Income Tax Law & Practice (B.Com Hons.) PDF

B.Com(Hons.) Semester-III Commerce Income Tax Law and Practice Core Course-VI Unit (I-V) SCHOOL OF OPEN LEARNING University of Delhi Department of Commerce ...

B.Com(Hons.) Semester-III Commerce Income Tax Law and Practice Core Course-VI Unit (I-V) SCHOOL OF OPEN LEARNING University of Delhi Department of Commerce  CONTENT Unit I Lesson 1 Basic Concepts Lesson 2 Agricultural Income Lesson 3 Residential Status Lesson 4 Incomes Exempt from Tax Unit II Lesson 5 Salaries - I Lesson 6 Salaries - II Lesson 7 Salaries - III Lesson 8 House Property Unit III Lesson 9 Profits and Gains of Business or Profession - I Lesson 10 Profits and Gains of Business or Profession - II Lesson 11 Capital Gains Lesson 12 Income from other Sources Unit IV Lesson 13 Clubbing of Income Lesson 14 Set off and Carry Forward of Losses Lesson 15 Deductions from Gross Total Income Lesson 16 Partnership Firms Unit V Lesson 17 Total Income and Tax Liability of Individuals, Leading Court Cases and Return of Income Edited by Substantial Revision K.B.Gupta Ankush Kumar Jindal SCHOOL OF OPEN LEARNING University of Delhi 5, Cavalry Lane, Delhi-110007  Unit I LESSON 1 BASIC CONCEPTS STRUCTURE OF THE CHAPTER 1.1 Objectives 1.2 Basics 1.3 Meaning of tax planning, tax avoidance, tax evasion and tax management 1.4 Definitions 1.5 Charge of income tax 1.6 Basic principles of income tax 1.7 Computation of total income 1.8 Computation of tax 1.9 Tax rates, rebate, surcharge and cess for the assessment year 2018-19 1.10 Special rates of tax on certain incomes 1.11 Rounded off of income and tax 1.12 Miscellaneous provisions 1.13 Summary 1.1 Objectives The objective of this chapter is to make the students familiar with some basic concepts of taxation. After studying this chapter, students will be able to understand Finance Acts, Income-tax Act, Income-tax Rules, Notifications, Circulars, etc. Further, students will understand the concepts of tax planning, tax evasion, tax avoidance and tax management. 1.2 Basics Income tax in India is paid on the income earned. The provisions of computation of income are given in Income Tax Act, 1961. Rules to assist the provisions of the Act are given in Income Tax Rules 1962. To make changes in the Act or Rules, CBDT (Central Board of Direct Taxes) issues notifications time to time. Notifications are binding. Apart from notifications, CBDT issues circulars also. Circulars are basically for providing information to officers of Income Tax Department. Circulars are not compulsorily to be followed by people but notifications are compulsorily to be followed by people. Different court rulings on different provisions of the Act are also given by Income Tax Tribunals, High Courts and Supreme Court. All relevant information related to Income Tax Act is available on the following website of the Government of India: www.incometaxindia.gov.in In case of any clarification related to Income Tax Act, readers should always refer the website: www.incometaxindia.gov.in 1.3 Meaning of tax planning, tax avoidance, tax evasion and tax management Some of the important concepts of taxation are tax planning, tax avoidance, tax evasion and tax management which are explained below – 1 Tax Planning Tax planning can be defined as an arrangement of one’s financial and economic affairs by taking complete legitimate benefit of all deductions, exemptions, allowances and rebates so that tax liability reduces to minimum. The benefits arising from tax planning are substantial particularly in the long run. Tax Avoidance Tax avoidance is reducing or negating tax liability in legally permissible ways and has legal sanction. Tax avoidance is sound law and certainly not bad morality for anybody to so arrange his affairs in such a way that the brunt of taxation is the minimum. This can be done within the legal framework even by taking help of loopholes in the law. Tax avoidance is intentional tax planning before the actual tax liability arises. Tax Evasion All methods by which tax liability is illegally avoided are termed as tax evasion. Tax evasion may involve an untrue statement knowingly, submitting misleading documents, suppression of facts, not maintaining proper accounts of income earned (if required under law), omission of material facts on assessment. Tax evasion is intentional attempt to avoid payment of tax after the liability to tax has arisen. Tax Management Tax management relates to past (i.e., assessment proceedings, rectification, revision, appeals etc.), present (filing of return of income on time on the basis of updated records) and future (corrective action). 1.4 Definitions Section 2 of the Income-tax Act gives definitions. Some of the relevant definitions are given below – Income [Sec. 2(24)] This term has not been defined in the Income-tax Act, except that it states as to what is included in income. Under this section, income includes: ▪ profits and gains; ▪ dividend; ▪ the value of any perquisite or profits in lieu of salary taxable under the head 'salaries'; ▪ any special allowance or benefit, other than granted to the assessee to meet his expenses; ▪ any allowance granted to the assessee either to meet his personal expenses, e.g., City Compensatory Allowance; ▪ the value of any benefit or perquisite; ▪ any sum paid by any such company in respect of any obligation; ▪ any profits on sale of import license; ▪ cash assistance received or receivable under exports; ▪ any refundable custom duty or excise the value of any benefit or perquisite arising from business or exercise of profession; ▪ any capital gains. 2 Person [Sec. 2(31)] The term “person” includes: ▪ an individual; ▪ a Hindu undivided family; ▪ a firm; ▪ a company; ▪ an association of persons or a body of individuals, whether incorporated or not; ▪ a local authority; and ▪ every artificial juridical person not falling within any of the preceding categories e.g., University of Delhi. Assessee [Sec. 2(7)] An assessee means a person: ▪ who is liable to pay any tax; or ▪ who is liable to pay any other sum of money under this Act (e.g., interest, penalty, etc.); or ▪ in respect of whom any proceeding under this Act has been taken for the assessment of his income; or ▪ in respect of whom any proceeding under this Act has been taken for the amount of refund due to him or to such other person; or ▪ who is deemed to be an assessee under any provision of this Act; or ▪ who is deemed to be an assessee in default under any provision of this Act. Casual Income Any receipt which is of a casual and non-recurring nature is casual income. It is an income the receipt of which is accidental and without a stipulation. It is in nature of an unexpected windfall. Examples of casual income: 1. Winnings form lottery, crossword puzzles, card games and other games of any sort or form, gambling or betting of any form or nature; 2. Receipts even from habitual betting are non-recurring receipts and assessable as casual income. 3. Prize awarded for coin collection or stamp collection may be a casual income. This income is due to hobby. Casual income does not include: ▪ Capital gains; ▪ Receipts arising from business or the exercise of a profession or occupation; ▪ Receipts by way of addition to remuneration of an employee; ▪ Voluntary payment received in exercise of an occupation, e.g., tips given in the ordinary way to taxi-drivers. Note – - Expenses are not deductible from casual incomes. - Set-off of losses is not permitted against casual income. Previous Year [Sec. 3] Previous year is not defined under section 2 of the Income-tax Act. It is defined separately under section 3 of the Income-tax Act. Previous year means the financial year immediately preceding the assessment year. In simple words, it can be said that the year in which income 3 is earned is known as previous year and the next year in which this income is taxable is known as assessment year. It will be the uniform previous year for all the assessees and for all sources of income. For newly set-up business or profession first previous year may be of less than 12 months. Exceptions to the general rule (i.e., when income of previous year is not taxable in the immediately following assessment year): The rule says the income of previous year is assessable as the income of the immediately following assessment year or in other words, it can be said that income of previous year is chargeable to tax in the next following assessment year. The above rule, however, has certain exceptions which are given below: 1. Income of non-resident from shipping: Conditions to be satisfied: ▪ The assessee is a non-resident who owns a ship or ship is chartered by a non- resident. ▪ The ship carries passengers, livestock, mail or goods shipped at a port in India. ▪ The non-resident may (or may not) have an agent/ representative in India. 2. Income of persons leaving India either permanently or for a long period of time; 3. Income of association of persons or a body of individuals or artificial juridical persons formed for short duration; 4. Income of a person trying to alienate his assets with a view to avoiding payment of tax; and 5. Income of a discontinued business. In these cases, income of a previous year may be taxed as the income of the assessment year immediately preceding the normal assessment year. These exceptions have been incorporated in order to ensure smooth collection of income-tax from the aforesaid taxpayers who may not be traceable if tax assessment procedure is postponed till the commencement of the normal assessment. Assessment year [Sec. 2(9)] “Assessment year" means the period of twelve months commencing on the 1st day of April every year. The income earned during any year is taxable in the next year which starts from April 1. For example, income is earned during the year April 1, 2018 to March 31, 2019. It will be taxable in the next year which starts from April 1, 2019 and ends on March 31, 2020. Thus, the assessment year for the income earned during the year 2018-19 is 2019-20. Therefore, year 2018-19 is known as previous year and year 2019-20 is known as assessment year for the previous year 2018-19. In simple words, it can be said that the year in which income is taxable is known as assessment year. For the previous year 2018-19, assessment year is 2019-20. Maximum marginal rate [Sec. 2(29C)] 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 body of individuals, as specified in the Finance Act of the relevant year. For instance, for the assessment year 2020-21, the maximum marginal rate of tax for an individual assessee is 42.744% (tax rate @ 30% + surcharge @ 37% + health & education cess @4% of income tax and surcharge). 