Income Tax Act

The Income Tax Act 1961 (the Act) is the principal and central legislation of India with respect to the levy and collection of direct tax on the total income* of various persons (assessees) for the relevant ‘previous year(financial year immediately preceding the ‘assessment year’).

* ‘Income’ is defined inclusively by section 2(24) of the Act

Finance Act

The Finance Act legislated at the beginning of each calendar year by the Central Government of India is the most significant law for direct (income) taxation purposes, as it generally includes the following features —

  • Determines and classifies the rate(s) of such income tax (and other levies like surcharge, cess etc.) chargeable on various persons
  • Details income tax benefits, exemptions, clarifications etc. under the Act
  • Amends, omits and/or repeals various provisions of the Act and/or preceding Finance Act(s)
  • Introduces or enacts the commencement of new provisions of the Act etc.

> Read more on the effect of Finance Act 2017 on Income Tax (Financial Year 2017-18 onwards)

 

Core Concepts

If a person (assessee) is determined a ‘tax resident’ of India under the relevant provision of the Income Tax Act 1961 (the Act) in respect of any source of income, then such person shall also be deemed to be a tax resident in respect of (any) other source(s) of income for the same said year and potentially liable to income tax under the Act for all such income(s).


Company

A Company is said to be an income tax resident in India in any previous year, if —

  • It is an Indian Company ; or
  • During that year, the control and management of its affairs is situated wholly in India.

Following shall be substituted for the above with effect from 1 April 2017

A Company is said to be a resident in India in any previous year, if—

  • It is an Indian company; or
  • Its place of effective management, in that year, is in India.

Explanation.—For the purposes of this clause “place of effective management” means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made.

> Read more on ‘Place of Effective Management’ (POEM)


Individuals

Under section 6 of the Income Tax Act 1961 (the Act), an individual* is said to be an income tax resident in India in any previous year, if he/she —

  • Is in India in that year for a period or periods amounting in all to 182 days or more; or
  • Having within the 4 years preceding that year been in India for a period or periods amounting in all to 365 days or more, is in India for a period or periods amounting in all to 60 days or more in that year.

However, an individual person is said to be a (tax) resident but “not ordinarily resident in India in any previous year if such person is —

  • An individual who has been a non-resident in India in 9 out of the 10 previous years preceding that year, or
  • Has during the 7 previous years preceding that year been in India for a period of, or periods amounting in all to, 729 days or less.

*In the case of an individual —

(a) being a citizen of India, who leaves India in any previous year as a member of the crew of an Indian ship as defined in clause (18) of section 3 of the Merchant Shipping Act, 1958 (44 of 1958), or for the purposes of employment outside India, the provisions of sub-clause (c) shall apply in relation to that year as if for the words “sixty days”, occurring therein, the words “one hundred and eighty-two days” had been substituted ;

(b) being a citizen of India, or a person of Indian origin within the meaning of Explanation to clause (e) of section 115C, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply in relation to that year as if for the words “sixty days”, occurring therein, the words “one hundred and eighty-two days” had been substituted.

For the purposes of this clause, in the case of an individual, being a citizen of India and a member of the crew of a foreign bound ship leaving India, the period or periods of stay in India shall, in respect of such voyage, be determined in the manner and subject to such conditions as may be prescribed.


Other Tax Assessees (excluding HUFs)

Every other person is said to be an income tax resident in India in any previous year in every case, except where during that year the control and management of his affairs is situated wholly outside India.


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Through section 90 of the Income Tax Act 1961 (the Act), the Indian Government has entered into a number of Tax Treaties with many countries and tax jurisdictions in the form of Comprehensive Double Taxation Avoidance Agreements (DTAAs), Tax Information Exchange Agreements (TIEAs), Limited Agreements etc., generally for the the avoidance of double taxation on income, prevention of fiscal evasion with respect to taxes on income and capital gains and exchange of information on taxes and tax entities within the relevant contracting party’s jurisdiction, relevant to the determination, assessment and collection of such taxes, the recovery and enforcement of tax claims, or the investigation or prosecution of tax matters.

> Read more on ‘International Taxation’


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Person

Section 2(31) of the Income Tax Act 1961 (the Act) provides the definition of a “person” which includes —

  • Individual
  • Hindu Undivided Family (HUF)
  • Company
  • Firm
  • ^Association of Persons (AOP) or Body of Individuals (BOI) (whether incorporated or not)
  • Local Authority, and
  • Every Artificial Juridical Person (not falling in the categories above)

^ An AOP or a BOI or a local authority or an artificial juridical person is deemed to be a ‘person’, whether or not it was formed or established or incorporated with the object of deriving income, profits or gains.

