PRINCIPLES OF TAXATION

UNIT 1: INTRODUCTION TO TAXATION IN INDIA

Taxation in India is a sovereign act of the government to collect revenue for public
expenditure. The power to levy taxes is derived from the Constitution of India,
particularly Articles 265 ("No tax shall be levied or collected except by authority
of law") and Article 246 (division of subjects in Union, State, and Concurrent
Lists). The tax system includes both direct and indirect taxes, with authority
distributed between the Centre and the States.

History of Tax Law in India

Ancient Period: References to taxation are found in Manusmriti and Kautilya's

Arthashastra, which laid down principles for equitable taxation.

British Period: The modern tax structure began with the Income Tax Act of
1860 introduced by Sir James Wilson to manage the post-1857 rebellion deficit.

Post-Independence: The Income Tax Act, 1961, replaced earlier legislation.

The Goods and Services Tax (GST) was a landmark reform introduced in 2017,
unifying indirect taxes across India.

Government Financial Policy and Tax Structure

The Indian tax structure is based on:

Progressive taxation in direct taxes to ensure equity.

Broad-based indirect taxation like GST to ensure uniformity and ease of

compliance.

Revenue generated through taxation funds infrastructure, social welfare,

defense, and governance.
The Union Budget is a critical instrument reflecting financial policy and resource
allocation through taxation.

Nature and Characteristics of Tax

Compulsory Exaction: Taxes are mandatory and not a matter of contract.

No Quid Pro Quo: There is no direct benefit to the payer.

Legal Sanction: Taxes must be backed by law.

Revenue Generation: Main objective is to finance public expenditure.

Imposed by Government Authority: Only government (Union/State) can

impose taxes.

Distinction Between Direct and Indirect Tax

Basis Direct Tax Indirect Tax
Incidence &
Same person bears both Passed to another (consumer)
Impact
Examples Income Tax, Wealth Tax GST, Customs Duty
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Basis Direct Tax Indirect Tax

Equity More equitable Regressive in nature
Collected through
Administration Collected by Government directly
intermediaries
Tax vs Fee vs Cess
Tax: General revenue without specific service in return (e.g., Income Tax).
Fee: Charges for specific services rendered (e.g., Court Fees, License Fees).
Cess: A tax imposed for a particular purpose (e.g., Education Cess), usually as an
additional levy over an existing tax.
Tax Planning, Tax Evasion, and Tax Avoidance
Legali
Concept Meaning Example
ty
Tax Legitimate planning within legal Investing in PPF
Legal
Planning provisions or 80C
Tax
Exploiting loopholes without Grey Artificial
Avoidanc
breaking the law area transactions
e
Tax Deliberately concealing income Not disclosing
Illegal
Evasion to avoid tax income

Judgment: McDowell & Co. v. CTO (1985) – Supreme Court condemned tax
avoidance practices and emphasized substance over form.

India’s tax system has evolved from ancient principles to a complex legal
structure aligned with constitutional mandates and economic goals. A clear
understanding of its components—including tax types, distinctions, and ethical
dimensions like planning vs evasion—is essential for legal and fiscal governance.
 PRINCIPLES OF TAXATION

UNIT 2: LEGISLATIVE POWER TO LEVY TAXES IN INDIA

1. Constitutional Provision: Article 265

Article 265 of the Constitution of India states:

“No tax shall be levied or collected except by authority of law.”

This is the foundation of tax legality in India, ensuring that:

Taxes must have legislative backing.

Both levy and collection must be authorised by a valid law passed by a

competent legislature. Key Case:

Chhotabhai Jethabhai Patel & Co. v. Union of India (1962) – Supreme Court
held that no tax can be imposed without a valid statute, and executive
orders or circulars cannot substitute law.

2. Distribution of Legislative Powers: Union vs State (Articles 246 &

Schedule VII)

The power to legislate on taxes is divided between the Parliament and the State
Legislatures through:

Article 246 – Subject-matter of laws made by Parliament and State

Legislatures:

List I – Union List (Entry 82 to 92C): Income tax, corporate tax, customs,
excise (except alcohol), service tax (now under GST), etc.

