BASIC INCOME-TAX CONCEPTS

Contents

1 Introduction

2 Income Tax

3 Assessment Year

4 Previous Year

5 Classification of Taxable Income

6 Residential Status

7 Income From the Head "Salaries"

8 Residents and Non-Resident Concepts

9 Exceptions to the Rule Relating to Residence

10 "Not Ordinarily Resident"—Definition

11 Summary
Introduction

The persons for whom this monograph has been conceived, planned and written are the
most valuable treasure of a society who have served the country in various capacities in
the best years of their lives and are now in the evenings of their lives. With vast
improvements in life styles, rapid developments in medical and information technologies,
life spans have increased and this is amply born out by this year's census figures.

With average age of the citizens in the country having gone up substantially since
independence and in the background of the fact that it is improving year by year, persons
deriving income from pension and other sources constitute a significant segment of
population and consequently of taxpayers in the country. Amongst these persons, those
who have retired or are on the verge of retirement, deserve special concern. The
Government is fully conscious of its responsibility in respect of such persons and has
been trying to do its best in spite of financial constraints to take care of such persons in
the absence of an organized social security system in the country. Such persons have
special problems of their own, characteristic of the stage of life through which they are
passing. To cite just one example, after retirement, persons who have lived comfortable
lives are usually constrained to depend upon fixed monthly incomes by way of pension
even though they may still have important responsibilities to discharge-like-acquiring of
a residential accommodation, marriage of children, education of grown-up children,
looking after sick spouse, etc. In these circumstances, one information that such persons
would be keen to know is how much money they will be left with each year after paying
taxes to meet their varied needs. The tax department has always been sympathetic
towards such persons and in the past few years has extended a helping hand to such
category of taxpayers by reducing their tax burdens so that savings in the form of tax
could be used by them to augment their income and live better.

In this monograph, an attempt has been made to cater to the quest for information of such
taxpayers and to explain to them, in simple words, with suitable illustrations, as to what
are their rights and obligations under the Income-tax and Wealth Tax Acts so that they
can plan for their future in an organized manner and discharge their tax liability under the
Direct Tax Laws correctly and in time with no botheration. In doing so, an attempt has
been made to avoid legal phrases and to use simple jargon-free language so that the
message proposed to be conveyed is well understood. Hence this write-up may not be
considered as a legal exposition of the relevant provisions under the Income-tax and
Wealth Tax Acts.
Income-Tax

The basis for the levy of income-tax is spelt out in Section 4 of the Income-tax Act, 1961.
This section provides the foundation for the levy of tax on all incomes, including
pensions and retirement benefits to the extent these are taxable. All taxpayers including
retired persons would find it advantageous to familiarise themselves with the basic
scheme of taxation envisaged under this section, for this presents a convenient starting
point for a discussion on matters relating to Income-tax. Further, some terms frequently
used in tax computations also need to be understood.

Assessment Year

Income-tax is an annual tax imposed separately for each assessment year (also called the
tax year). This commences from 1st April and ends on the next 31st March. It thus
corresponds with the financial year of the Government.

This concept is important because the law applicable to the facts of a particular case is the
law as it stands on the statute book on the 1st April of the relevant assessment year. The
rates of tax are specified in Part-1 of the First Schedule to the Finance Act. Finance Act is
passed annually by the Parliament of the country.

Previous Year

Tax is levied on the total income of the previous year. This is generally for a period of 12
months ending on 31st March just prior to the commencement of the assessment year. In
the case of a source of income coming into existence in the middle of the year, this may
not run for a full period of 12 months from 1st April to the following 318t March. It may
instead comprise a shorter period commencing from the date on which the source of
income, say business, is set up til 31st March following the date. In the same manner, a
source of income say salary can end also in the middle of the year. In non-technical
language, the "previous year" is also referred to as the "accounting year" or the "income
year".