 

Scope of Income

The ‘residency‘ of the relevant ‘person‘ when read with Section 5 of the Act (subject to other provisions of the Act, applicable tax treaties, DTAAs, special acts etc.) further determines the scope of the ‘total income’ chargeable to tax under the Act for any ‘previous year‘ for such person.


Resident

Total Income for a ‘resident’ includes therein all** the income from whatever source derived —

  • 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.


Resident but not Ordinarily Resident
**

The classification of a person (Individual or HUF) as resident but ‘not ordinarily resident in India(within the meaning of section 6(6) of the Act) excludes from income tax liability any income which accrues or arises to such person outside India, unless it is derived from a business controlled in or a profession set up in India.


Non-Resident

Subject to the provisions of the Act, the total income of any previous year of a person classified as a ‘non-resident’ includes all income from whatever source derived 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.


Income deemed to accrue or arise in India

Section 9 of the Act lists incomes that are deemed to accrue or arise in India and includes —

  • All income accruing or arising through or from any business connection^^ in India
  • Such income accruing or arising through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India
  • Income if it falls under the income head “Salaries”, if earned in India
  • Income chargeable under the head “Salaries” payable by the Government to a citizen of India for service outside India
  • Dividend paid by an Indian company outside India
  • Interest, Royalty or Fees for Technical Services payable by the GOI, resident or non-resident for the purposes of a business or profession carried on by such person in India (and other prescribed criteria)

^^Section 9A of the Act, subject to provisions thereunder, excludes certain activities of an ‘eligible investment fund’ as not constituting a ‘business connection’ in India.


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Section 10 of the Income Tax Act 1961 (the Act) excludes the income(s) thereunder from the total income and consequential tax liability of a previous year of the prescribed person, some of these excluded income(s) have been listed below —

  • Agricultural income
  • Person being a partner of a partnership firm which is separately assessed as such, his/her share in the total income of the firm
  • Allowances or perquisites paid or allowed as such outside India by the Government of India to its citizen for rendering service overseas
  • Employee Retirement benefits and compensation payments (such as pension, gratuity, retrenchment compensation, voluntary retirement, termination of services etc.) to eligible person or heirs, from approved sources and prescribed tax-free amounts
  • Sum received under a life insurance policy (including sum allocated by way of bonus) excluding certain specified sums and other conditions
  • Accumulated balance due and becoming payable to an employee participating in a recognised provident fund (to the extent provided in rule 8 of Part A of the Fourth Schedule of the Act)
  • Income received by any person on behalf of approved non-profit entities for education, health, public religious and/or charitable purposes etc.(and subject to conditions specified)
  • Dividend income (as referred to in section 115-O of the Act regarding distributed profits of Domestic Companies)
  • Income to Shareholder on account of Share Buy-back (not listed on a recognised stock exchange) by Company (referred to in section 115QA of the Act)
  • Income from units of a Mutual Fund (specified under section 10(23D) of the Act)
  • Capital Gains from transfer of agricultural land by Individual or a Hindu undivided family (HUF) (and subject to specified conditions)
  • Income from the transfer of long-term capital asset – Equity Share in a Company or a unit of an ‘Equity oriented fund’ or a unit of a Business Trust’ (subject to specified conditions) etc.


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For the purpose of computing ‘total income’ of a ‘person’ (assessee) under the Income Tax Act 1961 (the Act), except as otherwise provided by the Act, all incomes are classified under the following ‘heads’ of income —


Salaries

  • Salary income is chargeable to income tax under section 15 of the Income Tax Act 1961 (the Act) on “due basis” or “receipt basis” whichever is earlier.
  • Existence of relationship of employer and employee is must between the payer and payee to tax the income under this head.


Taxable Components of Salary Income

Income from salary taxable during the year shall consists of following —

  • Any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not;
  • Any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him;
  • Any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.


Income from House Property

The ‘Annual Value‘ of a ‘house property’ as computed under section 23 of the Act is chargeable to income tax under the head “Income from house property” —

  • House property should consist of any building or land appurtenant thereto;
  • Taxpayer/Assessee should be the owner of the subject property;
  • House property should not be occupied/used for the purpose of business or profession carried on by said Assessee.
  • Income chargeable under the above said head is computed after making the deductions allowed under section 24 of the Act.


