirect-taxes-pack-direct-punch. (Retrieved on 28 March 2013)
References
Taxmanns Income Tax Rules. (2012). Taxmann Publications Pvt. Ltd.
Ahuja, Girish & Ravi Gupta. (2011). Professional Approach to Direct Taxes:
Law & Practice. New Delhi: Bharat Law House Pvt. Ltd.
Agrawal, Kaushal Kumar. (2007). Tax Planning and Management. New
Delhi: Atlantic Publisher and Distributor (P) Ltd.
Satpathy, Sanjay. (2009). Tax Management. Swayam Education:
Bhubaneswar.
Ahuja, Girish & Ravi Gupta. (2012). Direct Taxes Ready Reckoner. New
Delhi: Bharat Law House Pvt Ltd.

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E-References
http://www.taxmanagementindia.com/. (Retrieved on 15 April 2013)
http://www.livemint.com/Money/JDadzvUZfcoRg2qZ6RQ1pK/DYKDifference-between-direct-and-indirect-tax.html. (Retrieved on 15 April
2013)
http://www.thehindubusinessline.com/industry-and-economy/taxation-andaccounts/profits-flying-overseas-cant-escape-the-taxmans-net/
article4564615.ece. (Retrieved on 28 March 2013)
http://www.goacom.com/goa-news-highlights/7296-get-ready-indirecttaxes-pack-direct-punch. (Retrieved on 28 March 2013)

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