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Basics of Indian Income Tax-A crisp analysis

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Today entrepreneurs contemplate to start new line of product/service or expand their business and plan to turn them into mutli million dollar enterprise, the first hurdle they face is requirement of funds. To obviate this hurdle they approach any bank, NBFC or venture capital fund. At this moment, amongst other requirements, they are asked to submit their proof of Income Tax returns and at this moment entrepreneurs goes blank.

So what is so critical about Income tax return?

Income tax return is nothing but a tax form giving details about income earned from various sources by the entity and tax payable thereon to Government for a particular year before certain dates.

In the following we will try to highlight how the Indian taxation works and its basics and later move on to compliances required under the Income Tax Act.

What is Income Tax?

Constitution of India empowers Government to tax any person who earns income in India/ accrued or arised in India. This tax is levied on the basis of an Act called Income Tax Act (IT Act) which was passed by the Parliament of India in 1961.

Every year rates of income tax, education cess, surcharges, deductions, exemptions etc are revised  by the Finance Minister in budget (called as Finance Bill) depending upon the economic situation of the country.

On whom Income Tax is levied?

It is levied on all types of persons (Individuals, Companies, proprietorship, partnership firms. LLP, Trust, Society, etc) based on the residential status (not citizenship). There is a set procedure to compute the residential status of according to different types person under Income Tax Act.

How taxpayers are termed?

The taxpayers are termed as assesses. Assesses are the person liable to tax under the IT Act. However the definition of person is different what we use in common parlance. Person covers natural as well as artificial persons.

For the purpose of charging Income-tax, the term ‘person’ includes Individual, Hindu Undivided Families, Association of Persons, Body of individuals, Firms, LLPs, Companies, Local authority and any artificial juridical person not covered under any of the above.

What is the difference between Financial Year and Assessment Year?

Financial Year (also called FY) or Previous Year is the year in which the person has earned income.

In the subsequent year, there is requirement to submit your income tax return. This year is called Assessment Year (also called AY).

E.g.: If income earned in FY 2015-16, return needs to be submitted in next year which is AY 2016-17.

So the income earned in the financial year is assessed in the next year

How Income is computed?

Income earned by person will be classified as under:

The total income of a person is segregated into five heads:-

1.     Income from Salaries

All income received as salary under employer-employee relationship is taxed under this head.

2.     Income from House Property

All income earned by renting/ let out of immovable property is covered under this head.

3.     Profits and gains of business or profession

All income earned by way of any profession and business is taxed under this head.

4.     Capital Gains

Any profit arising on sale/ transfer of assets (not stock in trade) is taxed under this head.

5.     Income from Other Sources

Any income not covered under above 4 heads is covered here (e.g.: lottery, gifts, interest from bank deposits, etc).

Heads of Income

The sum total of all above heads results in Gross Total Income. From the Gross Total Income certain deductions are allowed which reduces the Gross Total Income resulting in lower payment of tax

 

Deductions

Tax deduction helps in reducing your taxable income. It decreases overall tax liabilities and helps in saving taxes. Depending on the type of tax deduction claim, the amount of deduction varies. Claim for tax deduction can be made for amounts spent in tuition fees, medical expenses and charitable contribution, amount invested in Public Provident Fund, Employees Provident Fund, etc.

After reducing the Deductions from Gross Total Income, the resulting is Taxable Income.

It is the income on which tax rates are computed. Any advance tax paid or TDS credit available is reduced from tax liability to arrive at amount due to be paid to Government or if any excess credit is available then it is refunded to the assesses.

To Summarize,

formula

What is Advance Tax?

Also known as ‘Pay as you earn’. Advance tax refers to paying a part of your taxes before the end of the financial year. Advance tax is the income tax payable if your tax liability is more than Rs.10,000 in a financial year. It should be paid in the year in which the income is received.

The amount of advance tax paid is reduced from overall tax liability at the time of filing return of income

E.g. If income is earned in FY 2016-17 and the estimated tax liability is more than Rs10,000 then advance tax needs to be paid in specified installments on due dates.

What is TDS (Tax Deducted at Source)

Any persons responsible for making payments are required to deduct tax at source at prescribed rates. Instead of receiving tax on your income from you at a later date, the Government wants the payers to deduct tax before hand and deposit it with the Government. It is essentially an indirect method of collecting tax which combines the concepts of “pay as you earn” and “collect as it is being earned”.

The recipient of income receives the net amount (after deducted of tax at source). The recipient from whose income tax has been deducted at source, gets the credit of the amount deducted in his personal assessment on the basis of the certificate issued by the deductor and can take the credit of the same at the time of filing return of income.

E.g.: M/s X ltd receives service of Mr. Z, a lawyer (professional service)  and proposes to pay Rs. 2 lakhs, then as per Income Tax Act M/s X ltd should withhold Rs. 20,000 (10%) and pay Rs. 180,000 to Mr. Z and Rs. 20,000 to Government before due date. Mr. Z. will take credit of Rs. 20,000 at the time of filing return of income.

The income for the entire year needs to be computed/ classified as per methods/ procedures laid out in Income Tax Act. Apart from the above computation, at times losses if available are set off with income, rebates are taken and interest liability is taken in account.

From the above, basic idea can be drawn about how Income Tax in India operates and Entrepreneurs       can take into consideration for adhering legal compliance.

 

(The author CA Shakeel Ahmed Khan  can be reached at [email protected])

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