Module - 01

Income Tax Act, 1961

History of Tax:
Tax is the compulsory financial charge levy by the government on income, commodity, services,
activities or transaction. The word ‘tax’ derived from the Latin word ‘Taxo’. Taxes are the basic
source of revenue for the government, which are utilized for the welfare of the people of the
country through government policies, provisions and practices.
In India, Income Tax was first time introduced in the year 1860 by Sir James Wilson in order to meet

the loss caused on account of ‘military mutiny’ in 1857.

In the year 1886, a separate Income Tax Act was passed; this act was in force for a long time,
subject to the various amendments from time to time. This act remains in force to the assessment
year 1961-62.

At present, this law is governed by the Act of 1961 which is commonly known as Income Tax Act,
1961 which came into force on and from 1st April 1962. It applies to the whole of India. Any law is
in itself is not complete unless the gaps are being filled. The law of Income Tax in India governed by
the Income Tax Act of 1961 and the gaps are being filled by the Income Tax Rules, Notifications,
Circulars and judicial pronouncement including rulings by the Tribunal.

The Income Tax law in India consists of the following components;

1. Income Tax Act, 1961: The Act contains the major provisions related to Income Tax in
India.
2. Income Tax Rules, 1962: Central Board of Direct Taxes (CBDT) is the body which looks
after the administration of Direct Tax. The CBDT is empowered to make rules for carrying
out the purpose of this Act.

3. Finance Act: Every year Finance Minister of Government of India presents the budget to
the parliament. Once the finance bill is approved by the parliament and get the clearance
from President of India, it became the Finance Act.
4. Circulars and Notifications: Sometimes the provisions of an act may need clarification
and that clarification usually in a form of circulars and notifications which has been issued
by the CBDT from time to time. It includes clarifying the doubts regarding the scope and
meaning of the provisions.
Introduction:
Tax is a compulsory payment to be made by every resident of India. It is a charge or burden laid upon
persons or the property for the support of a Government. Government decided the rates and the items
on which tax will be charged, like income tax, GST, etc
Tax can be defined in very simple words as the government’s revenue or source of income. The
money collected under the taxation system is put into use for the country’s development.

Definition of Tax: “Prof. Seligman” defines a tax which is compulsory contribution from the
person to the government to defray the expenses incurred in the common interest of all national,
without reference to special benefits conferred.

Objectives of Tax:

• Economic Development
• Revenue generation
• Regulation of production & consumption
• Better distribution of Income & wealth.
• Reduce the effect of inflation & deflation.
• Price Stability

Types of Taxes:
Taxes are levied by the government on the taxpayer. On the Basis of Incidence and Impact of Taxes,
taxes are divided into two parts namely, Direct Tax and Indirect Tax.

Direct Tax is levied directly on the income of the person. Income Tax and Wealth Tax are the part of
Direct Tax.

Whereas, in indirect taxes, the person who pays the tax, shifts the burden to the person who
consumes the goods or services. Before 2017 the Indirect Tax comprises of various taxes and
duties like Service Tax, Sales Tax, Value Added Tax, Customs Duty, Excise Duty and etc. From
July 1st, 2017 all such Indirect Taxes are submerged in one tax law which was named as ‘The Goods
and Services Tax Act, 2017”.

Differences between Direct and Indirect Taxes:

Context Direct Tax Indirect Tax

Imposition Imposed on income or profits Imposed on goods and services

Individuals, HUFs, firms and End-consumer of the goods and
Taxpayer
companies services
Applicable to every stage of the
Applicability Applicable to the taxpayer alone
production-distribution chain
The burden falls directly on the The burden is shifted to the consumer
Tax burden
individual by the manufacturer or service provider
 Cannot be transferred to anyone Can be transferred from one taxpayer
Transferability
else to the other
Confined to an entity or Wide coverage because all the
Coverage
individual taxpayer members of the society are taxed
Tax evasion Possible Not possible
Most common
Income, Wealth, Corporate Tax GST or Goods and Services Tax
types (in India)

Basic Concepts and Definitions:

Basic Concept of Income Tax Act:

“Income Tax is levied on the total income of the previous year of every person”. To understand the
basic concept, it is very important to know the various other concepts.