4 1.5 Charge of income tax Where any Central Act enacts that income-tax shall be charged for any assessment year at any rate (or rates), income-tax at that rate (or those rates) shall be charged for that year in accordance with, and subject to the provisions of, this Act in respect of the total income of the previous year of every person. Finance Act gives the tax rates every year and all the amendments in the Income Tax Act. Finance Act becomes an Act from the Finance Bill. Finance bill is a Money bill and is presented in the Lok Sabha on February 1 of every year by the Finance Minister. For some days, discussion on Finance bill takes place in Lok Sabha and Rajya Sabha. After the Finance bill is passed by both Lok Sabha and Rajya Sabha and after the assent of the President, the Finance bill becomes Finance Act. Every Finance Act shows the proposals for the coming financial year. For instance, Finance Act 2019 shows the proposals for 2019-20 (i.e., April 1, 2019 to March 31, 2020). As far as tax rates are concerned, Part I of The First Schedule of the Finance Act 2019 shows the tax rates for the financial year 2018-19 and Part III of The First Schedule of the Finance Act 2019 shows the tax rates for the financial year 2019-20. Similarly, Finance Act 2020 shows the proposals for 2020-21 (i.e., April 1, 2020 to March 31, 2021). As far as tax rates are concerned, Part I of The First Schedule of the Finance Act 2020 shows the tax rates for the financial year 2019-20 and Part III of The First Schedule of the Finance Act 2020 shows the tax rates for the financial year 2020-21. Part III of The First Schedule of current year’s Finance Act becomes Part I of The First Schedule of next year’s Finance Act. For instance, Part III of The First Schedule of the Finance Act 2019 becomes Part I of The First Schedule of the Finance Act 2020. 1.6 Basic principles of income-tax Following are some basic principles of income-tax: 1. Income tax is an annual tax on income. 2. Tax rates are fixed by the annual Finance Act. 3. Tax is charged on the total income of every person computed in accordance with the provisions of this Act. 4. Income tax is to be deducted at source or paid in advance as provided under provisions of the Act. 5. Total income is computed on the basis of residential status of the assessee. 5 1.7 Computation of total income Taxable income of any assessee is computed as per the format given below – Computation of net taxable income/ total income of an assessee for the assessment year 2018- 19: Particulars Amount (Rs.) Income under the head “Salaries” XX Income under the head “House Property” XX Income under the head “Profits and gains of business or profession” XX Income under the head “Capital Gains” XX Income under the head “Income from other sources” XX Gross total income (GTI) XX Less: Deductions under chapter VIA [Sec. 80] XX Net taxable income or Total income (NTI) XXX 1.8 Computation of tax Tax to be paid by any assessee is computed as per the format given below – Computation of tax liability of an assessee for the assessment year 2018-19: Particulars Amount (Rs.) Income-tax on net taxable income XX Less: Rebate under section 87A XX XX Add: Surcharge (% of income-tax) XX Total (a) XX Add: Health & Edu. Cess @ 4% XX Total XX Less: Relief under section 89 XX Tax Liability XX Add: Interest/ Penalty etc. XX Less: Pre-paid taxes [i.e., advance tax, self-assessment tax, TDS, TCS, MAT credit] XX Tax Payable XXX 1.9 Tax rates, rebate, surcharge and cess for the assessment year 2020-21 Tax Rates for “Individuals” Situation 1: For a resident senior citizen (who is 60 years or more at any time during the relevant previous year 2019-20 but less than 80 years on the last day of the relevant previous year 2019-20): Annual net taxable income Tax Up to Rs. 3,00,000 Nil 6 Rs. 3,00,001 – Rs. 5,00,000 5% of income exceeding Rs. 3,00,000 Rs. 5,00,001 – Rs. 10,00,000 Rs. 10,000 + 20% of income exceeding Rs. 5,00,000 Above Rs. 10,00,000 Rs. 1,10,000 + 30% of income exceeding Rs. 10,00,000 Situation 2: For a resident super senior citizen (who is 80 years or more at any time during the relevant previous year 2019-20): Annual net taxable income Tax Up to Rs. 5,00,000 Nil Rs. 5,00,001 – Rs. 10,00,000 20% of income exceeding Rs. 5,00,000 Above Rs. 10,00,000 Rs. 1,00,000 + 30% of income exceeding Rs. 10,00,000 Situation 3: For any other resident individual (who is less than 60 years of age at any time during the relevant previous year 2019-20), any non-resident individual, every HUF/ AOP/ BOI/ artificial juridical person: Annual net taxable income Tax Up to Rs. 2,50,000 Nil Rs. 2,50,001 – Rs. 5,00,000 5% of income exceeding Rs. 2,50,000 Rs. 5,00,001 – Rs. 10,00,000 Rs. 12,500 + 20% of income exceeding Rs. 5,00,000 Above Rs. 10,00,000 Rs. 1,12,500 + 30% of income exceeding Rs. 10,00,000 Tax Rates for “Firms” A firm is taxable at a flat rate of 30%. Tax Rates for “Companies” Company Tax Rate In the case of a domestic company: 30% However, a domestic company (whose gross receipt / turnover during the PY 2017-18 does not exceed ` 400 crores) is taxable @25% In the case of a foreign company: 40% Rebate of tax in case of certain individuals [Sec. 87A] This rebate is given to provide tax relief to individual taxpayers who are in lower income bracket. Any resident individual whose net taxable income (i.e., GTI minus deductions under section 80C to 80U) is Rs. 5,00,000 or less is entitled to claim rebate under section 87A which is 100% of income tax payable on total income or Rs. 12,500, whichever is less. This rebate is available from income tax (before adding surcharge and cess). Surcharge The amount of Income Tax shall be increased by a surcharge as follows :- Person Net Income Range (in Rs.) Surcharge (as % of income tax) Individual / HUF/ 0-50 Lakh NIL AOP/BOI/AJP 50 Lakhs – 1 Crore 10% 7  1 Crore – 2 Crore 15% 2 Crore – 5 Crore 25% Above 5 Crore 37% Firm / Co-Operative 0 - 1 Crore NIL Society / local Above 1 Crore 12 % Authority Marginal relief Surcharge is subject to marginal relief. - In case of an individual / HUF / AOP / BOI /AJP assessee, if net income exceeds Rs. 50 lakhs, the amount payable as income tax and surcharge shall not exceed the total amount payable as income-tax on total income of Rs. 50 lakhs by more than the amount of income that exceeds Rs. 50 lakhs. - In case of any other assessee, if net income exceeds Rs. 1 crore, the amount payable as income tax and surcharge shall not exceed the total amount payable as income-tax on total income of Rs. 1 crore by more than the amount of income that exceeds Rs. 1 crore. Health and Education Cess (HEC) 4% of (income tax after deducting rebate under section 87A and after adding surcharge) 1.10 Special rates of tax on certain incomes Some incomes under the Income Tax Act are taxable at special rates. While applying tax on these incomes, exemption slab applicable for an assessee is of no use. It means even if income of an individual assessee is less than Rs. 2,50,000 (i.e., exempted slab of an individual assessee who is less than 60 years of age) or Rs. 3,00,000 (i.e., exempted slab of a resident senior citizen who is less than 80 years of age but more than 60 years of age) or Rs. 5,00,000 (i.e., exempted slab of a resident super senior citizen who is 80 years or more of age), these incomes are taxable at flat rate given below – 1. Long term capital gain is taxable at a flat rate of 20%. 2. Short term capital gain covered under section 111A is taxable at a flat rate of 15%. 3. Casual incomes (viz., gambling, lottery, betting, etc.) is taxable at a flat rate of 30%. 1.11 Rounded off of income and tax liability (288A and 288B) Net taxable income as well as tax should be rounded off to the nearest multiple of Rs. 10. Income is rounded off u/s 288A and tax liability is rounded – off u/s 288B. If the last figure in the amount is five or more, the amount shall be increased to the next multiple of Rs. 10 and if last figure is less than five, the amount shall be reduced to the previous multiple of ` 10. 8 For Example : Income / Tax liability before rounding off Income / Tax liability after rounding off 17,56,333.99 17,56,330 18,88,994.99 18,88,990 13,44,225 13,44,230 9,99,999.07 10,00,000 12,11,234 12,11,230 1.12 Miscellaneous provisions Exemption and Deduction – Difference If an income is exempt from tax, it is not included in the computation of income. Exemption can never exceed the amount of income. Deduction is generally given from income chargeable to tax. Deduction can be less than or equal to more than the amount of income. If the amount deductible is more than the amount of income, the resulting amount will be taken as loss. Method of Accounting Mainly there are two types of accounting methods – mercantile system and cash system. Under the mercantile system, income and expenditure are recorded at the time of occurrence during the previous year. Under the cash system, revenue and expenses are recorded only when received or paid. Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” is to be computed in accordance with the method of accounting regularly employed by the assessee. In case of income chargeable under the heads “Salaries”, “Income from house property” and “Capital gains”, method of accounting adopted by the assessee is not relevant in calculating taxable income. For calculating taxable income under these heads, one has to follow the statutory provisions of the Income-tax Act which expressly provide whether revenue (or expenditure) is taxable (or deductible) on “accrual basis” or “cash basis”. 1.13 Summary In this chapter, we have discussed the basics of tax. These basics will be applicable in studying other chapters. Books recommended – 1. Singhania, V.K. and Singhania, Monica , Students’ Guide to Income Tax (University Edition), Taxmann Publications (P) Ltd. 2. Ahuja, Girish and Gupta, Ravi , Simplified Approach to Income Tax (University Edition), Flair Publications Pvt. Ltd. 9  LESSON 2 AGRICULTURAL INCOME STRUCTURE OF THE CHAPTER 2.1 Objectives 2.2 Definition of Agricultural income 2.3 Scheme of Partial Integration 2.4 Summary 2.5 Exercise 2.1 Objectives This chapter explains the provisions of Income Tax Act applicable for agricultural income earned by the assessees. 2.2 Definition of Agricultural income Agricultural Income [Sec. 2(1A)] “Agricultural income” means: 1. Any rent or revenue derived from land which is situated in India and is used for agricultural purposes; 2. Any income derived from land (which is situated in India and is used for agricultural purposes) by agricultural operations. Following are the three instances of this type of agricultural income: a. Any income derived by agriculture from land situated in India and used for agricultural purposes; b. Any income derived by a cultivator or receiver of rent-in-kind of any process ordinarily employed to render the produce raised or received by him to make it fit to be taken to market; or c. Any income derived by such land by the sale by a cultivator or receiver of rent-in- kind of the produce raised or received by him in respect of which no process has been performed other than a process of the nature described in (b). 3. Income from farm building Note – Capital gain arising from the transfer of agricultural land shall not be treated as agricultural income. 10 Partly agricultural incomes: Income1 Non - agricultural Agricultural income income Growing and manufacturing tea in India 40% 60% Sale of centrifuged latex or cenex or latex based 35% 65% crepes Sale of coffee grown and cured by seller 25% 75% 2.3 Scheme of Partial Integration Agricultural income is totally exempt from tax. However, agricultural income is taken into consideration while computing the tax on non-agricultural income of an assessee. This is known as scheme of partial integration. The scheme of partial integration of non-agricultural income with agricultural income is applicable if the following conditions are satisfied: 1. The taxpayer is an individual, a HUF, a body of individual, an association of persons or an artificial juridical person. 2. The taxpayer has non-agricultural income exceeding the amount of exemption limit [i.e., Rs. 5,00,000 (in the case of a resident super senior citizen who is 80 years or more), Rs. 3,00,000 (in the case of a resident senior citizen who is 60 years or more), and Rs. 2,50,000 (in the case of any other individual or every HUF) for the relevant previous year]. 3. The agricultural income of the taxpayer exceeds Rs. 5,000. If the above conditions are satisfied, then the scheme of partial integration of tax on non- agricultural income with income derived from agriculture is applicable. It is to be noted that this scheme is NOT applicable in the case of a firm, company, co- operative society etc. Procedure of computing tax as per the scheme: Step 1: Net agricultural income is to be computed as if it were income chargeable to income-tax. Step 2: Agricultural and non-agricultural income of the assessee will then be aggregated and income-tax is calculated on the aggregate income as if such aggregate income were the total income. 1 Income in respect of the business given above is, in the first instance, computed under the Act as if it were derived from business after making permissible deduction. 40% or 35% or 25% of the income so arrived at is treated as business income and the balance is treated as agricultural income. Salary and interest received by a partner from a firm is taxable only to the extent of 40% or 35% or 25% and the balance is treated as agricultural income. 11 Step 3: The net agricultural income will then be increased by the amount of exemption limit (i.e., the first slab of income on which tax is charged at nil rate) and income-tax is calculated on net agricultural income, so increased, as if such income was the total income of the assessee. Step 4: The amount of income-tax determined at step 2 will be reduced by the amount of income-tax determined under step 3. Step 5: Find out the balance. In the balance so arrived, add surcharge and cess. It is to be noted that for applicability of surcharge, non-agricultural income is considered. Step 6: This will be the total income-tax payable by the assessee. 2.4 Summary In this chapter, we have discussed the tax aspect of agricultural income. Though agricultural income earned in India is exempt from tax, it is still included while computing income tax of an assessee for other incomes earned by him. It is to be remembered that agricultural income earned outside India is not treated as an agricultural income earned in India and thus, such incomes are fully taxable in India. 2.5 Exercise The working notes given below in the solutions of unsolved questions are only for clarity purposes and for solving some typical concepts. However, in the final examination, students are expected to be more cautious in preparing working notes. Working notes in the examination must mention the concepts along with numerical calculation. Problem 1 – For the assessment year 2020-21, Mrs. X (Date of birth: Sept. 1, 1950) furnishes the following information: Amount (Rs.) Gross agricultural income 12,21,000 Expenditure on earning agricultural income 90,000 Non-agricultural income (Gross total income) 4,00,000 Determine the tax liability of Mrs. X for the assessment year 2020-21 on the assumption that she contributes Rs. 60,000 towards PPF and pays insurance premium of Rs. 90,000 on her life insurance policy (sum assured: Rs. 3,00,000). Solution: Mrs. X is a senior Citizen. Computation of taxable income of Mrs. X for the assessment year 2020-21: Amount (Rs.) Gross total income 4,00,000 Less: Deduction under section 80C (60,000 + 30,000) 90,000 Net taxable income 3,10,000 12 In the present case, assessee is a senior citizen whose non-agriculture income is more than the exemption limit of Rs. 3,00,000 and net agriculture income (i.e., Rs. 11,31,000) is more than Rs. 5,000. So, tax has to be computed as per the scheme of partial integration which is as follows – Step 1: Net agricultural income is to be computed as if it were income chargeable to income- tax. Agricultural and non-agricultural income of the assessee will then be aggregated and income-tax is calculated on the aggregate income as if such aggregate income were the total income. Thus, total income including agricultural income is Rs. 14,41,000 (Rs. 3,10,000 + Rs. 11,31,000). Tax on Rs. 14,41,000 is Rs. 2,42,300 [1,10,000 + 30% (14,41,000 – 10,00,000)] Step 2: The net agricultural income will then be increased by the amount of exemption limit (i.e., the first slab of income on which tax is charged at nil rate) and income-tax is calculated on net agricultural income, so increased, as if such income was the total income of the assessee. Amount (Rs.) Agriculture income 11,31,000 Add: Exemption limit in case of resident senior citizen 3,00,000 Total 14,31,000 Tax on Rs. 14,31,000 is Rs. 2,39,300 [1,10,000 + 30% (14,31,000 – 10,00,000)] Step 3: The amount of income-tax determined at step 1 will be reduced by the amount of income-tax determined under step 2 and find out the balance. Amount (Rs.) Tax in step 1 2,42,300 Add: Tax in step 2 2,39,300 Balance 3,000 Step 4: From the balance so arrived, give rebate under section 87A (if applicable), add surcharge and cess and deduct prepaid taxes (if any). This will be the total income-tax payable by the assessee. It is to be noted that for applicability of rebate and surcharge, non-agricultural income is considered. Amount (Rs.) Balance 3,000 Less: Rebate under section 87A 3,000 Tax Payable NIL Note – It is assumed that policy is issued on or after April 1, 2013 and thus, maximum limit of deduction for life insurance premium is 10% of sum assured. Problem 2 – From the following information, calculate tax liability of X, a resident and ordinarily resident in India, for the assessment year 2020-21: Amount (Rs.) Income from house property 1,60,000 Income from growing and manufacturing tea in India 1,00,000 Share of profit from a firm carrying agricultural business in India 1,20,000 13 Donation to Prime Minister’s National Relief Fund 40,000 Solution: Particulars Non-agricultural Agricultural income (Rs.) income (Rs.) Income from house property 1,60,000 ---- Tea business [40%; 60%] 40,000 60,000 Share of profit from firm [Exempt U/S 10(2A)] ---- ---- Gross total income 2,00,000 60,000 Less: Deduction U/S 80G 40,000 ---- Net taxable income 1,60,000 60,000 Here, tax liability is nil because scheme of partial integration is not applicable as non- agriculture income (i.e., Rs. 1,60,000) is less than the exemption limit of Rs. 2,50,000. Notes – In case of income related to growing and manufacturing tea in India, 40% income is treated as non-agriculture income and 60% is treated as agricultural income. Problem 3 – ‘X’ is a non-resident for PY 2019-20. He earned the following incomes during the previous year in India: a. Net agricultural income: Rs. 5,40,000 b. Income from business: Rs. 3,00,000 