List II – State List (Entry 45 to 63): Land revenue, stamp duty, agricultural
income tax, excise on alcohol, taxes on vehicles, etc.

List III – Concurrent List: No taxing power is given. Taxation is exclusively

distributed between Union and States.

Separation Principle:

Each level of government cannot encroach upon the taxing power of the
other. Any overlap is resolved by constitutional interpretation.

Key Case:

State of West Bengal v. Union of India (1963) – Reiterated the federal

structure and the exclusive legislative domains of the Union and States.

3. Post-GST Constitutional Amendment (101st Amendment, 2016)

Introduced Goods and Services Tax (GST) – subsumed many indirect taxes.

Article 246A added – allows both Parliament and State Legislatures to levy
GST.
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Article 279A – GST Council created to recommend tax rates and structure. Key
Case:

Union of India v. Mohit Minerals Pvt. Ltd. (2022) – Supreme Court ruled that
GST Council's recommendations are not binding, maintaining cooperative
federalism.

4. Doctrine of Colourable Legislation

If a legislature tries to impose a tax disguised under another entry, the court
can strike it down.

Case: K.C. Gajapati Narayan Deo v. State of Orissa (1953)

– The doctrine means "what cannot be done directly, cannot be done
indirectly."

5. Role of Judiciary in Taxation Powers

The Supreme Court and High Courts have consistently ensured that:

The legislature stays within its allocated power.

There is no violation of Article 265 or encroachment on another list.

India’s taxation system is deeply rooted in the constitutional framework.

Article 265 ensures legality, while Article 246 and Schedule VII maintain a federal
division of taxing powers. The judiciary acts as a check to preserve the sanctity
of constitutional limits and taxpayer rights.
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UNIT 3: DEFINITION CLAUSE – INCOME TAX ACT, 1961

Definitions under Section 2 of the Income Tax Act, 1961 form the foundation of
computation, chargeability, and procedural assessment of income. Key
terms such as assessee, income, person, and assessment year are exhaustively
defined to provide clarity and scope.

1. Assessee – [Section 2(7)]

An assessee is a person by whom:

Any tax or any other sum of money is payable, or

Against whom any proceeding under the Act has been initiated. This includes:

Legal representatives of deceased persons,

Companies undergoing winding up,

Persons who are deemed to be assessee under the Act.

Practical Relevance: Broad definition ensures that even those not directly liable
but legally connected are held accountable.

2. Assessment Year – [Section 2(9)]

Assessment Year (AY) refers to the 12-month period commencing from 1st
April to 31st March, during which income earned in the previous year is
assessed.

Example: For income earned in FY 2024–25, the AY is 2025–26.

3. Previous Year / Financial Year

As per Section 3:

The previous year is the financial year immediately preceding the assessment
year.

Income is earned in the previous year, but taxed in the assessment year.

Exception: In cases like new business or source of income, income may be

taxed in the same year.

4. Income – [Section 2(24)]

Income includes:

i. Profits and gains,

ii. Dividends,
iii. Perquisites,
iv. Capital gains,
v. Winning from lotteries, etc.
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It's an inclusive definition, not exhaustive, giving wide scope to taxation.

Case Laws:

CIT v. Shaw Wallace & Co. (6 ITC 178, PC): Compensation received for
termination of agency not taxable as income, since not recurring.

Gopal Saran Narain Singh v. CIT [1953] 3 ITR 237 (PC): Income from
interest on compensation was held taxable.

CIT v. Varadarajan (1997) 224 ITR 9 (SC): Reimbursement of expenses by

employer held taxable under salary income.

5. Person – [Section 2(31)]

"Person" includes:

i. Individual,
ii. HUF (Hindu Undivided Family),
iii. Company,
iv. Firm,
v. AOP/BOI,
vi. Local Authority,
vii. Every artificial juridical person.

Importance: Defines taxability unit, i.e., who can be taxed. A "person" may be
natural or artificial.