Illustration

The previous year to the assessment year 2001-2002 is the financial year starting from
1.4.200 and ending on 31.3.2001. The total income earned during this period is to be
taxed during the assessment year 2001-2002 at the rates, and in accordance with the law,
applicable to this assessment year. The pension earned during this previous year is also
assessable in the assessment year 2001-2002.
Classification of Taxable Income

Tax is levied on a taxpayer's total income not as popularly understood but in accordance
with the provisions of the Income-tax Act. The Act prescribes five heads of income.
These are:

a. Salaries
b. Income from house property
c. Profits and gains of business or profession
d. Capital gains
e. Income from other sources

(The definition of salary in section 17(1) includes any annuity or pension).

Between themselves, these heads of income exhaust all possible types of income which
can accrue to or be received by tax payers. Income is first to be computed in accordance
with the provisions governing a particular head of income. The final figures of income or
loss under each head of income, after allowing for stipulated deductions, allowances and
other adjustments, are then aggregated to arrive at the gross total income. From the latter,
further deductions are allowed in respect of certain kinds of income and expenditure
under Chapter VI-A of the Act. The resultant figure is then, in terms of Section 288A,
rounded off to the nearest ten rupees. This is the total income of the assessee forming the
tax base on which tax is levied.

The figure of total income under the Income-tax Act, may not always coincide with the
figure based on the popular conception of the term. To take just one rough and ready
example, for the previous year 1.4.2000 to 1.4.2001 corresponding to the assessment year
2001-2002. Mr. A, a pensioner had four sources of income viz. Salary (Rs. 6000),
pension (Rs. 36000), dividend (Rs. 3000) and bank interest (Rs. 15000). The two
computations below will indicate the difference between the concept of total income in
popular sense and for tax purposes.

Name of the assessee Mr. A

Assessment year 2001-2002
Previous year 2000-2001
Computation of income in popular sense :
Pension Rs. 36,000
Salary Rs. 6,000
Dividends Rs. 3,000
Bank interest Rs. 15,000
-------------
Total income Rs. 60,000
Computation of total income for tax purposes.

1st step

Computation of income under each head separately.

I Salaries:

a) Pension Rs. 36,000

b) Salaries
Rs. 6,000
------------
Rs. 42,000
Less : Standard deduction u/s 16(i)
Rs. 25000 or 33.33 % of income
whichever is lower 33.33 % being
Rs. 14,000
lower is deductible Rs. 14000
Income under the head 'Salaries' Rs. 28,000

I
Other sources :
I
Bank interest Rs. 15,000
dividend from Indian Companies
(NIL being exempt under section
NIL
10(33) presuming that it satisfies
condition of section 115-O
Income from other sources Rs. 15,000

2nd Step:

Aggregate the income under each head to arrive at the gross total income

I. Income from Salaries Rs. 28,000

II
Income from other sources Rs. 15,000
.
------------
Gross total income Rs. 43,000

3rd Step :

Allow deductions under Chapter VI-A from Gross total income

 .
Deduction under section 80L for bank interest Rs. 12,000
Less:
-------------
Total income Rs. 31,000

Now suppose further that the assessee also owns a self-occupied house in respect of
which he has to pay interest of Rs. 30,000 p.a. on capital borrowed for the construction or
purchase of the house (before 1.4.99). He will, in that event be allowed a deduction of Rs.
30,000 (the maximum admissible u/s 24(l)(vi) read with Section 24(2) for the assessment
year 2001-2002. The gross total income will thus come down to Rs. 13,000 and taxable
income to Rs. 1,000. Since this would be very much below the taxable limit for the year
2001-2002 of Rs. 50,000, no tax would be payable by this person.

From the figures as given earlier, it would be seen that as against the receipts of Rs.
60,000, the taxable income is reduced to Rs. 1,000 only, because of benefits/ concessions
available under the Income-tax Law.

(Interest on borrowing can be claimed as deduction only by the person who has acquired
or constructed the property with borrowed fund. It is not available to the successor to the
property. If the successor has not utilized borrowed funds for acquisition or construction
of property).

