INTRODUCTION AND BASIC CONCEPTS OF INCOME TAX

INTRODUCTION:
Under the Constitution of India, Central Government is empowered to levy tax on the
income. Accordingly, the Central Government has enacted the Income Tax Act, 1961. The
Act provides for the scope and machinery for levy of Income Tax in India. The Act is
supported by Income Tax Rules, 1961 and several other subordinate and regulations. Besides,
circulars and notifications are issued by the Central Board of Direct Taxes (CBDT) and
sometimes by the Ministry of Finance, Government of India dealing with various aspects of
the levy of Income tax. Unless otherwise stated, references to the sections will be the
reference to the sections of the Income Tax Act, 1961.

TAX

Tax is the compulsory financial charge levy by the government on income, commodity,
services, activities or transaction. The word ‘tax’ derived from the Latin word ‘Taxo’.

Income tax is a tax on the total income of a person called the assessee of the previous year
relevant to the assessment year at the rates prescribed in the relevant Finance Act.

The authority of the government to levy tax in India is derived from the Constitution of
India, which allocates the power to levy taxes to the Central and State governments. All taxes
levied within India need to be backed by an accompanying law passed by the Parliament or
the State Legislature.

The payment of tax is beneficial on multiple levels including the development of nation,
betterment of infrastructure, the upliftment of the society, and even for welfare activities for
the nation.

HISTORY
In India, Income Tax was first time introduced in the year 1860 by Sir James Wilson in order to
meet the loss caused on account of ‘military mutiny’ in 1857.

In the year 1886, a separate Income Tax Act was passed, this act was in force for a long time,
subject to the various amendments from time to time. In the year 1918, a new Income Tax Act
was passed, but again, it was replaced by another new act of 1992. The Act of 1922 became very
complicated due to various amendments. This act remains in force to the assessment year 1961-
62. In the year 1956, the Government of India referred to the Law Commission in order to
simplify the law and also to prevent the evasion of Tax.
The Law Commission submitted its report in September 1958 in consultation with the Ministry of
Law. At present, this law is governed by the Act of 1961 which is commonly known as Income
Tax Act, 1961 which came into force on and from 1st April 1962. It applies to the whole of India,
including the state of Jammu & Kashmir.

Any law is in itself is not complete unless the gaps are being filled. The law of Income Tax in
India governed by the Income Tax Act of 1961 and the gaps are being filled by the Income Tax
Rules, Notifications, Circulars and judicial pronouncement including rulings by the Tribunal.

IMPORATANCE

The Taxation Structure of the country can play a very important role in the working of our
economy. Some time back the emphasis was on higher rates of Tax and more incentives. But
recently, the emphasis has shifted to Decrease in rates of taxes and withdrawal of incentives.
While designing the Taxation structure it has to be seen that it is in conformity with our
economic and social objectives. It should not impair the incentives to personal savings and
investment flow and on the other hand it should not result into decrease in revenue for the
State.

DEFINITIONS
Some of the important definitions under Income Tax Act, 1961 are as follows:

ASSESSMENT YEAR – S. 2(9)

Section 2(9) defines an “Assessment year” as “the period of twelve months starting from the
first day of April every year.” An assessment year begins on 1st April every year and ends on
31st March of the next year. For example, Assessment year 2012-13 means the period of one
year beginning on 1 st April, 2011 and ending on 31st March, 2012. In an assessment year,
income of the assessee during the previous year is taxed at the rates prescribed by the relevant
Finance Act. It is therefore, also called as the “Tax Year”

PREVIOUS YEAR- S. 2(34) & S. 3

Section 3 defines “Previous year” as “the financial year immediately preceding the
assessment year”. Income earned in one financial year is taxed in the next financial year. The
year in which income is earned is called the “previous year” and the year in which it is taxed
is called the “assessment year” Common previous year for all source of income:

A person may earn income from more than one sources but previous year will always be
common for all the sources of income. This will be so even if a person maintains records or
books of accounts separately for different sources of income.
 Total income of a person from all the sources of income will be taken together and
considered in the previous year or the financial year immediately preceding the assessment
year.

PERSON [ Section 2(31) ]

The word “Person” is a very wide term and embraces in itself the following :

 Individual :  It refers to a natural human being whether Male or Female , Minor or

Major.
 Hindu Undivided Family (HUF) : It is a relationship created due to operation of
Hindu Law. The Manager of HUF is called “ Karta” and its member are called
‘Coparceners’.
 Company : It is an artificial person registered under Indian Companies Act 1956 or
any other Law.
 Firm : It is an entity which comes into existence as a result of partnership agreement.
The Income Tax accepts only these entities as Firms which are accessed as Firms
under Section 184 of the Act.
 Association of Persons (AOP) or Body of Individuals (BOI) : Co-operative
societies, MARKFED, NAFED, etc are the example of such persons. When persons
combine together to carry on a joint enterprise and they do not constitute partnership
under the ambit of law, they are assessable as an Association of Persons. An A.O.P.
can have firms, companies, associations and individuals as its members. A Body of
Individual ( B.O.I.) cannot have non-individuals as its members. Only natural human
being can be members of a Body of Individuals
 Local Authority : Municipality, Panchayat, Cantonment Board, Port Trust etc. are
called Local Authority.
 Artificial Judicial Person : Statutory Corporations like Life Insurance Corporation, a
University etc. are called Artificial Judicial Persons.