6. Transfer – [Section 2(47)]

i. Transfer in relation to capital assets includes:

ii. Sale, exchange, relinquishment,
iii.Compulsory acquisition,
iv. Conversion of asset into stock-in-trade,
v. Granting possession of immovable property (under part performance, Sec.
53A TP Act),
vi. Any transaction that has the effect of transferring rights.

The definition clauses under Section 2 of the Income Tax Act create a precise
legal framework to guide assessment, enforcement, and adjudication. These
definitions are dynamic and have been judicially interpreted to reflect the
economic realities behind transactions.
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UNIT 4: BASIC CONCEPTS IN INCOME TAX

Understanding basic concepts like capital vs revenue receipt, application vs

diversion of income, and scope of total income (Sec. 4 & 5) is essential to
determine the taxability of income.

1. Capital Receipt vs Revenue Receipt

The distinction determines taxability:

Basis Capital Receipt Revenue Receipt

Receipt for parting with a capital asset Receipt from a recurring activity
Nature
or source of income (business, profession, salary)
Taxabi Generally not taxable, unless Taxable as income under
lity covered under capital gains (Sec. 45) respective heads
Examp Compensation for compulsory
Rent received from property
le acquisition of land

Tests to Distinguish:

Enduring Benefit Test: If it gives lasting advantage → capital.

Source vs Return: If it is from the source itself (sale of factory) → capital; if from
use of source (factory rent) → revenue.

Frequency Test: Recurrent receipts = revenue; one-time = capital (usually).

2. Application of Income vs Diversion by Overriding Title

This concept determines whether income is taxable in the hands of the

assessee.

Taxable
Concept Meaning
?
Diversion by Income never reaches the assessee; it is diverted Not
Overriding Title at the source due to legal obligation taxable
Application of Income reaches assessee first, then applied or paid
Taxable
Income to others

Key Case:

P.C. Mullick & Co. v. CIT (1938): Payment to widow after income reached
executors = application, hence taxable.

Bejoy Singh Dudhuria v. CIT (1933): Deduction due to pre-existing legal

obligation = diversion, not taxable.

3. Total Income of Assessee – Sections 4 and 5

Section 4 – Charging Section

Tax shall be levied on the total income of the previous year. Taxability depends
on provisions of the Act.
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Section 5 – Scope of Total Income

Depends on Residential Status (individuals, HUFs, etc.)

Indian
Residential Status Foreign Income
Income
Resident & Ordinarily
Taxable Taxable
Resident (ROR)
Resident but Not Ordinarily Taxable only if from business controlled
Taxable
Resident (RNOR) or profession set up in India
Not taxable unless received or
Non-Resident (NR) Taxable
accrued in India

Total Income Includes:

 Income from all five heads: salary, house property, business/profession,

capital gains, and other sources.
 Accrued, received or deemed to accrue/receive in India.

Distinguishing between capital and revenue receipts, understanding when income

is truly received, and calculating total income under Sec. 4 and 5 helps in
determining correct tax liability. These are foundational concepts tested both in
theory and practical applications.
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UNIT 5: AGRICULTURAL INCOME AND EXEMPTED INCOME UNDER INCOME

TAX ACT

1. What is Agricultural Income?

As per Section 2(1A) of the Income Tax Act, 1961, agricultural income includes:

a) Rent or revenue derived from land situated in India and used for agricultural
purposes,
b) Income derived from such land by agricultural operations including processing
for making produce marketable,
c) Income from farm buildings required for agricultural operations.

Such income is exempt under Section 10(1), provided the land is in India and
used for agriculture.

2. Meaning of "Agriculture"

In CIT v. Raja Benoy Kumar Sahas Roy (1957 AIR 768) – the Supreme Court
defined agriculture as:

"Performance of basic operations (like tilling, sowing, planting) and

subsequent operations (like weeding, cutting, harvesting) on land
for the purpose of raising a product which has some utility."

Key Takeaway: Mere ownership of land or trading in produce is not

agriculture; actual agricultural activity is essential.

3. Judicial Clarifications

CIT v. Saundarya Nursery (2000) 241 ITR 530 (Madras HC)

– Income from saplings and seedlings grown on land is agricultural income.