c. Income from other sources: Rs. 2,60,000 He made the following donations during the previous year: a. Donations to Prime Minster Relief Fund: Rs. 20,000 b. Donation to Charitable Trust: Rs. 40,000 c. Donation to Delhi Government for promoting family planning: Rs. 30,000 Compute the tax liability of ‘X’ for the assessment year 2018-19. Solution: Computation of taxable income of X for the assessment year 2018-19: Amount (Rs.) Business income 3,00,000 Income from other sources 2,60,000 Gross total income 5,60,000 Less: Deduction U/S 80G (W.N. – 1) 63,000 Net taxable income 4,97,000 Net agricultural income 5,40,000 In the present case, assessee is an individual whose non-agriculture income is more than the exemption limit of Rs. 2,50,000 and net agriculture income (i.e., Rs. 5,40,000) is more than Rs. 5,000. So, tax has to be computed as per the scheme of partial integration which is as follows – Step 1: Net agricultural income is to be computed as if it were income chargeable to income- tax. Agricultural and non-agricultural income of the assessee will then be aggregated and income-tax is calculated on the aggregate income as if such aggregate income 14  were the total income. Thus, total income including agricultural income is Rs. 10,37,000 (Rs. 4,97,000 + Rs. 5,40,000). Tax on Rs. 10,37,000 is Rs. 1,23,600 [1,12,500 + 30% (10,37,000 – 10,00,000)] Step 2: The net agricultural income will then be increased by the amount of exemption limit (i.e., the first slab of income on which tax is charged at nil rate) and income-tax is calculated on net agricultural income, so increased, as if such income was the total income of the assessee. Amount (Rs.) Agriculture income 5,40,000 Add: Exemption limit in case of non-resident 2,50,000 Total 7,90,000 Tax on Rs. 7,90,000 is Rs. 70,500 [12,500 + 20% (7,90,000 – 5,00,000)] Step 3: The amount of income-tax determined at step 1 will be reduced by the amount of income-tax determined under step 2 and find out the balance. Amount (Rs.) Tax in step 1 1,23,600 Add: Tax in step 2 70,500 Balance 53,100 Step 4: From the balance so arrived, give rebate under section 87A (if applicable), add surcharge and cess and deduct prepaid taxes (if any). This will be the total income-tax payable by the assessee. It is to be noted that for applicability of rebate and surcharge, non-agricultural income is considered. Amount (Rs.) Balance 53,100 Less: Rebate under section 87A Nil 53,100 Add: Cess @ 4% 2,124 Tax payable (Rounded off u/s 288B) 55,220 Note – Section 80G: No limit (100%): Relief fund [20,000*100%] 20,000 Limits: Limit is 10% of adjusted GTI i.e., 10% of 5,60,000 i.e., 56,000 Family Planning [100% of 30,000] 30,000 Other purpose [50% of 26,000*] 13,000 43,000 63,000 Problem 4 – Mr. A is resident but not ordinarily resident in India, age 62 years, earned a net agricultural income of Rs. 4,00,000 during the previous year 2019-20. Compute his tax liability assuming that he has non-agricultural income of Rs. 8,50,000 and he contributes Rs. 90,000 towards Public Provident Fund. 15 Solution: Computation of taxable income of A for the assessment year 2018-19: Amount (Rs.) Gross total income 8,50,000 Less: Deduction U/S 80C 90,000 Net taxable income 7,60,000 Net agricultural income 4,00,000 In the present case, assessee is an individual whose non-agriculture income (i.e., Rs. 7,60,000) is more than the exemption limit of Rs. 3,00,000 (resident senior citizen) and net agriculture income (i.e., Rs. 4,00,000) is more than Rs. 5,000. So, tax has to be computed as per the scheme of partial integration which is as follows – Step 1: Net agricultural income is to be computed as if it were income chargeable to income- tax. Agricultural and non-agricultural income of the assessee will then be aggregated and income-tax is calculated on the aggregate income as if such aggregate income were the total income. Thus, total income including agricultural income is Rs. 11,60,000 (Rs. 7,60,000 + Rs. 4,00,000). Tax on Rs. 11,60,000 is Rs. 1,58,000 [1,10,000 + 30% (11,60,000 – 10,00,000)] Step 2: The net agricultural income will then be increased by the amount of exemption limit (i.e., the first slab of income on which tax is charged at nil rate) and income-tax is calculated on net agricultural income, so increased, as if such income was the total income of the assessee. Amount (Rs.) Agriculture income 4,00,000 Add: Exemption limit in case of non-resident 3,00,000 Total 7,00,000 Tax on Rs. 7,00,000 is Rs. 50,000 [10,000 + 20% (7,00,000 – 5,00,000)] Step 3: The amount of income-tax determined at step 1 will be reduced by the amount of income-tax determined under step 2 and find out the balance. Amount (Rs.) Tax in step 1 1,58,000 Add: Tax in step 2 50,000 Balance 1,08,000 Step 4: From the balance so arrived, give rebate under section 87A (if applicable), add surcharge and cess and deduct prepaid taxes (if any). This will be the total income-tax payable by the assessee. It is to be noted that for applicability of rebate and surcharge, non-agricultural income is considered. Amount (Rs.) Balance 1,08,000 Less: Rebate under section 87A Nil 1,08,000 Add: Cess @ 4% 4,320 Tax payable 1,12,320 16 Books recommended – 1. Singhania, V.K. and Singhania, Monica , Students’ Guide to Income Tax (University Edition), Taxmann Publications (P) Ltd. 2. Ahuja, Girish and Gupta, Ravi , Simplified Approach to Income Tax (University Edition), Flair Publications Pvt. Ltd. 17  LESSON 3 RESIDENTIAL STATUS STRUCTURE OF THE CHAPTER 3.1 Objectives 3.2 Residence and citizenship 3.3 Determination of residential status of an assessee 3.4 Relationship between residential status and incidence of tax 3.5 Summary 3.6 Exercise 3.1 Objectives Taxability of income depends upon the residential status of an assessee. Also, it depends whether the income earned is an Indian income or foreign income. This chapter is, thus, divided into two parts – first part shows determining the residential status of an assessee and second part shows tax incidence. 3.2 Residence and citizenship The scope of total income of an assessee is determined with reference to his residential status in India in the previous year (Sec. 5). Tax incidence of an assessee depends upon his residential status rather than on his citizenship. Residence and citizenship are two different things. The incidence of tax has nothing to do with citizenship. An Indian may be non-resident and a foreigner may be resident for income tax purposes. The residence of a person may change from year to year but citizenship cannot be changed every year. 3.3 Determination of residential status of an assessee How to determine the residential status of an INDIVIDUAL [Sec. 6] An individual may be resident or non-resident. Further, if an individual is resident, he may be resident and ordinarily resident or resident but not ordinarily resident. Following are the rules to determine the residential status of an individual: a. Resident: Must satisfy at least one of the basic conditions. b. Resident and ordinarily resident (ROR): Must satisfy at least one of the basic conditions and both of the additional conditions. c. Resident but not ordinarily resident (RNOR): Must satisfy at least one of the basic conditions and one or none of the additional conditions. d. Non-resident (NR): Must not satisfy any of the basic conditions. Basic conditions [Sec. 6(1)] a. He is in India in the previous year for a period of 182 days or more; or 18  b. He is in India for a period of 60 days or more during the previous year and 365 days or more during 4 years immediately preceding the previous year. Exceptions: In the following two situations, basic condition (b) is not applicable: 1. An Indian citizen who leaves India during the previous year ▪ for the purpose of employment outside India; or ▪ as a member of crew of an Indian ship. 2. An Indian citizen or a person of Indian origin who comes on a visit to India during the previous year. Additional conditions [Sec. 6(6)] a. He has been resident in India in at least 2 out of 10 previous years immediately preceding the relevant previous year. b. He has been in India for a period of 730 days or more during 7 years immediately preceding the relevant previous year. How to determine the residential status of a HUF A Hindu undivided family (like an individual) is either resident in India or non-resident in India. A resident Hindu undivided family is either ordinarily resident or not ordinarily resident. Following are the rules to determine the residential status of a Hindu undivided family: a. A Hindu undivided family is said to be resident in India if control and management of its affairs are situated – ▪ Wholly in India or ▪ Partly in India and partly outside India It is to be noted that in order to determine whether a HUF is resident or non-resident, the residential status of the karta of the family during the previous year is not relevant. Residential status of the karta during the preceding years is considered for determining whether a resident HUF is “ordinarily resident” or not. A resident Hindu Undivided family is an ordinarily resident in India if karta or manager of the family satisfies the two additional conditions given above. However, if kata or manager of a resident HUF does not satisfy the two additional conditions, the family is treated as resident but not ordinarily resident in India. b. A Hindu undivided family is said to be non-resident in India if control and management of its affairs are situated wholly out of India. How to determine the residential status of a FIRM AND an ASSOCIATION OF PERSONS a. A partnership firm and an association of persons are said to be resident in India if control and management of their affairs, during the relevant previous year, are situated – ▪ Wholly in India or ▪ Partly in India and partly outside India 19  b. A partnership firm and an association of persons are said to be non-resident in India if control and management of their affairs, during the relevant previous year, are situated wholly out of India. How to determine the residential status of a COMPANY a. An Indian company is always resident in India. b. (i) A foreign company (whose turnover in the Previous Year is Rs. 50 Crore or less) is always non-resident in India. (ii) A foreign company (whose turnover in the previous year is more than Rs. 50 crores) will be resident in India if its place of effective management (POEM) is in India during the relevant previous year. For this purpose, “place of effective management” means a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made. How to determine the residential status of every OTHER PERSON a. Every other person is resident in India if control and management of its affairs, during the previous year, is situated – ▪ Wholly in India or ▪ Partly in India and partly outside India b. Every other person is non-resident in India if control and management of its affairs, during the previous year, is situated wholly out of India. 