Definition of Income Tax:

The Income Tax is the annual charge levied on the income viz. Salary, wage, commission,
dividend, bonus, etc. of an individual, company or a firm. For each assessment year, the rate of tax
levied on different income levels, as prescribed in the slab, is defined in the Union Budget (Finance
Act).

Concept of Income:
In common parlance, Income is known as a regular periodic return to a person from his activities.
However, the Income has broader classified in Income Tax law. The Income Tax Act, even take
consideration of income which has not arisen regularly and periodically. For instance, winning
from lotteries, crossword puzzles, income from winning of shows is also subject to tax as per
income tax.

• Cash or Kind
• Legal or Illegal Income
• Temporary or Permanent
• Receipt basis or Accrual basis
• Gifts
• Lump sum or Installments.

Assessment Year:
“Assessment Year” means the year in which income of the previous year of an assessee is taxed.
The timed lap of assessment year is of twelve months beginning from the 1st April every year.
The period starts from 1st April of one year and ending on 31st March of next year. Broadly,
assessment year is defined under section 2 (9) of the Act, also called as income tax year.
Previous Year:
earned during the year is taxable in the next year. The definition of “Previous Year” is given
under section 3 of the Act. Previous Year is the year in which income is earned. Previous year is
the financial year immediately preceding the relevant assessment year.

Assessment: according to section 2 (8), assessment is defined as a computation of income &

procedure for imposing the tax liability.

The various forms of assessment are as follows:

1. Self Assessment
2. Provisional Assessment
3. Regular Assessment
4. Best Judgment Assessment
5. Re- assessment

Assessee:
An assessee is a taxpayer means a person who under the income tax act is subject to pay taxes or
any other sum of money, as defined under section 2 (7) of the Act. The expression ‘any other sum
of money’ includes other such obligations payable, for instance fine, interest, penalty and other
tax or sometimes he is liable to pay tax on income of other person is known as “deemed to be
assessee”.

Person:

Income tax is levied on the total income of the previous year of every person, as per Section 2 (31),
the term Person includes:

• An individual,
• A Hindu undivided family (HUF),
• A company: a legal entity incorporated under the company act 1956.
• A firm: a separate taxable entity distinct from its partners.
• An association of persons (AOP) or a body of individuals (BOI), whether incorporated or not:
is the integration of two or more persons for a common purpose, and primarily with an intention to
earn some income.
• A local authority: Municipal Corporation, board, other legally entitled or entrusted to the government.
• every artificial juridical person (AJP): all artificial person with judicial personality like
councils, university, library, idol etc.,
The definition of Person starts with the word includes, therefore, the list is inclusive, not exhaustive.
Income:
The income is defined in Section 2(24) of the Act, "income is the sum of all the wages, salaries,
profits, interest payments, rents, and other forms of earnings received in a given period of time.

Or the term income includes: profits & gains, dividend, voluntary contribution received by trust,
perquisites in the hands of employee, any special allowance, dearness allowance, city
compensatory allowance, capital gains, insurance profit, winning from lottery, horse race, cross
word puzzle etc., For the tax purpose incomes are divided in to the following heads.

Heads of Income:
 Income from salary
 Income from house property
 Income from business or profession
 Income from capital gain
 Income from other sources

Gross Total Income:

According to Section 2 (14) of the Income Tax Act 1961, Gross Total Income is the aggregate of
all the income earned by assessee during a specified period. Gross Total Income is a cumulative
income which is computed under the five heads of income, i.e. salary, house property, business
or profession, capital gain and other sources but before making deductions under section 80C to
80U.

Total Income:

Sec – 2 (45) explains, Total Income is the income on which tax liability is determined. It is
necessary to compute total income to ascertain tax liability. Section 80C to 80U provides certain
deductions which can be claimed from Gross Total Income (GTI). The balance amount of income
left over after providing deductions under section 80C to 80U is called Total Income.