K. Lakshmanan v. CIT (1998 SC)

– Income from leasing land for racing horses was held not agricultural.

Bacha F. Guzdar v. CIT (1955 SC)

– Dividend income from an agricultural company is not agricultural income in
the hands of shareholders. Exemption applies only to direct agricultural
operations.

4. Exempted Incomes – Sections 11 to 13A

Section Content Exemption Available

Income from property held for To the extent applied for such
Sec. 11
charitable or religious purposes purposes
Income of trust from voluntary
Sec. 12 Exempt, not considered income
contributions
Sec.
Conditions for registration of Must be fulfilled to claim
12A &
charitable institutions exemption
12AB
Conditions under which exemption is
Denial of benefit under Sections
Sec. 13 denied (e.g. for private benefit,
11 & 12
investment in prohibited assets)
Sec. Income of political parties Exempt, subject to maintenance
 PRINCIPLES OF TAXATION

Section Content Exemption Available

of accounts, audit, and donations
13A
through prescribed modes

5. Rationale for Exemption of Agricultural Income

Federal Structure: Taxation of agricultural income is reserved for States under

Entry 46, List II of the Constitution.

Socio-economic Objective: To protect the income of farmers and

agriculturalists.

Agricultural income enjoys constitutional and statutory exemption under

Sections 2(1A) and 10(1), subject to the performance of real agricultural
operations. Charitable and political incomes are also exempt under specified
conditions in Sections 11–13A. Judicial decisions help in distinguishing genuine
cases from tax avoidance attempts.
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UNIT 6: Principle of Mutuality

1. Concept of Mutuality

The Principle of Mutuality is based on the idea that no one can make a profit
out of themselves. When a group of people contribute funds for a common
purpose and those funds are used only for the benefit of the contributors,
any surplus generated is not considered "income" in the eyes of tax law.

Key Elements:

Complete identity between contributors and participants.

Surplus funds are not distributed as profit, but are reinvested for the group's
benefit.

The organization must operate not for profit.

2. Relevant Provisions under the Income Tax Act, 1961

Although the principle of mutuality is not explicitly defined in the Act, it is

recognized judicially and interacts with:

Section 2(24) (Definition of Income) – excludes mutual income.

Section 4 (Charging Section) – income must arise to a “person”; mutual

organisations often fall outside this scope.

Section 44 – Certain cooperative societies may still be taxed unless exempted.

3. Key Case Laws

1. Bangalore Club v. CIT (2013) 350 ITR 509 (SC)

Facts: Bangalore Club earned interest from fixed deposits held with banks who
were also not members of the club.

Held: Principle of mutuality does not apply to income earned from non-
members (i.e., banks). Interest income was taxable.

Ratio:

“If there is any commercial transaction with non-members, the surplus

arising therefrom is liable to income tax.”

⚖️2. CIT v. Chelmsford Club (2000) 243 ITR 89 (SC)

Facts: Club collected subscription fees from members and used them for club
activities.

Held: Principle of mutuality applied, income not taxable.

Ratio:
 PRINCIPLES OF TAXATION

"Activities of the club were confined to its members and no profit motive
was present."

⚖️3. CIT v. Bankipore Club (1997) 226 ITR 97 (SC)

Facts: Income from club facilities provided only to members.

Held: Income exempt under mutuality.

Ratio:

"There must be identity between contributors and beneficiaries, and

absence of profit motive."

4. Exceptions Where Mutuality Doesn’t Apply

Income from non-members (e.g., bank interest, advertising).

Activities with commercial intent or profit sharing.

Clubs that allow public participation or outsiders.

The Principle of Mutuality is a judicially evolved doctrine that provides

exemption from tax for entities operating for and by members without
profit motive. However, the scope is narrow and strictly monitored,
especially after Bangalore Club. Transactions with non-members or commercial
character can attract tax.
 PRINCIPLES OF TAXATION

UNIT 7: RESIDENTIAL STATUS – INDIVIDUALS & HUFS

Residential status determines the scope of total income chargeable to tax in

India. It is governed by Sections 6(1) & 6(2) of the Income Tax Act, 1961.