3.4 Relationship between residential status and incidence of tax As per section 5 of the Income Tax Act, incidence of tax on a taxpayer depends on his residential status and also on the place and time of accrual or receipt of income. Meaning of “INDIAN INCOME” Any of the following three is an Indian income: 1. 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. 2. If income is received (or deemed to be received) in India during the previous year but it accrues or arises (or is deemed to accrue or arise) outside India during the previous year. 3. 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. Meaning of “FOREIGN INCOME” If the following two conditions are satisfied, then such income is “foreign income” – 1. Income is not received (or not deemed to be received) in India and 2. Income does not accrue or arise (or is deemed to accrue or arise) in India. Conclusions regarding taxability 1. Indian Income Indian income is always taxable in India irrespective of the residential status of the taxpayer. 20  2. Foreign Income Foreign income is taxable in the hands of resident (in case of a firm, an association of persons, a joint stock company and every other person) or resident and ordinarily resident (in case of an individual and a Hindu Undivided Family) in India. Foreign income is not taxable in the hands of non-resident in India. In the hands of resident but not ordinarily resident (RNoR) taxpayer, foreign income is taxable only in any of the following two situations – a. If it is business income and business is controlled wholly or partly from India, or b. If it is professional income and profession is set up in India. In any other case (like salary, rent, interest etc.), foreign income is not taxable in the hands of resident but not ordinarily resident taxpayers. 3.5 Summary This chapter explained the concept of residence and citizenship from income tax point of view. How to determine the residential status of an assessee is explained in detail in this chapter. Further, the students will be able to determine whether the income is an Indian income or foreign income. 3.6 Exercise 1: Long practical questions The working notes given below in the solutions of unsolved questions are only for clarity purposes and for solving some typical concepts. However, in the final examination, students are expected to be more cautious in preparing working notes. Working notes in the examination must mention the concepts along with numerical calculation. Problem 1 – Mr. X, a foreign national (not being a person of Indian origin) came to India for the first time on 16-10-2019 for a visit of 190 days. He furnishes the following particulars of his income earned during the previous year relevant to the assessment year 2020-21: Amount (Rs.) a. Interest received from Government of India (Received outside India) 2,50,000 b. Royalty received from a foreign company outside India (Paid for know-how used by payer organization in India) 1,00,000 c. Income from agriculture in Bhutan remitted to India 3,00,000 Compute total income of Mr. X for the previous year 2019-20 relevant to the assessment year 2020-21. Solution: Mr. X is a non-resident for the assessment year 2020-21 as he does not satisfy any of the following basic conditions: 1. He was present in India during the previous year 2019-20 for 168 days [16+30+31+31+29+31] and not for 182 days, as required. 2. He was present in India for a period of 60 days or more during the previous year 2019-20 but not for 365 days or more during 4 years immediately preceding the previous year 2019-20 [i.e., during 2015-16 to 2018-19, he was not present in India as he came to India on 16-10-2017 for the first time]. 21 Computation of total income of Mr. X (a non-resident) for the previous year 2019-20 relevant to the assessment year 2020-21: Particulars Amount (Rs.) Indian Income (Interest received from Government of India is deemed to be accrued in India) 2,50,000 Indian Income (Royalty received from a non-resident is deemed to be accrued in India if it is paid for know-how used by the payer in India) 1,00,000 Foreign Income [Agriculture income accrued and received outside India, foreign income is not taxable for a non-resident assessee] ---- Total income 3,50,000 Problem 2 – From the following information, compute gross total income of Mr. Y for the assessment year 2020-21 assuming Mr. Y is: (i) Not ordinarily resident, and (ii) Non-resident. Amount (Rs.) - Pensions for services rendered in India but received in England 1,00,000 - Remuneration for consultancy service in Canada but half of that received in Mumbai 2,00,000 - Loss incurred in textile business carried on in Bangladesh but controlled from India (75,000) - Fees for technical services payable by Z, a non-resident (the payable relates to a business carried on in India) 3,00,000 Solution: Computation of total income of Mr. X (a non-resident) for the previous year 2019-20 relevant to the assessment year 2020-21: Particulars RNoR (Rs.) NR (Rs.) Indian Income 1,00,000 1,00,000 (Pension for services rendered in India) Indian Income 1,00,000 1,00,000 (Money received in India) Foreign Income ---- --- (Remuneration for services accrued and received outside India) Foreign Income (business income accrued and received outside India, but (75,000) ---- business is controlled from India) Indian Income (Fees for technical services payable by a non-resident is deemed to be accrued in India if payment of technical fees 3,00,000 3,00,000 pertains to a business carried on in India Total income 4,25,000 5,00,000 22 Problem 3 – “Manan Sethia” is a citizen of India. He has been employed with an Indian company since 2013. On September 1, 2019 Manan left India to join employment in Germany with a foreign company. During the previous year 2019-20 his income included: a. Salary from an Indian company: Rs. 2,60,000 b. Salary from a foreign company: Rs. 4,70,000 c. Interest on bank deposits in India received in Germany: Rs. 1,30,000 Find out Manan’s total income chargeable to tax in India for the assessment year 2020-21. Solution: Since he left India for the purpose of employment outside India, he is covered under exceptional category of basic condition no. (2) of 60 days or more. It means basic condition of 60 days or more is not applicable for Manan Sethia. Further, he was present in India for 154 days [30+31+30+31+31+1] during the previous year 2019-20. Thus, he does not satisfy the basic condition of 182 days or more and therefore, he will be treated as non-resident for the assessment year 2020-21. Computation of taxable income: Amount (Rs.) Indian Income (Salary from an Indian company) 2,60,000 Foreign Income (Salary from a foreign company) ---- Indian Income (Interest on bank deposits in India) 1,30,000 Total Income 3,90,000 Problem 4 – Renuka Desai is a citizen of USA. She left India during 1987 and got permanently settled in New York. She was born in India in 1972 and her husband was also born in India in 1970. Her parents were born in UK prior to 1947; however, they migrated to India in 1967 and got permanently settled in Delhi. Renuka came to India on January 29, 2019 and stayed for 100 days. Before that also she had been coming to India for 100 days during every previous year since 1991. For the previous year 2019-20, she earned the following income/ loss: i. Income from salaries of services rendered in USA, received there: Rs. 7,96,000 ii. Income from house property in India received in USA: Rs. 2,84,000 iii. Interest on bank deposits in India received in USA: Rs. 3,60,000 iv. Loss from a business in India (controlled from USA): Rs. 1,10,000 v. Income from a business in Sri Lanka (controlled from India): Rs. 1,90,000 vi. Interest on bank deposits in USA subsequently remitted to India: Rs. 2,64,000 Compute Renuka’s total income and tax liability for the assessment year 2020-21, assuming that she is not entitled to deductions under section 80C to 80U. Solution: She is Resident but not ordinarily resident (RNoR) for the assessment year 2020-21 as she satisfies the basic condition no. (2) of 60 days or more during 2019-20 [3+29+31] and 365 days or more during 4 years immediately preceding the relevant previous year. Further he satisfies only one of the additional conditions. 