Capital & revenue receipts:

Capital Receipt: Capital receipts are the income received by the company which is nonrecurring
in nature. They are part of the financing and investing activities rather than operating activities.
The capital receipts either reduce an asset or increases a liability. The receipts can be generated
from the following sources:

• Issue of Shares
• The issue of debt instruments such as debentures.
• Loan taken from a bank or financial institution.
• Government grants.
• Insurance Claim.
• Additional capital introduced by the proprietor.
Revenue Receipt: Revenue Receipts are the receipts which arise through the core business
activities. These receipts are a part of normal business operations that is why they occur again and
again however its benefit can be enjoyed only in the current accounting year as its effect is short
term. The income received from the day to day activities of business includes all the operations
that bring cash into the business like:

• Revenue generated from the sale of inventory

• Services Rendered
• Discount Received from the creditors or suppliers
• Sale of waste material/scrap.
• Interest Received
• Receipt in the form of dividend
• Rent Received

Capital and revenue expenditure:

Capital Expenditure: The amount spent by the company for possessing any long-term capital
asset or to enhance the working capacity of any existing capital asset, or to increase its lifespan to
generate future cash flows or to decrease the cost of production, is known as Capital expenditure.
As a huge amount is spent on it, the expenditure is capitalized, i.e. the amount of expenditure is
spread over the remaining useful life of the asset.

The expenditure which is done for initiate current, as well as the future economic benefit, is capital
expenditure. It is a long-term investment done by the entity, in the name of assets, to create
financial gain for the years to come. For example – Purchase of Machinery or installation of
equipment to the machinery which will improve its productivity capacity or life years.

Revenue Expenditure: The expenditure which is incurred on a regular basis for conducting the
operational activities of the business are known as Revenue expenditure like the purchase of stock,
carriage, freight, etc.. As per the accrual accounting assumption, the recognition of revenues is
done when they are earned while expenditure is recognized when they are incurred. Therefore,
the revenue expenditure is charged to the Income Statement as and when they occur. This satisfies
the fundamental principle of accounting i.e. Matching Principle in which the expenses are
recorded in the period of their incurrence. The benefit generated by the revenue expenditure is for
the current accounting year.

The examples of revenue expenditure are as under – Wages & Salary, Printing & Stationery,
Electricity Expenses, Repairs and Maintenance Expenses, Inventory, Postage, Insurance, taxes,
etc.

Basis of charge or charge on income tax:

According to Sec – 4, the following basic principles are followed while charging the tax on income.
  Annual tax
 Tax rate of assessment year
 Tax rates fixed by finance act
 Tax on person
 Provisions as on 1sr April of the Assessment year.
 Tax on Total Income.

Scope of Total Income:

Section -5 of Income Tax Act, 1961 provides Scope of total Income in case of person who is a
resident, in the case of a person not ordinarily resident in India and person who is a non-resident
which includes.

Income can be Income from any source which,

• is received or is deemed to be received in India in such year by or on behalf of such

person or
• accrues or arises or is deemed to accrue or arise to him in India during such year or
• accrues or arises to him outside India during such year.

Residential status of an Individual:

The taxability of an individual in India depends upon his residential status in India for any particular
financial year. Residence in India – is determined by Section 6 of the Income Tax Act 1961.

Determination of Residential status of an Individual:

The residential status of an individual is determined on the basis of bellow conditions.

• Basic Conditions (sec. 6(1))

• Additional Conditions (sec. 6(6))

Basic Conditions (sec. 6(1)):

An individual is said to be resident in India if he satisfies any one of the following basic conditions:

a. He is in India for at least 182 days in the previous year (PY).

Or
 b. He is in India for at least 60 days in PY & for 365 days or more during 4 years immediately
preceding the PY.

NOTE: Both days i.e. the day when one left & the day on which he came to India is considered for
Number of days of stay in India.

Exceptions for second condition:

Condition 2 is not applicable when Indian citizen during PY:-

• Leaves India for employment outside India: In case of an individual, who is a citizen of India
and who leaves India in any previous year for the purposes of employment outside India, the
condition No. 2 shall not be applicable for the relevant previous year in which he leaves India.
• Leaves India as he is a crew member of an Indian ship.
• Comes to visit India: In case of an individual, who is a citizen of India, or is a person of Indian
origin, who, being outside India comes on a visit to India in any previous year, the condition
No. 2 mentioned above in his case also shall not be applicable. In other words, he shall not be a
resident in India unless his stay in India is at least 182 days during the relevant previous year in
which he visits India.