1. Residential Status of Individuals – Section 6(1)

An individual can be:

i. Resident and Ordinarily Resident (ROR)

ii. Resident but Not Ordinarily Resident (RNOR)
iii. Non-Resident (NR)

A. Test for Resident (Basic Conditions):

i. An individual is resident in India if he satisfies any one of the following:

ii. Stayed in India for 182 days or more during the relevant previous year,
OR
iii. Stayed in India for 60 days or more during the relevant year and 365 days
or more during the 4 preceding previous years.

 Exception: Indian citizens leaving for employment or NRIs visiting

India — 60 days replaced with 182 days.

B. Test for Ordinarily Resident (Additional Conditions):

A resident is ordinarily resident if:

i. He has been a resident in India in at least 2 out of 10 preceding years,

and
ii. He has stayed in India for 730 days or more in 7 preceding years.
iii. If either fails → RNOR

2. Deemed Resident [Section 6(1A) – Introduced by Finance Act 2020]

An Indian citizen with total income > ₹15 lakh (excluding foreign income)
who is not liable to tax in any other country, shall be deemed a resident of
India. Such a person is treated as RNOR to prevent tax evasion through shell
residency.

3. Incidence of Tax Based on Residential Status – Section 5

Income Type ROR RNOR NR

Income received/accrued in India ✅ ✅ ✅
Income accrued/received outside India ✅ ❌ ❌
Foreign business controlled from India ✅ ✅ ❌

Only ROR is taxed on global income, while RNOR and NR are taxed
only on Indian income.

4. Residential Status of HUF – Section 6(2)

A HUF is resident in India if:

 PRINCIPLES OF TAXATION

The control and management of its affairs is wholly or partly situated in

India.

A resident HUF is ‘ordinarily resident’ if:

 Karta satisfies both conditions of ROR in Section 6(6).

Otherwise, HUF is RNOR.

5. Key Judicial Insight

K. S. Ratnakar v. IT Dept. – Mere presence in India without meeting statutory

thresholds is not enough to become a resident.

Union of India v. Azadi Bachao Andolan (2003) – Validity of residential

planning upheld as long as it complies with statutory conditions.

Residential status under Section 6 is crucial for determining tax liability.

RORs are taxed on global income, while NR and RNOR enjoy limited taxation. For
HUFs, the location of control and management is decisive. The introduction of
deemed residency targets global tax avoidance schemes.
 PRINCIPLES OF TAXATION

UNIT 8: RESIDENTIAL STATUS OF COMPANIES UNDER INCOME TAX ACT,

1961

1. Legal Basis – Section 6(3)

As per Section 6(3) of the Income Tax Act, 1961, a company is said to be
resident in India if:

(a) It is an Indian company,

OR
(b) Place of Effective Management (POEM) is in India during that year.

2. Place of Effective Management (POEM)

POEM refers to:

"The place where key management and commercial decisions that are
necessary for the conduct of the business of an entity as a whole are made
in substance."

This concept was introduced to curb base erosion and profit shifting (BEPS)
and treaty shopping by foreign companies set up with shell structures.

3. Indian Company vs Foreign Company

Company Residential
POEM Consideration
Type Status
Indian Always
Not relevant
Company Resident
Foreign POEM in India → ResidentPOEM outside India Depends on
Company → Non-Resident POEM

4. Guidelines on POEM (CBDT Circular No. 06/2017)

To determine POEM, the following are considered:

A. Active Business Outside India (ABOI Test)

A foreign company is said to have active business outside India if:

i. Passive income (from dividends, interest, royalty) is ≤ 50% of total income.

ii. Employees, payroll, assets are mostly outside India.
iii. Head office and business decisions are not controlled from India.

✅ If ABOI is established → POEM is presumed to be outside India

unless proven otherwise.

B. Where ABOI is Not Established

In such cases, POEM is determined by:

i. Location of board meetings and decision-makers,

ii. Whether key policies and strategies are directed from India,
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iii. Role of Indian management in global affairs.