Profits and Gains of Business or Profession

Section 28 of the Act provides an exhaustive list of incomes that are required to be charged to income tax under the head “Profits and Gains of Business or Profession“. Such income(s) is computed in accordance with the provisions contained in sections 30 to 43D of the Act, which includes —

  • Deduction for rent, rates, taxes, repairs and insurance for buildings (section 30)
  • Deduction for repairs and insurance of machinery, plant and furniture (section 31)
  • Depreciation allowance (section 32)
  • Deduction for expenditure on scientific research
  • Other deductions (section 36)
  • Expenditure (excluding expenditure under sections 30 to 36 and not capital expenditure or personal expenses of the assessee) laid out/expended wholly and exclusively for business or profession (section 37)
  • Non-deductible amounts (section 40)
  • Expenses or payments not deductible in certain circumstances (section 40A)
  • Certain deductions to be only on actual payment (section 43B)


Capital Gains

Capital Gain‘ is chargeable (or partly/wholly exempt) to tax under the Act in the prescribed circumstances and applicable provisions of the Act, some of which are as follows —

  • Existence of a Capital Asset (defined under section 2(14) of the Act)
  • Capital Asset may be a ‘short-term’ capital asset (section 2(42A) of the Act) or a ‘long-term’ capital asset (Section 2(29A) of the Act), depending on the prescribed ‘period of holding’ by the relevant assessee
  • ‘Transfer’ (defined under section 2(47) of the Act) of such Capital Asset by the taxpayer during the previous year
  • Profits or gain results from such transfer as computed under section 48 of the Act (subject to different rates of tax or exemption therefrom if ‘short-term capital gain’ or ‘long-term capital gain'(LTCG), as the case may be)
  • Transactions not regarded as transfer (section 47)
  • Special provision for computation of capital gains in case of slump sale (section 50B)
  • Special provision for deemed full value of consideration on transfer of land or building or both (section 50C)
  • Special provisions with respect to exemption/deferment of LTCG (section 54 to 54GB)


Income from other sources

Income of every kind which is not to be excluded from the total income under the Act, is chargeable to income tax under the residuary head “Income from other sources(if such income(s) is not otherwise chargeable under any of the other heads of income).

Section 56(2) of the Act however requires the incomes listed thereunder to be chargeable to income tax under the head “Income from other sources”, which includes —

  • Dividends
  • Interest on Securities (if not taxable under the head ‘Profits and Gains of Business or Profession’)
  • Composite rental income from letting of plant, machinery or furniture with buildings (where such letting is inseparable and such income is not taxable under the head ‘Profits and Gains of Business or Profession’)
  • Sum of money or (moveable or immovable) property received by an individual or HUF from any person (except from ‘relatives’ or member of HUF or in given circumstances) in excess of prescribed quantum and/or without adequate consideration
  • Receipt (excludes transactions not regarded as ‘transfer’ under section 47) of Shares in a ‘closely held Company’ (‘public not substantially interested’) by a firm or another such closely held company from any person without consideration or for inadequate consideration, the aggregate fair market value of such shares as reduced by the consideration paid (if any) exceeds prescribed quantum etc.

Section 57 of the Act allows the deduction of expenditures from income chargeable to tax under the head ‘Income from Other Sources’, which includes expenditure (not being capital expenditure) expended wholly and exclusively for earning such income.


Expenditure incurred in relation to Income not includible in Total Income

For the purposes of computing the total income, section 14A of the Act disallows deduction in respect of expenditure incurred by the concerned person (assessee) in relation to income which does not form part of the total income under the Act.

For determining the quantum of such disallowance, the following procedure is prescribed —

  • The relevant Assessing Officer (AO) determines the amount of such expenditure incurred in accordance with such method prescribed (Rule 8D of Income Tax Rules 1962), where such AO having regard to the accounts of the assessee is not satisfied with the correctness of the claim of the assessee in respect of such expenditure.
  • These provisions also apply in relation to a case where an assessee claims that no expenditure has been incurred in relation to income which do not form part of the total income under the Act.


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Sections 70 to 80 (Chapter VI) of the Income Tax Act 1961 (the Act) enable the set-off and/or carry forward of losses sustained by persons (assessees) subject to the various conditions and methodology prescribed thereunder, which include the following —

Inter-Source Adjustment (section 70)

Set off of loss from one source against income from another source under the same head of income

  • Net result of a loss for any assessment year in respect of any source falling under any head of income (other than “Capital gains”) can be set off against income from any other source under the same head of income, by the relevant person (assessee).
  • Long-term Capital Loss can only be set-off against long-term Capital Gains (LTCG)
  • Short-term Capital Loss can be set-off against any Capital Gains (including LTCG)


Inter-Head Adjustment (section 71)

Set off of loss from one head against income from another

  • Net result of a loss under any head of income (other than ‘Capital Gains’) for any assessment year can be set off (subject to the provisions of the said Chapter of the Act) against assessable income (if any) for said year under any other head (if no income under the head ‘Capital Gains’ or optionally against it, if present).
  • Loss under the head ‘Profits and Gains of Business or Profession’ cannot be set-off against any income assessable under the head ‘Salaries’.
  • Net result of a loss under the head ‘Capital Gains’ cannot be set-off against any other income assessable under any other head of income.


