Basic Concepts

Study Note - 1
BASIC CONCEPTS

“It was only for the good of his subjects that he collected taxes from them, just as the Sun draws moisture
from the Earth to give it back a thousand fold” – Kalidas in Raghuvansh eulogizing King Dalip

This Study Note includes

1.1 Introduction
1.2 Direct Tax & Indirect Tax
1.3 Constitutional Validity of Taxes
1.4 Administration of Tax Laws
1.5 Sources of Income Tax Laws in India
1.6 Basic Principles for Charging Income Tax [Sec. 4]
1.7 Assessment Year (A.Y.) [Sec. 2(9)]
1.8 Previous Year or Uniform Previous Year [Sec. 3]
1.9 Assessee [Sec 2(7)]
1.10 Person [Sec. 2 (31)]
1.11 Income [Sec. 2(24)]
1.12 Heads of Income [Sec. 14]
1.13 Gross Total Income (GTI) [Sec. 80B(5)]
1.14 Rounding - off of Total Income [Sec. 288A]
1.15 Rounding - off of Tax [Sec. 288B]
1.16 Capital -vs.-Revenue
1.17 Tax Planning, Tax Evasion and Tax Avoidance
1.18 Diversion & Application of Income

1.1 INTRODUCTION

In a Welfare State, the Government takes primary responsibility for the welfare of its citizens, as in matters of health
care, education, employment, infrastructure, social security and other development needs. To facilitate these,
Government needs revenue. The taxation is the primary source of revenue to the Government for incurring such
public welfare expenditure. In other words, Government is taking taxes from public through its one hand and
through another hand; it incurs welfare expenditure for public at large. However, no one enjoys handing over his
hard-earned money to the government to pay taxes. Thus, taxes are compulsory or enforced contribution to the
Government revenue by public. Government may levy taxes on income, business profits or wealth or add it to the
cost of some goods, services, and transactions.

1.2 DIRECT TAX & INDIRECT TAX

There are two types of taxes: Direct Tax and Indirect Tax
Tax, of which incidence and impact fall on the same person, is known as Direct Tax, such as Income Tax. On the
other hand, tax, of which incidence and impact fall on two different persons, is known as Indirect Tax, such as GST,
etc. It means, in the case of Direct Tax, tax is recovered directly from the assessee, who ultimately bears such taxes,

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whereas in the case of Indirect Tax, tax is recovered from the assessee, who passes such burden to another person
& is ultimately borne by consumers of such goods or services.

Direct Tax Indirect Tax

� Incidence and impact fall on the same person � Incidence and impact fall on two different persons
� Assessee, himself bears such taxes. Thus, it pinches � Tax is recovered from the assessee, who passes
the taxpayer. such burden to another person. Thus, it does not
� Levied on income pinch the taxpayer.

� E.g. Income Tax � Levied on goods and services. Thus, this type of tax
leads to inflation and have wider base.
� Progressive in nature i.e., higher tax are levied on
person earning higher income and vice versa. � E.g. GST, Customs Duty, etc.
� Regressive in nature i.e., all persons will bear equal
wrath of tax on goods or service consumed by
them irrespective of their ability.
� Useful tool to promote social welfare by checking
the consumption of harmful goods or sin goods
through higher rate of tax.

1.3 CONSTITUTIONAL VALIDITY OF TAXES

The Constitution of India is the supreme law of India. It consists of a Preamble, 22 parts containing 444 articles and
12 schedules. Any tax law, which is not in conformity with the Constitution, is called ultra vires the Constitution and
held as illegal and void. Some of the provisions of the Constitution are given below:
Article 265 of the Constitution lays down that no tax shall be levied or collected except by the authority of law. It
means tax proposed to be levied must be within the legislative competence of the legislature imposing the tax1.
Article 246 read with Schedule VII divides subject matter of law made by legislature into three categories:
• Union list (only Central Government has power of legislation on subject matters covered in the list)
• State list (only State Government has power of legislation on subject matters covered in the list)
• Concurrent list (both Central & State Government can pass legislation on subject matters).
If a state law relating to an entry in List III is repugnant to a Union law relating to that entry, the Union law will prevail,
and the state law shall, to the extent of such repugnancy, be void. (Article 254).
Following major entries in the respective list enable the legislature to make law on the matter:

Union List (List I) Entry 82 - Taxes on income other than agricultural income i.e. Income-tax
State List (List II) Entry 46 - Taxes on agricultural income.

1.4 ADMINISTRATION OF TAX LAWS

The administrative hierarchy of tax law is as follows:

Central Board of Direct
Tax (CBDT)
Department of
Ministry of Finance
Revenue
Central Board of Indirect
Tax & Custom (CBIC)

1. Kunnathat Thathunni Moopil Nair –vs.- The State of Kerala 1961 AIR 552 (SC)

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Taxpoint:
� Both of the Boards have been constituted under the Central Board of Revenue Act, 1963.
� CBDT deals with levy and collection of all direct tax whereas matters relating to levy and collection of Central
indirect tax are dealt by CBIC.

1.5 SOURCES OF INCOME TAX LAWS IN INDIA

1. Income tax Act, 1961 (Amended up to date)

The provisions of income tax extends to the whole of India and became effective from 1/4/1962 (Sec. 1). The
Act contains provisions for -
(a) determination of taxable income;
(b) determination of tax liability;
(c) procedure for assessment, appeals, penalties and prosecutions; and
(d) powers and duties of Income tax authorities.