5. Judicial & Administrative Perspective

Though POEM is a relatively new concept, it aligns with international standards

like OECD’s Model Convention. Indian courts are yet to deliver detailed verdicts,
but CBDT's guidance plays a major interpretative role.

6. Impact of Residential Status

Resident Non-Resident
Income Type
Company Company
Income accrued or received in India Taxable Taxable
Global income Taxable Not taxable

The concept of POEM and Active Business Outside India under Section 6(3)
ensure that corporate residency is determined by control, not just
incorporation. This prevents foreign shell companies from escaping tax liability
if they are effectively managed from India.
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UNIT 9: DEEMED INCOME – SECTION 9 OF THE INCOME TAX ACT, 1961

1. Meaning of Deemed Income [Sec. 9]

Section 9 of the Income Tax Act deals with income that is deemed to accrue
or arise in India, even if it is earned outside India by a non-resident. It
ensures source-based taxation.

This is crucial to prevent tax avoidance by routing transactions outside India

while still deriving economic benefits from Indian sources.

2. Categories of Deemed Income under Section 9

Key inclusions under Section 9(1):

Income through business connection in India (Clause i)

Income from property, asset, or source in India

Salaries earned in India (Clause ii)

Dividend paid by an Indian company (Clause iv)

Royalty and technical fees payable by an Indian resident or against business in

India (Clauses vi & vii)

3. Business Connection – Section 9(1)(i)

“Business connection” includes any relationship or arrangement through

which a non-resident earns income in India.

Explanation 2 to Section 9(1)(i) (post-Vodafone amendment) defines

business connection to include agents, subsidiaries, or any significant
economic presence in India.

It now includes ‘digital nexus’ and ‘significant economic presence’ as per

Explanation 2A introduced by Finance Act, 2018.

4. Judicial Interpretation and Key Amendments

1. Vodafone International Holdings v. Union of India (2012) 6 SCC 757

Facts: Vodafone acquired shares of a Cayman Islands company holding Indian

telecom assets (Hutch). Indian tax authorities sought capital gains tax.

Held (Supreme Court):

The transaction was outside the territorial tax jurisdiction of India.

No capital gains accrued or arose in India.

"Look at" test applied to examine substance over form.

Outcome:
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Led to retrospective amendment to Section 9 via Finance Act, 2012:

Indirect transfer of assets located in India made taxable.

Now covered under Explanation 5 to Section 9(1)(i)

⚖️2. DIT v. Copal Research Ltd. (2014) Taxman 125 (Delhi HC)

Facts: Mauritius-based company providing online research support to an Indian

company.

Held:

No permanent establishment (PE) in India.

Payment for services not taxable as royalty or fees for technical services.

Relevance: Reinforces that mere data access or remote work doesn't

constitute business connection without a physical or significant digital presence.

5. Legislative Response – Vodafone Amendment (2012)

Explanation 4 & 5 to Section 9(1)(i) inserted to:

Tax indirect transfers of shares if substantial value derived from assets located
in India.

Apply retrospectively from 1962.

Explanation 2A: Introduced “Significant Economic Presence (SEP)” to tax

digital economy players even without physical presence in India.

6. Impact on Non-Residents

Non-residents are taxed on Indian-sourced income even if the transaction is

offshore, provided:

There is a business connection, or

The transaction involves assets located in India (directly or indirectly), or

Services are used in India.

Section 9 plays a crucial role in ensuring source-based taxation of cross-border

transactions. Landmark cases like Vodafone and Copal have shaped the
understanding of “business connection,” prompting legislative amendments to
widen tax net, especially in digital and indirect transfer domains.
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Basic Reading

The Law and Practice of Income Tax by Nani A. Palkhivala, LexisNexis

Further Reading

Taxmann: Analysis of Permanent Establishment & Deemed Income

Teaching Pedagogy: Case Law Discussions

Students to pre-read Vodafone and Copal

Discuss hypothetical: “A Singapore company sells Indian customer data to an

advertiser in Dubai. Is it taxable in India?”

Use Explanation 2A and Section 9(1)(i) to debate.