These are seven categories of person chargeable to tax under the Act. The aforesaid definition
is inclusive and not exhaustive . Therefore, any person, not falling in the above-mentioned
seven categories, may still fall in the four corners of the term “Person” and accordingly may
be liable to tax under Sec.4.

Example:

Determine the status of the following :

1. Delhi University
2. Microsoft Ltd.
3. Delhi Municipal Corporation
4. Swayam Education Pvt. Ltd.
5. Axsis Bank Limited.
6. ABC Group Housing Co-operative Society.
 7. DC & Co., firm of Mr. Dust and Mr. Clean

ASSESSEE–S. 2(7)

U/s 2(7) “Assessee” means a person by whom income tax or any other sum of money is
payable under the Act and it includes:

a. every person in respect of whom any proceeding under the Act has been taken for the
assessment of his income or loss or the amount of refund due to him

b. a person who is assessable in respect of income or loss of another person or who is deemed
to be an assessee, or

c. an assessee in default under any provision of the Act

A minor child is treated as a separate assessee in respect of any income generated out of
activities performed by him like singing in radio jingles, acting in films, tuition income,
delivering newspapers, etc. However, income from investments, capital gains on securities
held by minor child, etc. would be taxable in the hands of the parent having the higher
income (mostly the father), unless if such assets have been acquired from the minor’s sources
of income.

ASSESSMENT - S 2(8)

An assessment is the procedure to determine the taxable income of an assessee and the tax
payable by him. S. 2(8) of the Income Tax Act, 1961 gives an inclusive definition of
assessment “an assessment includes reassessment “ U/s 139 of the Act, every assessee is
required to file a self declaration of his income and tax payable by him called “return of
income”.

INCOME- S 2(24)

Although, income tax is a tax on income, the Act does not provide any exhaustive definition
of the term “Income”. Instead, the term ‘income’ has been defined in its widest sense by
giving an inclusive definition. It includes not only the income in its natural and general sense
but also incomes specified in section 2 (24).

Broadly the term “Income includes the following:

i. profits and gains ;

ii. dividend;
iii. voluntary contributions received by certain institutions
iv. Receipts by employees the value of any benefit or perquisite, whether convertible
into money or not.
v. Incomes from business – s-28
vi. any capital gains chargeable under section 45;
vii. any sum earlier allowed as deduction and chargeable to income-tax under Section 59
viii. any winnings from lotteries, crossword puzzles, races including horse races, card
games and other games of any sort or from gambling or betting of any form or nature
whatsoever
ix. any contribution received from employees towards any provident fund or
superannuation fund or Employees State Insurance Act, 1948 , or any other fund for
the welfare of such employees ;
x. any sum received under a Keyman insurance policy including the sum allocated by
way of bonus on such policy.
xi. any sum of money or value of property received as gift –S 56(2) and Shares of
closely held companies transferred to another company or firm are covered in the
definition of gift except in the case of transfer of such shares for reorganization of
business by amalgamation or demerger etc

SCHEME OF CHARGING INCOME TAX

Income tax is a tax on the total income of an assessee for a particular assessment year. This
implies that;

 Income-tax is an annual tax on income

 Income of previous year is chargeable to tax in the next following assessment year at the
tax rates applicable for the assessment year.

 Tax rates are fixed by the annual Finance Act and not by the Income-tax Act. For instance,
the Finance Act, 2012 fixes tax rates for the assessment year 2013-14

 Tax is charged on every person if the gross total income exceeds the minimum income
chargeable to tax