2. Annual Amendments
(a) Income tax Act has undergone several amendments from the time it was originally enacted through
the Union Budget. Every year, a Finance Bill is presented before the Parliament by the Finance Minister.
The Bill contains various amendments which are sought to be made in the areas of direct and indirect
taxes levied by the Central Government.
(b) When the Finance Bill is approved by both the Houses of Parliament and receives the assent of the
President, it becomes the Finance Act. The provisions of such Finance Act are thereafter incorporated
in the Income Tax Act.
(c) If on the 1st day of April of the Assessment Year, the new Finance Act has not been enacted, the
provisions in force in the preceding Assessment Year or the provisions proposed in the Finance Bill before
the Parliament, whichever is more beneficial to the assessee, will apply until the new provisions become
effective [Sec. 294]
Note: Besides these amendments, whenever it is found necessary, the Government introduces amendments
in the form of various Amendment Acts and Ordinances.

3. Income tax Rules, 1962 (Amended up to date)

(a) As per Sec. 295, the Board may, subject to the control of the Central Government, make rules for the
whole or any part of India for carrying out the purposes of the Act.
(b) Such rules are made applicable by notification in the Gazette of India.
(c) These rules were first made in 1962 and are known as Income tax Rules, 1962.
Since then, many new rules have been framed or existing rules have been amended from time to time and
the same has been incorporated in the aforesaid rules.

4. Circulars and Clarifications by CBDT

(a) U/s 119, the Board may issue certain circulars and clarifications from time to time, which have to be
followed and applied by the Income tax authorities.
(b) Effect of circulars: These circulars or clarifications are binding upon the Income tax authorities, but the
same are not binding on the assessee. However, assessee can claim benefit under such circulars.
Note: These circulars are not binding on the Income Tax Appellate Tribunal or on the Courts.

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5. Judicial decision
(a) Decision of the Supreme Court: Any decision given by the Supreme Court shall be applicable as law till
there is any change in law by the Parliament. Such decision shall be binding on all the Courts, Tribunals,
Income tax authorities, assessee, etc.
(b) Contradiction in the decisions of the Supreme Court: In case, there is apparently contradiction in two
decisions, the decision of larger bench, whether earlier or later, shall always prevail. However, where
decisions are given by benches having equal number of judges, the decision of the recent case shall
be applicable.
(c) Decisions given by a High Court or ITAT: Decisions given by a High Court or ITAT are binding on all
assessees and Income tax authorities, which fall under their jurisdiction, unless it is over ruled by a higher
authority.

1.6 BASIC PRINCIPLES FOR CHARGING INCOME TAX [SEC. 4]

1. Income of the previous year of a person is charged to tax in the immediately following assessment year.
2. Rate of tax is applicable as specified by the Annual Finance Act of that year. Further, though the Finance
Act prescribes the rates of tax, in respect of certain income, the Income Tax Act itself has prescribed specific
rates, e.g. Lottery income is to be taxed @ 30% (Sec.115BB), Long term capital gain is to be taxed @ 20%
(Sec.112), short term capital gain on listed shares u/s 111A is to be taxed @ 15%, etc.
3. In respect of income chargeable to tax, tax shall be deducted at source, or paid in advance (wherever
applicable).
Sec. 4 is a charging section and it is the backbone of the Income Tax Act. The tax liability arises by virtue of this
section and it arises at the close of a previous year. However, the finalisation of amount of tax liability is postponed
to the assessment year. It follows the rule that the liability to tax is not dependent upon assessment.

1.7 ASSESSMENT YEAR (A.Y.) [SEC. 2(9)]

Assessment year means the period of 12 months commencing on the 1st day of April every year. It is the year (just
after the previous year) in which income earned in the previous year is charged to tax. E.g., A.Y.2021-22 is a year,
which commences on April 1, 2021 and ends on March 31, 2022. Income of an assessee earned in the previous
year 2020-2021 is assessed in the A.Y. 2021-22.
Taxpoint:
� Duration: Period of 12 months starting from 1st April.
� Relation with Previous Year: It falls immediately after the Previous Year.
� Purpose: Income of a previous year is assessed and taxable in the immediately following Assessment Year.

1.8 PREVIOUS YEAR OR UNIFORM PREVIOUS YEAR [SEC. 3]

Previous Year means the financial year immediately preceding the Assessment Year. Income earned in a year is
assessed in the next year. The year in which income is earned is known as Previous Year and the next year in which
income is assessed is known as Assessment Year. It is mandatory for all assessee to follow financial year (from 1st
April to 31st March) as previous year for Income-Tax purpose.

Financial Year
According to sec. 2(21) of the General Clauses Act, 1897, a Financial Year means the year commencing on the
1st day of April. Hence, it is a period of 12 months starting from 1st April and ending on 31st March of the next year.

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It plays a dual role i.e. Assessment Year as well as Previous Year.

Example: Financial year 2020-21 is -
• Assessment year for the Previous Year 2019-20; and
• Previous Year for the Assessment Year 2021-22.

Determination of the first previous year in case of a newly set-up business or profession or for a new source of
income

In case of Previous year is the period

Business or profession being newly set-up Beginning with the date of setting up of the business &
ending on 31st March of that financial year.
A source of income newly coming into existence Beginning with the date on which the new source of
income comes into existence & ending on 31st March of
that financial year.
Notes:
1. Above explanation signifies that the first previous year may be a period of less than 12 months but in any
case it cannot exceed a period of 12 months. However, next and subsequent previous years shall always be
a period of 12 months.
2. Where an assessee has an existing regular income from various sources and he earns an income from a new
source during the financial year, his previous year shall commence -
• For the existing income: From 1st April of previous year; and
• For new income: From the date when on which the new source of income comes into existence.
However, assessee is liable to tax on aggregate income from all the sources, therefore, all the income
will be included in the previous year.