1. The additional condition which is satisfied is: She is resident in India in at least 2 years out of 10 years immediately preceding the relevant previous year. 2. The additional condition which is not satisfied is: 23 She is not present in India for a period of 730 days during 7 years immediately preceding the relevant previous year. She is not a person of Indian Origin and thus, not covered in exceptional category. Computation of taxable income: Amount (Rs.) Foreign income (salary received and accrued outside India) [not taxable for RNoR ] ---- Indian income (income accrued in India) 2,84,000 Indian income (income accrued in India) 3,60,000 Indian income (business in India) (1,10,000) Foreign income (accrued outside India; but business is controlled from India, taxable for RNoR) 1,90,000 Remittance ---- 7,24,000 Computation of tax: Amount (Rs.) Tax [12,500 + 20% (7,24,000 – 5,00,000)] 57,300 Add: Cess @ 4% 2,292 Tax (Rounded off) 59,590 Problem 5 – Determine the residential status in the cases given below for the assessment year 2020-21: i. Y (HUF), a Hindu Undivided Family, whose karta Y is a person of Indian origin. Y has been visiting India for 100 days every year since 2006-07. The family’s business is controlled by a team of professionals in India under the guidance of Y. ii. Mr. A is a citizen of Bangladesh. His maternal grandfather was born in a village near Dhaka in 1945. He comes to India for the first time since 1995-96 on October 4, 2019 for a visit of 200 days. Solution: i. Business of Y (HUF) is controlled by a team of professionals in India, thus, Y (HUF) is resident in India. To see whether Y (HUF) is ordinarily resident or not ordinarily resident, Y (Karta) has to satisfy two additional conditions – a. Basic condition no. (2) of 60 days or more is not applicable for a person of Indian Origin who comes on a visit to India during the previous year. So, to check whether he is resident or not, basic condition no. (1) of 182 days or more is relevant. Y (Karta) is not present for 182 days or more in any year and thus, he is non-resident in all the 10 years immediately preceeding the relevant previous year. It means additional condition no. (1) is not satisfied. b. Further, he was present only for 700 days during 2013-14 to 2019-20 and not 730 days or more, as required. Y (Karta) does not satisfy any of the additional conditions and thus Y (Karta) is not ordinarily resident. It implies that Y (HUF) is resident but not ordinarily resident (RNoR) for the assessment year 2020-21. 24  ii. Mr. A is non-resident for the assessment year 2020-21. Mr. A is a person of Indian Origin as his grandparents were born in undivided India. Basic condition no. (2) of 60 days or more is not applicable for a person of Indian Origin who comes on a visit to India during the previous year. To become a resident, Mr. A has to satisfy basic condition no. (1) which states that a person must be present in India for a period of 182 days or more during relevant previous year. Mr. A is present only for 180 [28+30+31+31+29+31] days during the previous year 2019-20. He does not satisfy the eligible basic condition and thus, he is non-resident for the assessment year 2020-21. Problem 6 – Discuss whether the following incomes are taxable or not in India: i. A non-resident owns a residential house in Delhi which is given on rent to a foreign embassy. Rent is however, payable outside India in a foreign currency. ii. Non-resident purchase goods from India and sells these goods abroad at profit. iii. Interest on loan is paid by the govt. of India to a non-resident outside India. iv. A non-resident owns commercial building in Mumbai which is transferred to another non-resident outside India. The consideration is payable in a foreign currency outside India. v. C, a non-resident Indian, is presently appointed by the govt. of India in its embassy at Saudi Arabia; salary for rendering service is paid to him in foreign currency outside India. Solution: i. Taxable, as it is accrued in India and thus, becomes an Indian income which is taxable for a non-resident. ii. Not taxable, as profit is earned and received outside India and thus, a foreign income which is not taxable for a non-resident. It does not matter whether the goods have been purchased from India or not. iii. Taxable, as interest paid by Government of India is assumed as an Indian income and thus, taxable for a non-resident. iv. Taxable, as it is accrued in India and thus, Indian income which is taxable for a non- resident. v. Taxable, as salary paid by the Indian Government to an Indian national is deemed to accrue or arise in India, even if service is rendered outside India. This provision is applicable only in respect of salary and not in respect of allowances and perquisites paid or allowed by the Government to Indian nationals working abroad, as such allowances and perquisites are exempt under section 10(7). C, though a non-resident, but an Indian national. Problem 7 – Mrs. Y is a foreign citizen. Her grandmother was born in Karachi on August 15, 1940. She came to India for the first time on November 3, 2019 for a period of 200 days. Her income for the previous year 2019-20 is as under: i. Income earned in Bangladesh but received in India Rs. 4,40,000. ii. Income earned and received outside India Rs. 5,60,000. iii. Royalty received in Germany from a resident of India for technical services provided for a business carried on in Germany Rs. 1,00,000. iv. Agricultural income in Sri Lanka Rs. 5,00,000. v. Dividend from Indian Company received in Pakistan Rs. 80,000. 25  vi. Profits of a business carried on in Pakistan but controlled from India Rs. 2,00,000 (out of which Rs. 50,000 is received in India). Solution: Mrs. Y is a non-Resident for the assessment year 2020-21 as she does not satisfy the basis condition of presence for a period of 182 days or more during the previous year 2019-20. She was present in India for a period of 150 days (28+31+31+29+31) only during the previous year 2019-20. Further, as she is a person of Indian Origin (because her grandmother was born in Undivided India), she is covered under the exception of basic condition no. (2) applicability. For a person of Indian Origin who comes on a visit to India during the previous year, basic condition no. (2) of 60 days is not applicable. Computation of taxable income of Mrs. Y (a non-resident): Amount (Rs.) Indian income (income received in India) 4,40,000 Foreign income (income received and accrued outside India) ---- Foreign income (royalty income received and accrued outside India) ---- Foreign income (accrued outside India) ---- [Though, agricultural income outside India is not exempt from tax] Dividend income from an Indian company [exempt from tax] ---- Indian income (received in India) 50,000 Foreign income (received and accrued outside India) ---- 4,90 Problem 8 – Mr. Ramesh & Mr. Suresh are brothers and they earned the following income during the financial year 2019-20. Mr. Ramesh settled in Canada in the year 1997 and has not visited India since. Mr. Suresh is settled in Delhi and has never left India. Compute their total income for the assessment year 2020-21. S. Particulars Mr. Ramesh Mr. Suresh No. (Rs.) (Rs.) 1. Interest on Canada Development Bonds (only 50% of 35,000 40,000 interest received in India 2. Dividend from British company received in London 28,000 20,000 3. Profit from a business in Nagpur, but managed directly 1,00,000 1,40,000 from London 4. Income from a business in Chennai 80,000 70,000 5. Fees for technical services rendered in India, but 1,00,000 ---- received in Canada 6. Interest on savings bank deposit in SBI, Delhi 7,000 12,000 7. Agricultural income from a land situated in Andhra 55,000 45,000 Pradesh 8. Rent received in respect of house property at Bhopal 1,00,000 60,000 9. Life insurance premium paid ---- 30,000 Solution: For the assessment year 2020-21, Mr. Ramesh is non-resident as he does not satisfy any of the 2 basic conditions and Mr. Suresh is resident and ordinarily resident as he satisfies both of the basic conditions. 26 Computation of their total income for the assessment year 2020-21: S. Particulars Mr. Ramesh Mr. Suresh No. (Non-Resident) (ROR) (Rs.) (Rs.) 1 Interest on Canada Development Bonds (only 50% of interest received in India) - Indian income [50%] 17,500 20,000 - Foreign income [50%] ---- 20,000 2 Foreign income --- 20,000 [Dividend from British company received in London] 3 Indian income 1,00,000 1,40,000 [Profit from a business in Nagpur, but managed directly from London] 4 Indian income 80,000 70,000 [Income from a business in Chennai] 5 Indian income 1,00,000 1,00,000 [Fees for technical services rendered in India, but received in Canada] 6 Indian income 7,000 12,000 [Interest on savings bank deposit in SBI, Delhi] 7 Indian income Exempt Exempt [Agricultural income from a land situated in Andhra Pradesh – (exempt u/s 10(1)] 8 Indian income [Rent received in respect of house property at Bhopal less standard deduction @ 30% (i.e., 1,00,000 – 30,000; 60,000 – 18,000)] 70,000 42,000 Gross total Income 3,74,500 3,24,000 Less: Deductions under sections: 80C ---- 30,000 80TTA 7,000 10,000 Total Income 3,67,500 3,84,000 3.6 Exercise 2: Short theory questions 1. When is a company to be treated as non-resident in India? ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… 27  2. How will you determine the residential status of Hindu undivided family? Explain fully. ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… ………………………………………………………………………………………… Books recommended – 1. Singhania, V.K. and Singhania, Monica , Students’ Guide to Income Tax (University Edition), Taxmann Publications (P) Ltd. 2. Ahuja, Girish and Gupta, Ravi , Simplified Approach to Income Tax (University Edition), Flair Publications Pvt. Ltd. 28  LESSON 4 INCOMES EXEMPT FROM TAX STRUCTURE OF THE CHAPTER 4.1 Objectives 4.2 Exempted incomes 4.3 Summary 4.1 Objectives After studying this chapter, students will be able to learn the application of section 10 of the Income Tax Act. Section 10 explains the incomes which are exempt from tax. Some incomes are fully exempt and some incomes are partially exempt from tax. 4.2 Exempted incomes Some of the incomes exempt under section 10 (excluding exempt incomes under the head “Salaries”) are – 1. Agricultural income 2. Share of income from Hindu Undivided Family 3. Share of income of a partner from his firm 4. Payment received by an individual under Bhopal Gas Leak Disaster Act 5. Educational Scholarships received by an individual 6. Awards made by the Government in public interest 7. Income of scientific research association 8. Income of news agency 9. Income of Khadi and Village Industries 10. Income of SAARC 11. Income of IRDA 12. Income of mutual fund 13. Income of Swachh Bharat Kosh and Clean Ganga Fund 14. Partial withdrawal from NPS (to the extent it does not exceed 25% of an employee’s contribution) is exempt from tax. 15. 