Additional Conditions (sec. 6(6)):

An individual who is resident in India, shall be resident and ordinarily resident in India if hesatisfies
both the following conditions

a. He has been 'Resident in India' for at least 2 out of 10 previous years immediately preceding
the relevant previous year. And

b. He has been in India for 730 days or more, during 7 previous years immediately preceding the
relevant previous year.

Determination of residential status:

 Resident & ordinarily resident: if he / she fulfill one basic condition & both the additional
condition.
 Resident & but not ordinarily resident: if he / she fulfill one basic condition but fail to
fulfill one or both the additional conditions.
 Non-resident: if he / she fail to fulfill none of basic conditions.

Incidence of Tax:

The incidence of tax on a taxpayer depends on his residential status and also on the place and time of
accrual of receipt of income. Section 5 deals with the incidence of income tax; this section gives a
discussion on different types of income taxable in the hands of ordinary resident, not ordinary resident
& non-resident.
Indian Income and foreign income

Indian Income: Any of the following three is an Indian income:

i. If income is received (or deemed to be received) in India during the previous year and at the
same time it accrues (or arises or is deemed to accrue or arise) in India during the previous
year;
ii. If income is received (or deemed to be received) in India during the previous year but it
accrues (or arises) outside India during the previous year;
iii. If income is received outside India during the previous year but it accrues (or arises or is
deemed to accrue or arise) in India during the previous year;

Foreign income: If the following conditions are satisfied, then such income is foreign income:

i) Income is not received (or not deemed to be received) in India; and ii) Income
does not accrue or arise (or does not deemed to accrue or arise) in India.

Table showing the tax liability on total income of individuals with their residential status:

Resident Resident but

Sl & not ordinarily Non-
Types of income
No Ordinarily resident resident
resident
Income received in India or
1 deemed to be received in India, Yes Yes Yes
whether accrued in India or not.
Income accrued or arises or
2 deemed to accrue or arise in India Yes Yes Yes
whether received or not.
Income accrued or arises outside
India from business controlled
3 Yes Yes No
from India or profession set up in
India.
Income accrued & received
4 Yes No No
anywhere outside India.
Past foreign income whether taxed
5 or not brought into India during the No No No
previous year.

a. Income received in India:

Any income which is received in India, during the previous year by any assessee, is liable to tax in
India, irrespective of the residential status of the assessee and the place of accrual of such income.

Receipts means the first receipt: The receipt of income refers to the first occasion when the recipient
gets the money under his own control. Once an amount is received as income, any remittance or
transmission of the amount to another place does not result in receipt within the meaning of this
clause at the other place.
 b. Income Deemed to be received:

The following incomes shall be deemed to be received in India in the previous year even in the
absence of actual receipt:

1. Contribution made by the employer to the recognized provident fund in excess of 12% of
the salary of the employee;
2. Interest credited to the RPF of the employee which is in excess of 9.5% p.a.
3. Transfer balance from the unrecognized fund to a Recognized Provident Fund (It has been
discussed in the Chapter on 'Income from Salaries');
4. The contribution made, by the Central Government or any other employer in the previous
year, to the account of an employee under a notified contributory pension scheme referred
to in section 80CCD.

c. Income received in India:

Any income which is received in India, during the previous year by any assessee, is liable to tax in
India, irrespective of the residential status of the assessee and the place of accrual of such income.

Receipts means the first receipt: The receipt of income refers to the first occasion when the recipient
gets the money under his own control. Once an amount is received as income, any remittance or
transmission of the amount to another place does not result in receipt within the meaning of this
clause at the other place.

d. Income Deemed to be received:

The following incomes shall be deemed to be received in India in the previous year even in the
absence of actual receipt:

1. Contribution made by the employer to the recognized provident fund in excess of 12% of
the salary of the employee;
2. Interest credited to the RPF of the employee which is in excess of 9.5% p.a.
3. Transfer balance from the unrecognized fund to a Recognized Provident Fund (It has been
discussed in the Chapter on 'Income from Salaries');
4. The contribution made, by the Central Government or any other employer in the previous
year, to the account of an employee under a notified contributory pension scheme referred
to in section 80CCD.
e. Income accrued or arises:
When an assessee gets a right to receive some income, that income is said to have been
accrued in India. Such incomes which accrue or arise in the hands of an assessee in India
during the previous year will be taxed in the hands of an assessee whether received or not.
Eg: Interest on fixed deposit.
f. Income deemed to accrue or arise:
 The incomes which are not accrued in India during the previous year, but presumed by the act
accrued in the hands of the assessee.