Exceptions to the general rule that income of a Previous Year is taxed in its Assessment Year
This is the general rule that income of the previous year of an assessee is charged to tax in the immediately following
assessment year. However, in the following cases, income of the previous year is assessed in the same year in
order to ensure smooth collection of income tax from the taxpayer who may not be traceable, if assessment is
postponed till the commencement of the Assessment Year:
1. Income of a non-resident assessee from shipping business (Sec. 172)
2. Income of a person who is leaving India either permanently or for a long period (Sec. 174)
3. Income of bodies, formed for a short duration (Sec. 174A)
4. Income of a person who is likely to transfer property to avoid tax (Sec. 175)
5. Income of a discontinued business (Sec. 176). In this case, the Assessing Officer has the discretionary power
i.e. he may assess the income in the same previous year or may wait till the Assessment year.

1.9 ASSESSEE [SEC. 2(7)]

“Assessee” means,
a. a person by whom any tax or any other sum of money (i.e., penalty or interest) is payable under this Act
(irrespective of the fact whether any proceeding under the Act has been taken against him or not);
b. every person in respect of whom any proceeding under this Act has been taken (whether or not he is liable
for any tax, interest or penalty) for the assessment of his income or loss or the amount of refund due to him;

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c. a person who is assessable in respect of income or loss of another person;

d. every person who is deemed to be an assessee under any provision of this Act; and
e. a person who is deemed to be an ‘assessee in default’ under any provision of this Act. E.g. A person, who was
liable to deduct tax but has failed to do so, shall be treated as an ‘assessee in default’.

1.10 PERSON [SEC. 2(31)]

The term person includes the following:

i) an Individual;
ii) a Hindu Undivided Family (HUF);
iii) a Company;
iv) a Firm;
v) an Association of Persons (AOP) or a Body of Individuals (BOI), whether incorporated or not;
vi) a Local authority; &
vii) every artificial juridical person not falling within any of the preceding categories.
Notes:
1. On the basis of a well settled principle that “the Crown cannot be charged to tax”, it can be said that unless
otherwise specifically mentioned the Union Government cannot be taxed in India.
2. An association of persons or a body of individuals or a local authority or an artificial juridical person shall be
deemed to be a person, whether or not such person or body or authority or juridical person was formed or
established or incorporated with the object of deriving income, profits or gains.
3. A firm includes limited liability partnership.

Individual
The word ‘individual’ means a natural person, i.e. human being. “Individual” includes a minor or a person of
unsound mind. However, Deities are assessable as juridical person.
Trustee of a discretionary trust shall be assessed as an individual

Hindu Undivided Family (HUF)

A Hindu Undivided Family (on which Hindu law applies) consists of all persons lineally descended from a common
ancestor & includes their wives & unmarried daughters.
Taxpoint:
� Only those undivided families are covered here, to which Hindu law applies. It also includes Jain and Sikh
families.
� Once a family is assessed as Hindu undivided family, it will continue to be assessed as such till its partition.

Company [Sec. 2(17)]

Company means:
a. any Indian company; or
b. any body corporate, incorporated under the laws of a foreign country; or
c. any institution, association or body which is or was assessable or was assessed as a company for any
assessment year on or before April 1, 1970; or

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d. any institution, association or body, whether incorporated or not and whether Indian or non-Indian, which is
declared by general or special order of the Central Board of Direct Taxes to be a company.

Indian Company [Sec. 2(26)]

An Indian company means a company formed & registered under the Companies Act, 1956 & includes

a. a company formed and registered under any law relating to companies formerly in force in any part of India
other than the state of Jammu & Kashmir and the Union territories specified in (c) infra;

b. a company formed and registered under any law for the time being in force in the State of Jammu &
Kashmir;

c. a company formed and registered under any law for the time being in force in the Union territories of Dadar
& Nagar Haveli, Goa, Daman & Diu and Pondicherry;

d. a corporation established by or under a Central, State or Provincial Act;

e. any institution, association or body which is declared by the Central Board of Direct Taxes (CBDT) to be a
company u/s 2(17).

In the aforesaid cases, a company, corporation, institution, association or body will be treated as an Indian
company only if its registered office or principal office, as the case may be, is in India.

Domestic Company [Sec. 2(22A)]

Domestic company means:

i) an Indian company; or

ii) any other company, which in respect of its income liable to tax under the Act, has made prescribed
arrangements for the declaration and payment of dividends (including dividend on preference share),
payable out of such income, within India.

Foreign Company [Sec. 2(23A)]

Foreign company means a company which is not a domestic company.

Company in which public are substantially interested [Sec. 2(18)]

Following companies are said to be a company in which public are substantially interested:

1. Government Company;

2. A company u/s 8 of the Companies Act, 2013;

3. Mutual benefit finance company;

4. Listed company;

5. Company in which shares are held by co-operative societies;

6. Company which is prescribed by CBDT

Firm

As per sec. 4 of Indian Partnership Act, 1932, partnership means “relationship between persons who have agreed
to share profits of the business carried on by all or any one of them acting for all”.

Persons, who enter into such business, are individually known as partners and such business is known as a Firm. A
firm is, though not having a separate legal entity, but has separate entity in the eyes of Income-tax Act.

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Taxpoint:
� A partnership firm is a separate taxable entity apart from its partners.
� In Income tax, a Limited liability partnership shall be treated at par with firm.