60% of the total amount received on account of assessee’s opting out of NPS or closing of NPS account. Incomes exempt under the head “Salaries” are explained in chapter of “Salaries”. 4.3 Summary Some of the examples of section 10 incomes are mentioned in the chapter. Books recommended – 1. Singhania, V.K. and Singhania, Monica , Students’ Guide to Income Tax (University Edition), Taxmann Publications (P) Ltd. 2. Ahuja, Girish and Gupta, Ravi , Simplified Approach to Income Tax (University Edition), Flair Publications Pvt. Ltd. 29  Unit II LESSON 5 SALARIES - I STRUCTURE OF THE CHAPTER 5.1 Objectives 5.2 Basics 5.3 Understanding some relevant concepts 5.4 Basis of charge 5.5 Retirement benefits 5.6 Summary 5.1 Objectives After studying this chapter, students will be able to compute the taxable amount of salary received by an employee from the employer. 5.2 Basics Section 15, 16 and 17 of the Act deals with the computation of income under the head “Salaries”. 5.3 Understanding some relevant concepts In order to understand the computation of income under the head “Salaries”, the following relevant concepts need to be understood first: 1. Employer-employee relationship – An income can be taxed under the head “Salaries” only and only if there is an employer- employee relationship between the payer and payee. If this relationship does not exist, then the income will not be taxable as salary income; it will be taxable under other heads of income. Employer may be an individual, firm, association of persons, company, local authority, Central Government, State Government, etc. Likewise, employer may be operating in India or outside India. The employee may be a full-time employee or a part-time employee. MPs or MLAs are not treated as employees of the Government. Thus, remuneration received by them is not taxable under the head “Salaries” but taxable as “Income from other sources”. However, pay and allowances received by the Chief Minister of a State are assessable as salary and not as income from other sources, in view of the provisions of article 164(5) of the Constitution. Any salary, bonus, commission or remuneration, by whatever name called, due to/ received by, a partner of a firm from the firm shall not be taxable under the head “Salaries” because 30 there is no employer-employee relationship between firm and its partners. Such remuneration, however, is taxable under the head “Profits and gains from business or profession” in the hands of partners. 2. No difference between salary and wages – Conceptually, there is no difference between ‘salary’ and ‘wages’, both being a payment for work done or services rendered. 3. Arrears of salary – Salary due to an assessee in the earlier years, which was neither paid nor was charged to tax in those years, will have to treated as ‘arrears of salary’ and thus, taxable under the head “Salaries”. 4. Advance salary – Salary received in advance is taxable in the year of receipt. It will not be taxable again in the year in which it becomes due. 5. Salary paid by foreign Government – Salary paid by a foreign Government to its employees serving in India is taxable under the head “Salaries”. 6. Salary from more than one employer – Salary received by an employee from more than one employer during the same previous year is taxable under the head “Salaries”. 7. Salary from former employer, present employer or prospective employer – Salary received (or due) during the previous year is chargeable to tax under the head “Salaries” irrespective of the fact whether it is received from a former, present or prospective employer. 8. Tax-free salary – If salary is paid tax-free by the employer, the employee has to include in his taxable income not only the salary received but also the amount of tax paid by the employer on this salary income of the employee. 9. Foregoing of salary – Once salary is earned by the employee, it becomes taxable in his hands though he may subsequently waive the right to receive the same from his employer. Such voluntary waiver or foregoing by an employee of salary due to him is merely an application of income and is chargeable to tax under the head “Salaries”. 10. Place of accrual – Income under the head “Salaries” is deemed to accrue or arise at the place where the service (in respect of which it accrues) is rendered. If the services are rendered in India and if the salary in respect of such service is received outside India, it will be treated as an income which is deemed to accrue or arise in India. Similarly, if a person, who after rendering services in India, retires and settles abroad, receives any pension on account of the same, such pension shall be an income which is deemed to accrue or arise in India because the services on account of which pension accrues, were rendered in India. 31 There is, however, an exception to the above rule. Salary payable by the Government of India to a citizen of India for services outside India is treated as income deemed to accrue or arise in India even though services are rendered outside India. 11. Method of accounting not relevant – Salary is taxable on receipt or due basis, whichever is earlier regardless of the fact whether books of account, in respect of salary income, are maintained by the assessee on mercantile basis or cash basis. Problem – N is an employee of XYZ Ltd. getting a salary of Rs. 50,000 per month which becomes due on the last day of each month but is paid on the fifth of next month. Compute the salary taxable for the assessment year 2020-21? Solution: For assessment year 2020-21, the relevant previous year is 2019-20. Salary is taxable on receipt basis or due basis, whichever is earlier. In this case, salary becomes due on the last day of each month and received on the fifth day of next month. Thus, salary of April 2019 will become due on April 30, 2019 and will be paid on May 5, 2019. So, salary of April 2019 will become taxable on April 30, 2019. On this basis, May 2019 salary will become taxable on May 31, 2019 and so on. Thus, during the previous year 2019-20, salary from April 2019 to March 2020 will be taxable and amount of taxable salary will be Rs. 6,00,000 [Rs. 50,000*12]. Problem – N is an employee of XYZ Ltd. His salary till March 31, 2019 was Rs. 40,000 and from April 1, 2019, his salary becomes Rs. 50,000. Salary becomes due on the first day of next month but is paid on the fifth of next month. Compute the salary taxable for the assessment year 2020- 21? Solution: In this case, salary becomes due on the first day of next month and received on the fifth day of next month. Thus, salary of April 2019 will become due on May 1, 2019 and will be paid on May 5, 2019. So, salary of April 2019 will become taxable on May 1, 2019. On this basis, May 2019 salary will become taxable in June 2019 and so on. However, March 2020 salary will become taxable in April 2020 which is not in our relevant previous year. But March 2019 salary is taxable in April 2019 which is in our relevant previous year 2019- 20. Thus, during the previous year 2019-20, salary from March 2019 to February 2020 will be taxable and amount of taxable salary will Rs. 6,90,000 [Rs. 40,000*1 + Rs. 50,000*11]. Problem – N is an employee of XYZ Ltd. getting a salary of Rs. 50,000 per month which becomes due on the last day of each month but is paid on the fifth of next month. He is paid the salary of April 2020 in advance in March 2020. Compute the salary taxable for the assessment year 2020- 21? 32 Solution: In this case, salary of April 2020 will become due on April 30, 2020 but it is received in March 2020. Thus, salary of April 2020 will become taxable on receipt basis which is earlier than the due date. Thus, taxable salary during the previous year 2019-20 will be: Salary from April 2019 to March 2020 [Rs. 50,000*12] Rs. 6,00,000 Advance salary of April 2020 (taxable in March 2020) Rs. 50,000 Rs. 6,50,000 Note: Since salary received in advance for April 2020 is included in the previous year 2019-20 on receipt basis. So, it will not be included again in the previous year 2020-21 when it becomes due. Problem – N joins a company on September 1, 2015 in the pay scale of Rs. 14,000 – Rs. 1,000 – Rs. 30,000 (salary at the time of joining is fixed at Rs. 18,000). As per the terms of employment salary becomes “due” on the first day of next month, and it is generally paid on the fifth day of the next month. Find out the taxable salary for the assessment year 2020-21. Solution: For the assessment year 2020-21, previous year is 2019-20. In this case, N gets an annual increment of Rs. 1,000. The amount of salary for different years will be as follows: September 1, 2015 to August 31, 2016 : Rs. 18,000 September 1, 2016 to August 31, 2017 : Rs. 19,000 September 1, 2017 to August 31, 2018 : Rs. 20,000 September 1, 2018 to August 31, 2019 : Rs. 21,000 September 1, 2019 to August 31, 2020 : Rs. 22,000 Rs. 1,000 will be added to the salary every year till he reaches the maximum point of Rs. 30,000. For the previous year 2019-20, salary will be taxable as follows: Month Due date of salary Amount (Rs.) [Due date or receipt date, whichever is earlier] March 2019 April 1, 2019 21,000 April 2019 May 1, 2019 21,000 May 2019 June 1, 2019 21,000 June 2019 July 1, 2019 21,000 July 2019 August 1, 2019 21,000 August 2019 September 1, 2019 21,000 September 2019 October 1, 2019 22,000 October 2019 November 1, 2019 22,000 November 2019 December 1, 2019 22,000 December 2019 January 1, 2020 22,000 January 2020 February 1, 2020 22,000 February 2020 March 1, 2020 22,000 March 2020 April 1, 2020 See note Total 2,58,000 33 Note: Salary of March 2020 will be taxable in April 2020 which falls in the previous year 2020-21. However, salary of March 2019 will be taxable in April 2019 which is in our relevant previous year 2019-20. 