• Capital gain arising on transfer of property situated in India.

• Income from business connection in India.
• Salary received by an Indian national from Government of India in respect of service rendered
outside India.

Incomes which do not form part of Total Income (Sec. 10):

In computing the total income of a previous year of any person, any income falling within any of the
following clauses shall not be included

• Agriculture Income [Section 10(1)]

• Any sum received by a Coparcener from Hindu Undivided Family (H.U.F.) [Section 10(2)]
• Share of Income from the Firm [Section 10(2A)]
• Interest paid to Non-Resident [Section 10(4)(i)]
• Leave Travel Concession or Assistance (LTC/LTA) to an Indian Citizen Employee [Section
10(5)]
• Perquisites and Allowances paid by Government to its Employees serving outside India
[Section 10(7)]
• Gratuity [Section 10(10)]
• Amount received as Leave Encashment on Retirement [Section 10(10AA)]
• Commuted value of Pension Received [Section 10(10A)]
• Retrenchment Compensation received by Workmen [Section 10(10B)]

Tax liability of an individual can be reduced through 3 different methods- Tax Planning, Tax
avoidance and Tax evasion.
All the methods are different and interchangeable.

Tax Planning:

Tax Planning can be understood as the activity undertaken by the assessee to reduce the tax liability
by making optimum use of all permissible allowances, deductions, concessions, exemptions, rebates,
exclusions and so forth, available under the statute. Having no intension to deceit the legal spirit
behind the tax law would naturally face within the ambit of tax planning.

Objectives of Tax Planning

• Minimal Litigation: There is always friction between the collector and the payer of tax. In
such a situation, it is important that the compliance regarding tax payment is followed and
used properly so that friction is minimum.
 • Productivity: Among the most important objectives of tax planning is channelization of
taxable income to various investment plans.
• Reduction of Tax Liability: As a tax payer, you can save the maximum amount from payable
tax amount by using a proper arrangement of your enterprise working as per the required laws.
• Healthy Growth of Economy: The growth in an economy depends largely upon the growth
of its citizens. Tax planning estimates generation of white money that is in free flow.
• Economic Stability: Stability is supplemented when the tax planning behind a business.

Tax avoidance:

Tax avoidance is the practice of adjusting your financial affairs in such a manner that you avoid
paying tax to the government. Here, one makes use of shortcomings and loopholes in the law unfairly
for personal benefit. When you indulge in tax avoidance, you don’t violate the tax law but you
override the intent of the law. It is not as severe as tax evasion but can be equally bad. Tax avoidance
is the use of legal methods to modify an individual's financial situation to lower the amount of income
tax owed. This is generally accomplished by claiming the permissible deductions and credits.

Tax Evasion:
Tax Evasion is an illegal way to minimize tax liability through fraudulent techniques like deliberate
under-statement of taxable income or inflating expenses. It is an unlawful attempt to reduce one’s tax
burden. Tax Evasion is done with a motive of showing fewer profits in order to avoid tax burden. It
involves illegal practices such as making false statements, hiding relevant documents, not
maintaining complete records of the transactions, concealment of income, overstatement of tax credit
or presenting personal expenses as business expenses. Tax evasion is a crime for which the assessee
could be punished under the law.

Tax Management:

Every assessee liable to pay tax needs to manage his/her taxes. Tax management relates to
management of finances for payment of tax, assessing the advance tax liability to pay tax in time.
Tax management has nothing to do with planning to save tax it is just related with operational aspect
of payment of tax i.e. while managing his taxes a person ensures that he/she is making timely payment
of taxes without running out of the money and he is complying with all the provisions of the law.

Elements of Tax Management:

• Reduce adjusted gross income
• Increase the amount of tax deductions
• Appropriate use of tax credits
• Tax Planning for Retirement Plans
• Tax gain-loss harvestingis another form of tax planning or management relating to
investments. It is useful because it can use a portfolio's losses to offset overall capital gains.