Association of Persons (AOP) or Body of Individuals (BOI)

An AOP means a group of persons (whether individuals, HUF, companies, firms, etc.) who join together for common
purpose(s). Every combination of person cannot be termed as AOP. It is only when they associate themselves in an
income-producing activity then they become AOP. Whereas, BOI means a group of individuals (individual only)
who join together for common purpose(s) whether or not to earn income.
Co-heirs, co-donees, etc joining together for a common purpose or action would be chargeable as an AOP or
BOI. In case of income of AOP, the AOP alone shall be taxed and the members of the AOP cannot be taxed
individually in respect of the income of the AOP
Difference between AOP and BOI
� In case of BOI, only individuals can be the members, whereas in case of AOP, any person can be its member
i.e. entities like Company, Firm etc. can be the member of AOP but not of BOI.
� In case of an AOP, members voluntarily get together with a common will for a common intention or purpose,
whereas in case of BOI, such common will may or may not be present.
Local Authority
As per Sec. 3(31) of the General Clause Act, a local authority means a municipal committee, district board, body
of Port Commissioners, Panchayat, Cantonment Board, or other authorities legally entitled to or entrusted by the
Government with the control and management of a municipal or local fund.
Artificial Juridical Person
Artificial juridical person are entities -
• which are not natural person;
• has separate entity in the eyes of law;
• may not be directly sued in a court of law but they can be sued through person(s) managing them
E.g: Deities, Idols, University, Bar Council, etc.
Note: Under the Income-tax Act, such person has been provided exemption from payment of tax under separate
provisions of the Act, if certain conditions mentioned therein are satisfied.

Illustration 1.
Determine the status of the following:

Case Status
a) Howrah Municipal Corporation Local authority
b) Corporation Bank Ltd. Company
c) Mr. Amitabh Bachchan Individual
d) Amitabh Bachchan Corporation Ltd. Company
e) A joint family of Sri Ram, Smt. Ram and their son Lav and Kush HUF
f) Calcutta University Artificial juridical person
g) X and Y who are legal heirs of Z BOI
h) Sole proprietorship business Individual
i) Partnership Business Firm

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1.11 INCOME [SEC. 2(24)]

To consider any receipt as income, following points should be kept in mind: -

Cash vs. Kind Income may be received in cash or in kind. Income received in kind is to be valued as per the
rules prescribed and if there is no specific direction regarding valuation in the Act or Rules, it
may be valued at market price.
Significance Method of accounting is In case of income under the head “Salaries”, “Income from house
of method of irrelevant property” and “Capital gains” method of accounting is irrelevant.
accounting Method of accounting is In case of income under the head “Profits & gains of business
relevant or profession” and “Income from other sources” (other than
Dividend) income shall be taxable on cash or accrual basis as per
the method of accountancy regularly followed by the assessee.
Notional income A person cannot make profit out of transaction with himself. Hence, goods transferred from
one department to another department at a profit, shall not be treated as income of the
business.
Source of Income may be from a temporary source or from a permanent source.
income
Capital vs. A capital receipt is not liable to tax, unless specifically provided in the Act, whereas, a
Revenue receipt revenue receipt is not exempted, unless specifically provided in the Act. (Further refer
following heading)
Loss Income also includes negative income.
Disputed income In case of dispute regarding the title of income, assessment of income cannot be withheld
and such income, normally, be taxed in the hands of recipient.
Lump-sum There is no difference between income received in lump sum or in installment.
receipt
Reimbursement Mere reimbursement of expenses is not an income.
Legality The Act does not make any difference between legal or illegal income.
Double taxation Same income cannot be taxed twice.
Income by In this regard it is to be noted that in case of mutual activities, where some people contribute
mutual activity to the common fund and are entitled to participate in the fund and the surplus arises which
is distributed among the contributors of the fund, such surplus cannot be termed as income.
Exceptions:
� Income derived by a trade, professional or similar association from rendering specific
services to its members shall be taxable u/s 28(iii).
� Profits and gains of any insurance business carried on by a mutual insurance company
or by a co-operative society.
� Profits and gains of any business of banking (including providing credit facilities) carried
on by a co-operative society with its members.
Pin money Pin money is money received by wife for her personal expenses & small savings made by
a woman from money received from her husband for meeting household expenses. Such
receipt is not treated as income.
Note: Income on investment out of pin money shall be treated as income.
Award Award received, by a person related to his business or profession, shall be treated as income
incidental to such business or profession. However, award received by a non-professional
person is in nature of gift and/or personal testimonial, the taxability thereof is subject to other
provisions of the Act

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Embezzlement Money embezzled is a gain to the embezzler and, therefore, falls within the wider definition
of income
Contingent A contingent or anticipated income is not taxable.
income
Subsidy Assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or
concession or reimbursement (by whatever name called) by the Central Government or a
State Government or any authority or body or agency in cash or kind to the assesse, e.g. LPG
Subsidy2, Subsidy for establishing manufacturing unit in backward area, etc. However,
a. subsidy or grant or reimbursement which is taken into account for determination of the
actual cost of the asset as per Explanation 10 to sec. 43(1) is not taxable separately.
b. the subsidy or grant by the Central Government for the purpose of the corpus of a trust
or institution established by the Central Government or a State Government
- shall not be taxable.

1.12 HEADS OF INCOME [SEC. 14]

According to Sec.14 of the Act, all income of a person shall be classified under the following five heads:
1. Salaries;
2. Income from house property;
3. Profits and gains of business or profession;
4. Capital gains;
5. Income from other sources.
For computation of income, all taxable income should fall under any of the five heads of income as mentioned
above. If any type of income does not become part of any one of the above mentioned first four heads, it should
be part of the fifth head, i.e. Income from other sources, which may be termed as the residual head.
Significance of heads of income
• Income chargeable under a particular head cannot be charged under any other head.
• The Act has self-content provisions in respect of each head of income.
• If any income is charged under a wrong head of income, the assessee may lost the benefit of deduction
available to him under the correct head.
Distinguish between Heads of income and Sources of income
There are only five heads of income as per Sec. 14 of the Act, but the assessee may generate the income from
various sources.
In the same head of income, there may be various sources of income. E.g. under the head ‘Income from house
property’, there may be two or more house properties and each house property shall be termed as a source of
income. The source of income decides under which head (among the five heads) income shall be taxable.