In the context of benefit of interest concerning self-occupied residential property it needs

to be mentioned that deduction regarding interest relating to borrowed funds for
construction or acquisition of such property have further been substantially liberalized as
under:

i. Where the property is acquired or constructed with capital

borrowed on or after 1.4.1999 and such acquisition or construction is
completed before 1st April 2003, the figure of Rs. 30,000 would get
increased to Rs. 1,00,000 (maximum amount deductible).
ii. With effect from 1.4.2002 i.e. for the assessment year 2002-2003,
the figure of Rs. one lakh has been increased to Rs. One lakh fifty
thousand, if the conditions mentioned at (i) are satisfied.

Note: The limited purpose behind this illustration is to show that there can indeed be a
variation, sometimes quite wide, between the figures of total income as computed under
the Act and that which adds to the purchasing power of a taxpayer.

Residential Status

The Residential status of the assessee as defined in the IT. Act, 1961 is important to
determine his tax liability. This is so because, in the case of residents, all incomes are
brought to tax regardless of where they are received or where they accrue or arise. In the
case of nonresidents or persons who are resident but not ordinarily resident, only the
following incomes are taxable.

i. Income received in India or deemed to have been so received;

ii. Income accruing or arising in India or deemed to have so arisen or
accrued;
iii. Income accruing or arising outside India if derived from a business
controlled in or a profession set up in India (applicable only in the case of
persons who are residents but not ordinarily residents).

In the context of pensions and retirement benefits, these general principles merely imply
that in the case of a resident, all pensions or other superannuation benefits received on
recurring basis and not exempt would be taxable regardless of where they accrue, or
arise, in the case of a person who is a resident but not ordinarily resident or a non-
resident, however, pension and other retirement benefits would be taxable only if they
accrue, arise or are received in India. Pensions or other incomes initially accruing or
arising abroad and received there would not be liable to tax even if these are remitted to
India subsequently.

Illustration

The following example indicates the implications of residential status for taxpayer with
income under the head "salaries (and pension)".

Mr. O is a resident. During the previous year 01.04.2000 to 31.03.2001 relevant to the
assessment year 2001-2002, he received the following income under the head "salaries".

Pension from the U.K. Government received in U.K., subsequently converted into rupees
at the rate of exchange for conversion in accordance with Rule 115 of the I.T. Rules and
brought in India Rs. 1,05,000.

Salary from M/s. DEF Limited, a

company situated in Delhi Rs. 65,000
Rs.
Gross Income under the head "Salaries"
1,70,000
Less :
Standard deduction u/s 16(i) at 33-1/3%
or Rs.20,000 whichever is lower
Rs. 20,000
--------------
Income from salaries includible in the Rs.
Total income 1,50,000

In this example, if Mr. O had been a non-resident or not ordinarily resident, his pension
of Rs. 1,05,000 would not be includible in his total income. The computation of income
under the head "salaries" would then be as under :
 Salary from M/s. DEF Ltd., a
company situated in Delhi 65,000
Less :
Standard deduction u/s 16(1) 21,667
Limited to 33.33% of the salary 43,333

Income From the Head "Salaries"

The amount being less than Rs. 50,000 (the basic exemption limit) there would be no
liability to Income-tax.

Residents and Non-Resident Concepts

According to the current test of residence, an individual becomes a resident, if he

a. is in India for 182 days or more during the previous year; or

b. has been in India for atleast 365 days within the preceding four years and
for atleast 60 days in the relevant previous year.

In other situations the person is to be treated as nonresident.

Illustration

1. Mrs. E retired from U.S. Government service in Washington on 31st March, 1999.
Since then, she spends her time partly in Delhi where she owns a house and partly
with her daughter in Washington D.C., U.S.A. During the previous year relevant
to the assessment year 2000-2001 she was in India from 15th April 1999 to 22nd
December, 1999. She then left India to be with her daughter in the U.S.A. for
Christmas. She returned to India on 28th January, 2000.
As Mrs. E was in India for more than 182 days during the previous year, her
residential status for the assessment year 2000-2001 would be "resident".

2. For the assessment year 2001-2002 (previous year 1.4.2000 to 31.3.2001) the
facts show that she was with her daughter in the U.S. from 15th April to 10th
November 2000. She was in India from 12th November to 15th December, 2000.
Then she went back to the U.S. for the entire winter returning to Delhi only on
15th April 2001.
For the assessment year 2001-2002, the status of Mrs. E would be that of a non-
resident because :
a. during the previous year she was in India for less than 60 days;
b. her total stay in India during the preceding four year was less than 365
days.