Carry forward and set off of loss from house property (section 71B)

Net result of a loss under the head ‘Income from House Property’ for an assessment year not set-off (wholly or partly, subject to a maximum loss of Rs.2 lacs for Assessment Year 2018-19 onwards) against income from any other head of income due to shortfall of the latter, is required to be carried forward to the following assessment year to be —

  • Set off against ‘income from house property’ assessable for that assessment year; and
  • Loss (if any) not so set-off wholly is to be carried forward to the following assessment year(s) (not being more than 8 assessment years immediately succeeding the assessment year for which the loss was first computed).


Carry forward and set off of business losses (section 72)

Net result of a loss for an assessment year under the head ‘Profits and Gains of Business or Profession(not loss sustained in ‘speculation business) not set-off (wholly or partly) against income under any head of income (as per section 71), quantum not so set-off (subject to the other provisions of the said Chapter of the Act) is to be carried forward to the following assessment year —

  • Set off against the profits and gains (if any) of any assessable business or profession carried on in that following assessment year;
  • Loss still not wholly set-off can be carried forward to the following 8 assessment years (immediately succeeding the assessment year for which the loss was first computed).
  • Assessee would be required to file an income tax return to carry forward and set-off the same for subsequent assessment year(s).


Losses under the head ‘Capital Gains’ (section 74)

Net result of a loss under the head ‘Capital Gains’ for an assessment year (subject to the other provisions of the said Chapter of the Act) is required to be carried forward to the following assessment year in the following manner —

  • Loss relating to short-term capital asset can be set off against income (if any) under the head ‘Capital Gains’ assessable for the following assessment year in respect of any other Capital Asset;
  • Loss relating to a long-term capital asset can be set off against income (if any) under the head ‘Capital Gains’ assessable for the following assessment year in respect of any long-term capital asset only (i.e.not being a short-term capital asset);
  • Loss not so wholly set off is required to be carried forward to the following assessment year(s) for another 8 assessment years (immediately succeeding the assessment year for which the loss was first computed).


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For the purpose of computing the ‘total income’ of a person (assessee), the provisions of Chapter VIA of the Income Tax Act 1961 (the Act) allows ‘deductions‘ from the concerned assessee’s ‘gross total income’ (GTI)*** in accordance with sections 80-IAC to 80VV and subject to any conditions and restrictions prescribed therein.

  • Some deductions can only be allowed if the concerned assessee furnishes a return of income for the relevant assessment year on or before the due date specified under the Act.
  • The aggregate amount of the deductions under the said Chapter cannot exceed the GTI of the concerned assessee.

*** ‘Gross Total Income’ (GTI) is defined as the total income computed in accordance with the provisions of the Act before making any ‘deduction’ under the said provisions and Chapter of the Act.


Important Deductions

  • Section 80C — Deduction in respect of life insurance premia, deferred annuity, contributions to provident fund, subscription to certain equity shares or debentures, etc.
  • Section 80CCC — Deduction in respect of contribution to certain pension funds
  • Section 80CCG — Deduction in respect of investment made under an equity savings scheme
  • Section 80D — Deduction in respect of health insurance premia
  • Section 80DD — Deduction in respect of maintenance including medical treatment of a dependant who is a person with disability
  • Section 80DDB — Deduction in respect of medical treatment, etc.
  • Section 80E — Deduction in respect of interest on loan taken for higher education
  • Section 80EE — Deduction in respect of interest on loan taken for residential house property
  • Section 80G — Deduction in respect of donations to certain funds, charitable institutions, etc.
  • Section 80GG — Deductions in respect of rents paid
  • Section 80GGA — Deduction in respect of certain donations for scientific research or rural development
  • Section 80GGB — Deduction in respect of contributions given by companies to political parties
  • Section 80GGC — Deduction in respect of contributions given by any person to political parties
  • Section 80TTA — Deduction in respect of interest on deposits in savings account.
  • Section 80U — Deduction in case of a person with disability.


Rebates and Reliefs from Income Tax – Chapter VIII of the Act

In computing the amount of income tax on the total income of an assesse as chargeable for any assessment year, certain deductions (rebates and reliefs) are allowed from such amount of income-tax (as computed before allowing the said deductions under the Chapter VIII). The aggregate amount of such deductions are limited to the amount of income tax otherwise so computed on the total income.


Important Provisions

  • Section 87A — Rebate of income-tax in case of certain individuals
  • Section 88 — Rebate on life insurance premia, contribution to provident fund, etc.
  • Section 89 — Relief when salary, etc., is paid in arrears or in advance.


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