1.13 GROSS TOTAL INCOME (GTI) [SEC. 80B(5)]

Gross total income is the aggregate of income under all the five heads of income after adjusting the set-off &
carry forward of losses. Deductions under chapter VIA is provided from GTI, to arrive at Total income or taxable
income.

2
Finance Ministry has clarified that LPG subsidy received by an individuals in their bank accounts will continue to be exempt from income tax.

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Computation of Total Income for the A.Y.___

Particulars Amount
1. Salaries ***
2. Income from house property ***
3. Profits and gains of business or profession ***
4. Capital gains ***
5. Income from other sources ***
Gross Total Income ****
Less: Deduction u/s 80C to 80U ****
Total Income ****

1.14 ROUNDING-OFF OF TOTAL INCOME [SEC. 288A]

The total income so computed will have to be rounded off to the nearest multiple of ` 10, i.e., if the last figure in
the ‘rupee element’ is ` 5 or more, it should be rounded off to the next higher amount, which is a multiple of ` 10.
The ‘paise’ element should be ignored.
Thus, if the total income works out to ` 41,645, it should be rounded off to ` 41,650, but if it works out to ` 41,644.98,
it should be rounded off to ` 41,640.

1.15 ROUNDING-OFF OF TAX [SEC. 288B]

The tax calculated on the total income should be rounded off to the nearest ` 10. Amount of tax (including TDS or
advance tax), interest, penalty, etc. and refund shall be rounded off to the nearest ` 10.
Provision illustrated

Tax liability actually worked out (`) 4,876.49 6,452.50 8,738.92 5,132.75
Tax liability as rounded off (`) 4,880 6,450 8,740 5,130

1.16 CAPITAL-VS.-REVENUE

Receipts
A capital receipt is not liable to tax, unless specifically provided in the Act, whereas, a revenue receipt is not
exempted, unless specifically provided in the Act. Further, capital receipts are to be charged to tax under the
head “Capital Gains” and revenue receipts are taxable under other heads. The Act does not provide exhaustive
definition of the income, thus, distinction between capital receipts and revenue receipts is not easily made.
However, based on a number of judicial pronouncements, the following principles are worthwhile to note:
1. Receipt in lump sum or in Instalments: Whether any income is received in lump sum or in instalments, it will
not make any difference as regards its nature, e.g., an employee is to get a salary of ` 10,000 p.m. Instead of
this he enters into an agreement to get a sum of ` 3,60,000 in lump sum to serve for a period of 3 years. The
receipt where it is monthly remuneration or lump sum for 3 years is a revenue receipt.
2. Nature of receipt in the hands of recipient: Whether a receipt is capital or revenue will be determined in the
hands of the persons receiving such income. No attention will be paid towards the source from which the
amount is coming. Salary even if paid out of capital by a new business will be it revenue receipt in the hands
of employee.
3. Accounting treatment: The name given to the transaction by the parties involved or its treatment in the books
of account may not alter its character as capital or revenue.

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4. Income from wasting assets: Profits from capital which is consumed and exhausted in the process of realization,
e.g. royalties from mines and quarries, is taxable as income regardless of the consumption of capital involved
in the process.

5. Magnitude of receipt: The magnitude of the receipt, whether big or small, cannot decide the nature of the
receipt.

6. Time of receipt: The nature of the receipt has to be determined at the time when it is received and not
afterwards when it has been appropriated by the recipient.

7. Quality of receipt: Whether the income is received voluntarily or under a legal obligation, it will not make any
difference as regards its nature.

8. Tests as to the purpose of keeping an article: If a person purchases a piece of sculpture to keep as decoration
piece in his house, if sold later on, will bring capital receipt but if the same sculpture is sold by an art dealer it
will be his revenue receipt.

Instances of transactions which are capital in nature but specifically taxable:

1. Capital gains arising from sale of capital assets being defined u/s 2(14). [Sec. 45]
2. Compensation for termination of service or modification in the terms of service [Sec. 17(3)]
3. Compensation or other payments due to or received by the persons specified u/s 28(ii)/28(va).

Expenses
Similarly, a capital expenditure is not allowable as expenses, unless specifically allowed in the Act, whereas, a
revenue expenditure is allowable as expenses, unless specifically disallowed in the Act. Based on a number of
judicial pronouncements, the following principles are worthwhile to note:
1. Acquiring asset or advantage of enduring nature: Bringing into existence an asset or advantage of enduring
nature3 would lead to the inference that the expenditure disbursed is of a capital nature.
2. Capital assets belonging to third parties: Even though a expenditure results in the creation of a capital asset,
if the capital asset belongs to a third party, such expenses will be treated as revenue expenditure.
3. Profit-earning process: Where the outgoing expenditure is so related to the carrying on or the conduct of the
business that it may be regarded as an integral part of the profit-earning process and not for acquisition of
an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the
business, the expenditure may be regarded as revenue expenditure
4. Object of the transaction: The object of the transaction which has impact on the business, the nature of trade
for which the expenditure is incurred and the purpose thereof, etc.
5. Fixed capital -vs.- Circulating capital: An item of disbursement may be regarded as of a capital nature
when it is relatable to a fixed capital, whereas if it is related to circulating capital or stock-in-trade it would be
treated as revenue expenditure.
6. Expenditure on removing restriction: Where the assessee has an existing right to carry on a business, any
expenditure made by it during the course of business for the purpose of removal of any restriction or obstruction
or disability would be on revenue account, provided the expenditure does not result in the acquisition of any
capital asset.
7. Payment made to rival dealer to ward off competition in business would constitute capital expenditure
8. If the expenditure is a part of the working expenses in ordinary commercial trading, it is not capital but
revenue expenditure.