Exceptions to the Rule Relating to Residence

An exception has been made in the case of those persons who are citizens of India and
persons of Indian origin and have to leave the country for employment abroad, or is an
Indian citizen who leaves India during the previous year as a member of the crew of an
Indian ship as defined in clause (18) of section 3 of the Merchant Shipping Act. 1958. In
their case, the criterion of stay of 60 days (supra) has been enhanced to 182 days. That is
to say, when a person leaves for employment abroad, he will continue to be a resident if
he remains in India for 182 days or more in the previous year. If his stay in India during
the previous year is less than 182 days, he will be a non-resident.

The second exception to this rule relates to those individuals who being Indian citizens or
persons of India origin are residing outside India and visit India during a previous year.
Such individuals would become residents, if they remain in India for 182 days or more in
the previous year, or if during the preceding four years they have been in India for 365
days or more and during the previous year have been in India for 182 days or more. A
person is deemed to be of Indian origin if he, or either of his parents or any of his grand
parents, was born in undivided India.

Illustration

1. PQR an Indian citizen is an Engineer with the Central Public Works

Department (CPWD). During the previous 1.4.2000 to 31.3.2001, he was
sponsored by the Government for a 10 month assignment to Tunisia. He
left to India on 31st October, 1996 and was in Tunisia even after the close of the
previous year.
As Mr. PQR was in India for less than 182 days during the previous year ended
on 31.3.2001, his status would be "non-resident" for the assessment year 2001-
2002.
2. Mr. L is an Indian citizen, settled in England. He visits India every year to meet
his relatives and friends. He came to India on 15th July 2000 and left on
17.1.2001. During the preceding four years 1992-93 to 1996-97 he was in India
for more than 365 days.
Since during the relevant previous year 1.4.2000 to 31.3.2001, he visited India
from 15th July to 17th January, his stay in India was for more than 182 days. Hence
for the assessment year 2001-2002 his status would be that of a resident.

"Not Ordinarily Resident"—Definition

Apart from "resident" and "non-resident", a third category of residential status also exists,
namely, "not ordinarily resident". That is to say a person may well qualify as a resident
by the criterion laid out above, but yet qualify as "not ordinarily resident in India". In that
event, his income accruing or arising abroad will not form part of his total income, unless
it is derived from a business controlled in or a profession set up in India.

A person is not ordinarily resident in India, if

 a. he has not been a resident in nine out of the ten previous years, or
b. has not been in India for 730 days or more during the preceding seven years.

Illustration

During the previous 2000-2001, relevant to the assessment year 2001-2002 Mr. A.L. was
in India for more than 182 days. He would thus in the first instance qualify as a resident
but his total stay in India during the preceding seven years was only 600 days. Mr. A.L.
received a pension from a company based in Canada, which accrued to him in Canada.
This would not be includible in his total income as it accrued to him outside India. The
same would be the case if Mr. A.L. had not been resident in nine out of ten preceding
previous years.

Summary

To summarize then, the basic scheme of taxation under Income-tax Act, 1961 envisages a
single annual tax on the total income of the previous year at the rates indicated in the
relevant Finance Act for the assessment year in accordance with the law applicable to the
latter. In the case of a resident, the scope of total income includes all incomes of the
previous year earned by the tax payer, regardless of where these incomes accrued, arose
or were received. On the other hand in the case of a non-resident, or a person who is
"resident but not ordinarily resident", only the following incomes earned by him are
includible in his total income.

a. incomes which accrued or arose to him in India during the previous year
or which are deemed to have so accrued or arisen or;
b. incomes which were received in India during the previous year or which are
deemed to have been so received.
c. incomes which accrued or arose to him outside India if derived from a business
controlled in, or a profession set up in India (applicable only in the case of a
person who is resident but not ordinarily resident).

Thus these concepts viz., residential status, previous year and assessment year are very
relevant in determining the tax liability of a taxpayer including a pensioner.