OBJECTIVES OF TAXATION
Initially, governments impose taxes for three basic purposes: to cover the cost of
administration, maintaining law and order in the country and for defense. But now
government’s expenditure pattern changed and gives  service to the public more than these
three basic purpose and it restore social justice in the society by providing social services
such as public health, employment, pension, housing, sanitation and other public services.
Therefore, governments need much amount of revenue than before. To generate more
revenue a government imposes taxes on various types. In general objective of taxations are:
1.  Raising revenue: to render various economic and social activities, a government needs
large amount of revenue and to meet this government imposes various types of taxes.
2.  Removal of inequalities in income and wealth: government adopts progressive tax
system and stressed on canon of equality to remove inequalities in income and wealth of the
people.
3.  Ensuring economic stability: taxation affects the general level of consumption and
production. Hence, it can be used as effective tool for achieving economic stability.
Governments use taxation to control inflation and deflation
4.  Reduction in regional imbalances: If there is regional imbalance with in the country,
governments can use taxation to remove such imbalance by tax exemptions and tax
concessions to investors who made investment in under developed regions.
5.  Capital accumulation
Tax concession or tax rebates given for savings or investment in provident funds, life
insurance, investment in shares and debentures lead to large amount of capital accumulation,
which is essential for the promotion of industrial development.
6.  Creation of employment opportunities
Governments might minimize unemployment in the country by giving tax concession or
exemptions to small entrepreneurs and labor intensive industries.
7.  Preventing harmful consumptions
Government can reduce harmful things on the society by levying heavy excise tax on
cigarettes, alcohols and other products, which worsen people’s health.
8.  Beneficial diversion of resources
Governments impose heavy tax on non- essential and  luxury goods to discourage producers
of such goods and give tax rate reduction or exemption on most essential goods. This diverts
produce’s attention and enables the country utilize to utilize the limited resources for
production of essential goods only.
9.  Encouragement of exports
Governments enhance foreign exchange requirement through export-oriented strategy. These
provide a certain tax exemption for those exporters and encourage them with arranging a free 
trade zones and by making a bilateral and multilateral agreement
10.  Enhancement of standard of living
The government also increases the living standard of people by giving tax concessions to
certain essential goods.
 
  CHARACTERISTICS OF A GOOD TAX SYSTEM
(1) Tax is a Compulsory Contribution
A tax is a compulsory payment from the person to the Government without expectation of
any direct return. Every person has to pay direct as well as indirect taxes. As it is a
compulsory contribution, no one can refuse to pay a tax on the ground that he or she does not
get any benefit from certain public services the government provides.
(2) The Assesses will be required to pay Tax if is due from him
No one can be forced by any authority to pay tax, if it is not due from him. Suppose, if there
is a tax on liquor, the state can force an individual to pay the tax only when he drinks liquor.
But, if he does not drink liquor, he cannot be forced to pay the tax on liquor. Similarly, if an
individual’s income is below the exemption limit, he cannot be forced to pay tax on income.
For example individuals earning monthly salary below birr 150 cannot be forced to pay tax
on income.
(3) Taxes are levied by the Government
No one has the right to impose taxes. Only the government has the right to impose taxes and
to collect tax proceeds from the people.
(4) Common Benefits to All
The tax, so collected by the Government, is spent for the common benefit of all the people. In
other words, when the government collects a tax, its proceeds are  spent to extend common
benefits to all the people.  The Government incurs expenditure on the defense of the country,
on maintenance of law and order, provision of social services such as education, health etc.
Such benefits are given to all the people- whether they are tax-payers or non-taxpayers. These
benefits satisfy social wants. But the Government also spends on subsidies to satisfy merit
wants of poor people.
(5) No Direct Benefit
In the modern times, there is no direct relationship between the payment of tax and direct
benefits. In other words, there is absence of any benefit for taxes paid to the Governmental
authorities. The government compulsorily collects all types of taxes and does not give any
direct benefit to tax-payers for taxes paid. For example, when taxable income is earned by an
individual or a corporation, he or it simply pays the tax amount at the specified rate cannot
demand any benefit against such payment.
(6) Certain Taxes Levied for Specific Objectives
Though taxes are imposed for collecting revenue for the government to meet expenditure on
social wants and merit wants, certain taxes are imposed to achieve specific objectives. For
example, heavy taxes are imposed on luxury goods to reduce their consumption so that
resources are directed to the production of essential goods, such as cheaper variety of cloth, 
less costly goods of mass consumption, etc. Thus, taxes are levied not only to earn revenue
but also for diversion of resources or saving foreign exchange.  Certain taxes are imposed to
reduce inequalities of income and wealth.
(7) Attitude of the Tax-Payers
The attitude of the tax-payers is an important variable determining the contents of a good tax
system. It may be assumed that each tax-payer would like to be exempted from taxpaying,
while he would not mind if other bears that burden. In any case, he would want his share to
be within the general level of tax burden being borne by others. In other words, it is essential
that a good tax system should appear equitable to the tax-payers. Similarly, overall burden of
the tax system is of equal importance. The attitudes of the tax-payers in this regard are
influenced by a host of other factors like the political situation such as war or peace, natural
calamities like floods and droughts, economic situations like prosperity or depression and so
on.
(8) Good tax system should be in harmony with national objectives
A good tax system should run in harmony with important national objectives and if possible
should assist the society in achieving them. It should try to accommodate the attitude and
problems of tax payers and should also take into consideration the goals of social and
economic justice. It should also yield adequate revenue for the treasury and should be flexible
enough to move with the changing requirements of the State and the economy.
(9) Tax-system recognizes basic rights of tax-payers
A good tax system recognizes the basic rights of the tax-payers. The tax-payer is expected to
pay his taxes but not undergo harassment. In other words, the tax law should be simple in
language and the tax liability should be determined with certainty. The mode and timings of
payment should be convenient to the tax-payer. At the same time, a tax system should be
equitable between tax-payers. It should be progressive and burden of taxation should be
equitable on all the tax-payers.