3
‘enduring’ does not mean ‘everlasting’ or ‘perpetual’.

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9. If the expenditure is incurred for the initial outlay or for extension of business or substantial replacement of
equipment, it is capital expenditure but if it is incurred for running the business or is laid out as part of the
process of profit making, it is revenue in character.
10. If expenditure is incurred for ensuring the regular supply of raw material, maybe for period extending over
several years, it is on revenue account
11. When an owner incurs expenditure on additions in a building which enhances its value the expenditure
can be of a capital nature. But, if a tenant incurs an expenditure on a rented building for its renovation, he
does not acquire any capital asset, because the building does not belong to him and, ordinarily, such an
expenditure will be of a revenue nature.
12. Acquisition of the goodwill of the business is acquisition of a capital asset, and, therefore, its purchase price
would be capital expenditure. It would not make any difference whether it is paid in a lump sum at one time
or in instalments distributed over a definite period. Where, however, the transaction is not one for acquisition
of the goodwill, but for the right to use it, the expenditure would be revenue expenditure
13. Expenses incurred by the assessee for the purpose of creating, curing or completing the title is capital
expenditure and on the other hand if such expenses are incurred for the purpose of protecting the same, it
is revenue expenditure.

Illustration 2.
Birla Ltd., a cement manufacturing company, entered into an agreement with a supplier for purchase of additional
cement plant. One of the conditions in the agreement was that if the supplier failed to supply the machinery
within the stipulated time, the company would be compensated at 5% of the price of the respective portion
of the machinery without proof of actual loss. The company received ` 8.50 lakhs from the supplier by way of
liquidated damages on account of his failure to supply the machinery within the stipulated time. What is the
nature of liquidated damages received by Birla Ltd. from the supplier of plant for failure to supply machinery to
the company within the stipulated time — a capital receipt or a revenue receipt? [CMA – Inter Dec. 2011]

Solution:
In the case of CIT -vs.- Saurashtra Cement Ltd. (2010) 325 ITR 422, the Apex Court has held that the damages
were directly and intimately linked with the procurement of a capital asset, which lead to delay in coming into
existence of the profit-making apparatus. It was not a receipt in the course of profit earning process. Therefore,
the amount received by the assessee towards compensation for sterilization of the profit earning source, not in the
ordinary course of business, is a capital receipt in the hands of the assessee.

1.17 TAX PLANNING, TAX EVASION AND TAX AVOIDANCE

Tax planning is a way to reduce tax liability by taking full advantages provided by the Act through various
exemptions, deductions, rebates & relief. In other words, it is a way to reduce tax liability by applying script &
moral of law. It is the scientific planning so as to attract minimum tax liability or postponement of tax liability for the
subsequent period by availing various incentives, concessions, allowance, rebates and relief provided in the Act.
Tax evasion is the illegal way to reduce tax liability by deliberately suppressing income or sale or by increasing
expenses, etc., which results in reduction of total income of the assessee. Tax evasion is illegal, both in script &
moral. It is the cancer of modern society and work as a clog in the development of the nation.
Tax avoidance is an exercise by which the assessee legally takes advantages of loopholes in the Act. Tax avoidance
is a practice of bending the law without breaking it. It is a way to reduce tax liability by applying script of law only.
Most of the amendments are aimed to curb such loopholes. There are two thoughts about tax avoidance –
a) As per first thought it is legal. Such thought is also supported by various judgments of the Supreme Court,
some of them are as follows -

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 Direct Taxation

Helvering vs. Greggory (1934)

“Anyone may so arrange his affairs that his taxes shall be as low as possible. He is not bound to choose that
pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

IRC vs. Duke of Westminster (1936)

“Taxpayer is entitled to so arrange his affairs that the tax under the appropriate Act is less than what otherwise
it could be.”

Inland Revenue Commissioners vs. Fishers Executors (1958)

“The highest in authority, have always recognized that the subject is entitled so to arrange his affairs as not to
attract taxes imposed by the Crown, so far he can do so within the law, and that he may legitimately claim
the advantage of any express terms or any omissions that he can find in his favour in taxing Act. In doing so,
he neither comes under liability, nor incurs blame.”

CIT vs. Raman & Co. (1968)

“Avoidance of tax liability by so arranging commercial affairs that the charge of tax is distributed, is not
prohibited. A taxpayer may resort to a device to divert the income before it accrues or arises to him.
Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income-
tax Act.”

Smt. C. Kamala vs. CIT (1978)

“It is quite possible that when a transaction is entered into in one form known to law, the amount received
under that transaction may attract liability under the Act and if it is entered into in another form which is
equally lawful, it may not attract such tax liability. But when the assessee has adopted the latter one, it would
not be open to the court to hold him liable for tax.”

CWT vs. Arvind Narotham (1988)

“It is true that tax avoidance in an underdeveloped or developing economy should not be encouraged on
practical as well as ideological grounds. One would wish….. that one could get the enthusiasm ….. that taxes
are the price of civilization and one would like to pay that price to buy civilization. But the question which
many ordinary taxpayers very often, in a country of shortages with ostentatious consumption and deprivation
for the large masses, ask is, does he with taxes buy civilization or does he facilitate the waste and ostentation
of the few. Unless ostentation and waste in Government spending are avoided or eschewed, no amount of
moral sermons would change people’s attitude to tax avoidance.”

b) As per second thought it is not a legal way to reduce tax burden and it should be prohibited.

