Tax Basics

Taxes form a major source of revenue for the Government. These are of two types:

a) Direct Tax - Direct taxes like income-tax, wealth-tax, expenditure-tax etc.  are those whose burden falls directly on the taxpayer.

b) Indirect Tax - Indirect taxes like excise duty, customs duty, service tax, sales tax, etc  form the cluster of indirect taxes.

In personal finance we will deal with income tax which falls on total income of a person. A person includes-

1. An Individual

2. Hindu Undivided Family

3. Firm

4. Association of Persons or Body of Individuals

5. Local Authority - BMC, NMMC

6. Artificial Juridical Person - Trusts (Religious / Educational Trust)

Assessee – An income tax is to be paid by the assesse under this act. Assessee  means a person by whom tax is payable, or a person by whom any other sum of money (interest / penalty) is payable.

Assessment Year (AY) – Income tax is charged in an assessment year (1^st April – 31^st March). Income earned in previous year (PY) is charged in AY.

Previous Year (PY) – PY means a financial year immediately preceding AY. It is the year in which an income is earned.

Types of income

Income tax is a tax on all incomes received, or accruing, or arising to a tax payer during a previous year. Incomes from various sources are computed under five different heads as:

1.  Salary: Includes allowances, value of perquisites, profits in lieu of salary and pension.

2.  House Property: whether residential or commercial, self-occupied or rented.

3.  Profits and gains: from business or profession

4.  Capital gains

5.  Income from other sources: - Includes bank interest, interest on securities, lotteries, crossword puzzles, races, games, gifts from unrelated persons exceeding the specified limit etc.

Gross total income is total income computed before making any deductions under chapter VI-A. Total income is calculated after making deductions and rebate known as taxable income.

Exemption vs Deduction vs Rebate–

Exemption – It is not considered under any source of income while calculating total income of a person.

Deduction – First mention the head of income then claim the deduction.

Rebate – It is allowed on the amount of income tax so computed.

Determination of Residential Status of an individual–

According to Income Tax Act 1961, every person, who is an assessee and whose total income exceeds the maximum exemption limit, shall be chargeable to the income tax at the rate or rates prescribed in the finance act. Such income tax shall be paid on the total income of the previous year in the relevant assessment year. However scope of the total income depends on the residential status of a person. The residential status of a person is determined for each previous year separately.

It is determined on the basis of the physical presence of the individual as against nationality or domicile in India. It is determined for every previous year separately. A person may be a resident in one previous year and non-resident in next year.

An individual may be resident, Resident and ordinary resident, Non-resident or resident but  not ordinarily resident.

a) Resident:

 An individual is treated as resident in a year if he is present in India, any one of the following conditions to be satisfied:-

           i)  For 182 days or more during the previous year

          ii)  For 60 days or more during the previous year and 365 days or more during the preceding four previous years

However this second condition is not applicable for Indian citizen or a person of Indian origin or a person coming on a visit to India or in case of an Indian citizen going abroad as a member of the crew of an Indian ship or for employment

              Hindu Undivided Family or Firm or other Association of Persons is Resident of India in any previous year except where the control and management of its affairs is wholly situated outside India in that previous year.

Company is resident of India if

 i)  It is an Indian company

 ii) During the previous year its control and management is Situated wholly in India.

b) Resident and ordinarily resident (ROR)-

For person to be ROR, both the following conditions are to be satisfied-
1) He has been resident in India in 2 out of the 10 P.Ys preceding the relevant P.Y.
2) He has been in India of 730 days or more during the 7 P.Ys preceding the relevant P.Y.
If none or only one of the above condition is satisfied, the individual will be treated as a resident but not ordinarily resident (RBNOR). 

c) Resident but not ordinarily resident (RBNOR):

A resident who was not present in India for 730 days during the preceding seven years or who was non-resident in nine out of ten preceding years or resident in India in 2 out of the 10 P.Ys preceding the relevant P.Y. is treated as not ordinarily resident. In effect, a newcomer to India remains not ordinarily resident.

d) Non-resident:

Non-residents are taxed only on income that is received in India or arises or is deemed to arise in India. A person not ordinarily resident is taxed like a non-resident but is also liable to tax on income accruing abroad if it is from a business controlled in or a profession set up in India.

Income Received in India-

Income received in India is included in the total income of all the persons, irrespective of their residential status. Any amount received outside India but later on brought to India is not treated as income received in India. Also past untaxed foreign income (i.e. Income earned outside India) brought to India during PY is not treated as income received in India. Hence not taxable.

So this is all what I wanted to cover in basics of tax. In upcoming articles we will see each and every head of income and their tax implications. Also we will see how you can save tax (legally :)) with little restructuring of the income that you earn. Any additions / comments are welcome.

Till then Ciao!