12. Meaning of salary [Section 17(1)] – Salary includes – a. wages; b. any annuity or pension; c. any gratuity; d. any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages; e. any advance of salary; f. any payment received by an employee in respect of any period of leave not availed by him; g. employer’s contribution towards Recognized Provident Fund (RPF) in excess of 12% of employee’s salary and interest credited to RPF in excess of 9.5% p.a.; h. transferred balance in a recognized provident fund to the extent it is taxable; and i. the contribution made by the Central Government (or any other employer) in the previous year, to the account of an employee under a notified pension scheme referred to in section 80CCD. 13. Profits in lieu of salary [Section 17(3)] – It includes the following – a. the amount of any compensation due to or received by an assessee from his employer (or former employer) at or in connection with the termination of his employment or the modification of the terms and conditions thereto; b. any payment due to or received by an assessee from his employer (or former employer) except the following: i. Payment of gratuity exempted under section 10(10); ii. Payment of commuted pension exempted under section 10(10A); iii. Payment of retrenchment compensation exempted under section 10(10B); iv. Payment from statutory provident fund (SPF) – Section 10(11); v. Payment from recognized provident fund (RPF) to the extent it is exempt under section 10(12); vi. Payment from an approved superannuation fund under section 10(13); vii. Payment of HRA exempted under section 10(13A). c. Any payment from unrecognized provident fund (UPF) or such other fund to the extent to which it does not consist of contributions by the assessee or interest on such contributions. d. Any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy. e. Any amount due to or received, whether in lump sum or otherwise, by an assessee from any person prior to employment or after cessation of employment. 34 5.4 Basis of charge Under section 15, the following income shall be chargeable to income-tax under the head “Salaries” – a. any salary due from an employer (or a former employer) to an assessee in the previous year, whether actually paid or not; b. 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; and c. 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. Computation of salary income – Income under the head “Salaries” is computed in the following manner: Particulars Amount (Rs.) Income from salary XX Income by way of allowances XX Taxable value of perquisites XX Gross salary XX Less: Deductions under section 16: Standard Deduction u/s 16 (ia) XX Entertainment allowance u/s 16 (ii) XX Professional tax u/s 16 (iii) XX Income from salaries XXX 5.5 Retirement benefits Retirement benefits are considered as those benefits which are generally given to the employees at the time of retirement. Some common retirement benefits are explained below – Leave Salary – Employees are entitled to different types of leaves while they are in service. The leaves may either be allowed to be availed by them or if not availed, then these leaves may either lapse or encashed every year or accumulated and encashed at the time of retirement/ death/ or leaving the job. Tax treatment – The tax treatment is given below: Nature of leave encashment Status of employee Taxability Leave encashment during Government/ It is fully chargeable to tax. continuity of employment non-Government employee However, relief can be taken under section 89. Government employee It is fully exempt from tax (see the provisions given below). Leave encashment at the time Non-Government employee It is fully or partially exempt of retirement/ leaving job from tax. Here, exemption depends upon the provisions given below (see the provisions given below). 35 Government employees getting leave encashment at the time of retirement – In case of Central/ State Government employees, any amount received as cash equivalent of leave salary in respect of earned leaves standing to their credit at the time of retirement/ leaving the job is exempt from tax. Non-Government employees getting leave encashment at the time of retirement – In case of non-Government employees (including an employee of a local authority or public-sector undertaking), leave salary is exempt from tax to the extent of least of the following four amounts: a. Period of earned leave (in number of months) standing to the credit of employee at the time of retirement/ leaving the job (earned leave entitlements cannot exceed 30 days for every year of actual service)*Average monthly salary b. 10*Average monthly salary c. Amount specified by the government (i.e., Rs. 3,00,000 minus amount exempted earlier) d. Leave encashment actually received at the time of retirement Notes: 1. How to find out the leave standing to the credit of employee at the time of retirement or leaving the job - Step 1: Find out duration of service in years (ignore any fraction of the year). Step 2: Find out the rate of earned leave entitlement from the service book of the employees – such entitlement cannot exceed 30 days in a year. For example, if leave entitlement allowed is 20 days per year, then 20 days per year will be taken (because it is less than 30 days in a year). However, if leave entitlement allowed is 40 days per year, then for the purpose of computing leave entitlement, 30 days would be taken and not 40. Step 3: Find out the leaves actually availed or encashed while in service (in number of days). Step 4: Multiply step 1 with step 2 and then divide the resulting figure by step 3 and result would be in number of days. For example, if duration of service is 24 years 9 months, step 1 becomes 24. If leave entitlement as per service rules is 35 days per year, step 2 becomes 30. If leaves actually availed while in service is 90 days, then step 3 becomes 90. Thus, step 4 becomes 24*30–90 = 630 days which is to be further divided by 30 to get the result in number of months and the final leaves standing to one’s credit in numbers of months comes out to be 21 (630/30). 2. Meaning of salary – Salary for this purpose means basic salary (+) dearness allowance (if terms of employment so provide) (+) commission based upon fixed percentage of turnover achieved by an employee. It is to be noted that dearness allowance/ pay shall be considered only when it is part of salary for computing all retirement benefits (like provident fund, pension, leave encashment, gratuity, etc.). If dearness allowance/ pay is part of salary for computing only some (not all) of the retirement benefits, then it is not taken into consideration for this purpose. 3. Average salary – Average salary for this purpose is to be calculated on the basis of average salary drawn during the period of 10 months immediately preceding the retirement. For 36 example, if a person retires on 30 Nov. 2019, average salary will be taken from Feb. 1, 2019 to Nov. 30, 2019. 4. Actual years of service – While computing completed/ actual years of service, any fraction of the year shall be ignored. 5. When earned leave encashment is received from two or more employers – Where leave salary or leave encashment is received by a non-Government employee from two or more employers (may be in the same year or different years), the maximum amount of exemption cannot exceed Rs. 3,00,000 during the lifetime of the concerned employee. 6. Other relevant points – ▪ Relief under section 89 would be admissible in respect of encashment of leave salary by an employee while in service. ▪ Salary paid to the legal heirs of the deceased employee in respect of privilege leave standing to the credit of such employee at the time of his/ her death is not taxable as salary. Problem – N, an employee of the State Government, retires on November 30, 2019 and receives Rs. 10,00,000 as leave encashment. How much amount is taxable as Salary? Solution: Since N is a Government employee, Rs. 10,00,000 received as cash equivalent of leaves standing to his credit, is fully exempt from tax. Problem – N was employed by XYZ Ltd. upto August 31, 2005. At the time of leaving XYZ Ltd., he was paid Rs. 4,00,000 as leave salary out of which Rs. 80,000 was exempted from tax as per the provisions of Income-tax Act at that time. Thereafter, he joined another private company, ABC Ltd. and from this company, he retired on October 31, 2019 after receiving leave salary of Rs. 5,04,000. Determine the taxable leave salary for the assessment year 2020-21 from the following information: Salary at the time of retirement Rs. 28,000 Salary till March 31, 2019 Rs. 25,000 Salary after March 31, 2019 Rs. 28,000 Duration of service 14 years 11 months Leave entitlement for every year of service 60 days Leave availed while in service 300 days Leave at the credit of employee at the time of retirement [(14*60 - 300÷30] 18 months Leave salary paid at the time of retirement (18*Rs. 28,000) 5,04,000 Solution: The amount of taxable leave salary for the assessment year 2020-21 is computed as follows: N has retired from ABC Ltd., a private sector company, on October 31, 2019. 37 Out of Rs. 5,04,000 received as leave salary, least of the following four points is exempt from tax: a. Earned leave (in number of months) standing to the credit*Average monthly salary [i.e., 4*Rs. 27,100] Rs. 1,08,400 b. 10*Average monthly salary [i.e., 10*Rs. 27,100] Rs. 2,71,000 c. Amount specified by the government (Rs. 3,00,000 minus amount exempted earlier) [i.e., Rs. 3,