McDowell & Co. Ltd. vs Commercial Tax Officer (1985)

Supreme Court observed - “we think time has come for us to depart from Westminster principle….tax planning
may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax
planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of
tax by resorting to dubious methods. It is the obligation of every citizen to pay the honestly without resorting
to subterfuges.”

CIT vs B.M. Kharwar (1969)

Supreme Court held – “the taxing authority is entitled and is indeed bound to determine the true legal
relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is
open to the taxing authorities to unravel the device and to determine the true character of relationship. But
the legal effect of a transaction cannot be displaced by probing into substance of the transaction.”

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Basic Concepts

Distinguish between Tax Planning, Tax Evasion, Tax Avoidance and Tax Management
Difference between tax planning, tax avoidance, tax evasion & tax management

Points of Tax planning Tax Avoidance Tax Evasion Tax Management

distinction
Definition It is a way to reduce It is an exercise by It is the illegal way to It is a procedure
tax liability by taking full which the assessee reduce tax liability to comply with the
advantages provided legally takes by deliberately provisions of the
by the Act through advantage of the suppressing income or law.
various exemptions, loopholes in the Act. sale or by increasing
deductions, rebates & expenses, etc., which
relief. results in reduction of
total income of the
assessee.
Feature Tax planning is a Tax avoidance is a Tax evasion is illegal, It is implementation
practice to follow the practice of bending both in script & moral. or execution
provisions of law within the law without part of taxation
the moral framework. breaking it. department of an
organisation.
Object To reduce tax liability To reduce the tax To reduce tax liability To comply with the
by applying script & liability to the minimum by applying unfair provisions of laws.
moral of law. by applying script of means.
law only
Approach It is futuristic and It is futuristic but short It is concerned with It is a continuous
positive in nature. The term in nature, as past and applied after approach, which
planning is made today loophole of the law will the liability of tax has is concerned with
to avail benefits in be corrected in future arisen. It is done with past (rectification,
future. by amendments of the negative approach to revisions etc.),
law. avail benefits by killing present (filing of
the moral of law. return, etc.) & future
(corrective action).
Benefit Generally, arises in long Generally, arises in short Generally, benefits Penalty, interest &
run. run. do not arise but it prosecution can be
causes penalty and avoided.
prosecution.
Treatment of It uses benefits of the It uses loopholes in the It overrules the law. It implements the
Law law. law. law.
Practice It is tax saving. It is tax hedging. It is tax concealment. It is tax
administration.
Need It is desirable It is avoidable It is objectionable It is essential.
Morality It is moral in nature. It is immoral in nature It is illegal. It is duty.

1.18 DIVERSION & APPLICATION OF INCOME

There is a very thin line of difference between Diversion of income & Application of income.
Diversion of income: Where by virtue of an obligation, income is diverted before it reaches to the assessee, it is
known as diversion of income & it is not taxable (i.e. even if the assessee were to collect the income he does so on
behalf of the person to whom it is payable).
Example: A, B and C are co-authors of a book. The publisher of the book gave the whole royalty of `6,00,000 to A.
A paid `2,00,000 to B and C each. Such payment is not application of income but diversion of income.
Application of income: Whereas, application of income means to discharge an obligation (which is gratuitous or
self-imposed) after such income reaches the assessee & hence it is taxable.

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 Direct Taxation

Annexure
TAX RATES FOR THE A.Y. 2021-22
Individual/HUF/Association of Persons/Body of Individuals/Artificial Juridical Person
In case of Super Senior citizen
Total Income Range Rates of Income Tax
Up to ` 5,00,000 Nil
` 5,00,001 to ` 10,00,000 20% of (Total income – ` 5,00,000)
` 10,00,001 and above ` 1,00,000 + 30% of (Total income – ` 10,00,000)
Super Senior Citizen means an individual who is resident in India and is of at least 80 years of age at any time during
the relevant previous year (i.e. any resident person, male or female, born before 02-04-1941).
In case of Senior citizen
Total Income Range Rates of Income Tax
Up to ` 3,00,000 Nil
` 3,00,001 to ` 5,00,000 5% of (Total Income – ` 3,00,000)
` 5,00,001 to ` 10,00,000 ` 10,000 + 20% of (Total income – ` 5,00,000)
` 10,00,001 and above ` 1,10,000 + 30% of (Total income – ` 10,00,000)
Senior Citizen means an individual who is resident in India and is of at least 60 years of age at any time during the
relevant previous year. (i.e., a resident person, male or female, born on or after 02-04-1941 but before 02-04-1961)
In case of other Individual1 / HUF / Association of Persons / Body of Individuals / Artificial Juridical Person

Total Income Range Rates of Income Tax

Up to ` 2,50,000 Nil
` 2,50,001 to ` 5,00,000 5% of (Total Income – ` 2,50,000)
` 5,00,001 to ` 10,00,000 ` 12,500 + 20% of (Total income – ` 5,00,000)
` 10,00,001 and above ` 1,12,500 + 30% of (Total income – ` 10,00,000)
1
. born on or after 02-04-1961 or non-resident individual
Rebate u/s 87A
Applicable to: Resident Individual
Conditions to be satisfied: Total income of the assessee does not exceed ` 5,00,000.
Quantum of Rebate: Lower of the following:
a. 100% of tax liability as computed above; or
b. ` 12,500/-
Example
Compute rebate u/s 87A in the following cases:

Particulars Case 1 Case 2 Case 3 Case 4 Case 5 Case 6

Assessee Individual Individual Senior Citizen Senior Citizen Individual HUF
Residential status Resident Resident Non-Resident Resident
Total Income ` 4,90,000 ` 5,12,000 ` 4,25,000 ` 5,40,000 ` 2,60,000 ` 2,65,000
Tax on above ` 12,000 ` 14,900 ` 6,250 ` 18,000 ` 500 ` 750
Rebate u/s 87A ` 12,000 Nil ` 6,250 Nil Nil Nil
Reason Total income Total income Assessee is Assessee is not
exceeds ` 5 lacs exceeds ` 5 lacs non-resident an individual
Tax after rebate Nil ` 14,900 Nil ` 18,000 ` 500 ` 750

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Basic Concepts

Surcharge on tax after rebate u/s 87A

Surcharge at the following rate is also payable on tax as computed above after rebate u/s 87A

Total Income Rate of Surcharge

Total income does not exceed ` 50 lacs Nil
Total income exceeds ` 50 lacs but does not exceed ` 1 crore 10% of tax
Total income exceeds ` 1 crore but does not exceed ` 2 crores 15% of tax
Total income exceeds ` 2 crores but does not exceed ` 5 crores 25% of tax*
Total income exceeds ` 5 crores 37% of tax*
*
Where the total income includes dividend, any income chargeable u/s 111A and 112A, the surcharge on the
amount of income-tax computed on that part of income shall not exceed 15%. In other words, surcharge higher
than 15% is applicable only on tax on income other than dividend, income covered u/s 111A and 112A.
Health & Education Cess
Applicable on: All assessee
Rate of cess: 4% of Tax liability after Surcharge
Marginal Relief
Example: Compute tax liability of the assessee (52 years) whose total income is:
(Case 1) ` 49,90,000 (Case 2) ` 50,10,000; (Case 3) ` 60,00,000
Particulars Working Case 1 Case 2 Case 3
Tax liability before Rebate ` 2,50,000 * Nil Nil Nil Nil
` 2,50,000 * 5% 12,500 12,500 12,500
` 5,00,000 * 20% 1,00,000 1,00,000 1,00,000
Balance Income * 30% 11,97,000 12,03,000 15,00,000
Total 13,09,500 13,15,500 16,12,500
Less: Rebate u/s 87A As income exceeds ` 5,00,000 Nil Nil Nil
Liability [A] 13,09,500 13,15,500 16,12,500
Add: Surcharge B = [10% of (A)] Nil 1,31,550 1,61,250
Tax and surcharge payable 13,09,500 14,47,050 17,73,750
Analysis of case (1) and case (2)
Increase in income ` 20,000
Liability for surcharge increased ` 1,31,550

To provide relaxation from levy of surcharge to a taxpayer where the total income exceeds marginally above
` 50 lakh or ` 1 crore or 2 crores or 5 crores, the concept of marginal relief is designed.
Condition: Total income exceeds ` 50,00,000 (or ` 1 crore or 2 crores or 5 crores)
Relief: Marginal relief is provided to ensure that the additional income tax payable including surcharge on
excess of income over ` 50,00,000 or ` 1,00,00,000 or ` 2,00,00,000 or ` 5,00,00,000 is limited to the amount by
which the income is more than ` 50,00,000 or ` 1,00,00,000 or ` 2,00,00,000 or ` 5,00,00,000
Marginal relief = Calculated Surcharge - 70% (Income – ` 50,00,000)] (if positive)
Or
Marginal relief = [(Income tax + surcharge) on income] - [(Income tax on ` 50,00,000) + (Income – ` 50,00,000)]
Similar relief shall also be provided where income exceeds marginally above ` 1 crore or ` 2 crores or ` 5 crores.
In that case, the aforesaid equation shall be changed accordingly.

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 Direct Taxation

Now, computation of tax liability is made after considering marginal relief:

Particulars Working Case 1 Case 2 Case 3

Liability [A] 13,09,500 13,15,500 16,12,500
Add: Surcharge B = [10% of (A)] Nil 1,31,550 1,61,250
Tax and surcharge 13,09,500 14,47,050 17,73,750
Less: Marginal relief [(B)–{70%(50,10,000–50,00,000)}] Nil 1,24,550 Nil
Effective Surcharge [C] Nil 7,000 1,61,250
Liability after surcharge [A + C] 13,09,500 13,22,500 17,73,750
Add: Health & Education cess 4% of above 52,380 52,900 70,950
Total Rounded off u/s 288B 13,61,880 13,75,400 18,44,700
Taxpoint: The concept of marginal relief is not applicable in case of cess.
An Individual / HUF can opt for alternative tax regime u/s 115BAC. The provision relating to sec. 115BAC will be
discussed in subsequent chapter.

Firm or Limited Liability Partnership (LLP)

A partnership firm (including limited liability partnership) is taxable at the rate of 30%
Surcharge: 12% of income-tax (if total income exceeds ` 1 crore otherwise Nil)
Marginal Relief: Available
Health & Education Cess: 4% of tax liability after surcharge

Company

Company Rate
In the case of a domestic company
- Where its total turnover or gross receipts during the previous year 2018-19 does not exceed ` 400 25%
crore
- In any other case 30%
In the case of a foreign company 40%

Surcharge

Total Income Domestic Company Foreign Company

If total income exceeds ` 10 crore 12% 5%
If income exceeds ` 1 crore but does not exceed ` 10 crore 7% 2%
If income does not exceed ` 1 crore Nil Nil

Marginal Relief: Available at both points (i.e., income exceeds ` 1,00,00,000 or ` 10,00,00,000)
Health & Education Cess: 4% of tax liability after surcharge

In few cases and subject to certain conditions, companies are liable to be taxed at different rate.

18 The Institute of Cost Accountants of India