Income tax

Introduction               Next     Main

The Indian Income Tax law is a highly complicated and confusing piece of document. For the common man the task of understanding the procedure and provisions of law is daunting, to say the least. Not only is the process of tax calculation very difficult, its practical implementation is tedious and cumbersome. However, under the law, the taxpayer is legitimately entitled to plan his taxes in such a manner that his tax liability is minimal. Tax Planning can be defined as an arrangement of the financial affairs within the scope of law in a manner that derives maximum benefit of the exemptions, deductions, rebates and relief and reduces the tax liability to minimal. As long as you are within the framework of law, you can plan your financial affairs. However, in the name of tax planning, you can not indulge in Tax Avoidance or Tax Evasion. And the line between Tax Planning and Tax Avoidance is very thin, so you need to tread carefully. When financial transactions are arranged in a way that it becomes obvious that they were entered with a malafide intention of either not paying taxes or with a view to defeat the genuine spirit of law, they can not be accepted as legitimate Tax Planning. Twisting of facts or taking a very strict and literal interpretation of law without understanding the basic purpose of the law can only lead to punishable Tax Avoidance and not Tax Planning.

An attempt is made in the following pages to present a bird eye's view of the Indian Income Tax laws so that you can avoid making trips to your chartered accountant and by taking advantage of the available legal avenues for tax planning, reduce your tax liability. This material does not deal in procedural matters such as assessment, appeals and revisions.

To begin with lets understand the structure of tax regime in the country. Taxes are the basic source of revenue to the government. Revenue so raised is utilised for meeting the expenses of government as well as to carry out developmental works.

There are basically two types of taxes, Direct and Indirect taxes. Direct taxes are those, which are, collected by the government directly from the tax payer through levies such as income tax, wealth tax and interest tax. Whereas indirect taxes comprise of excise duty, sales tax, customs duty and value added tax. While direct taxes form 30 per cent of government's revenue indirect taxes contribute a larger chunk of 70 per cent. Gift tax and estate duty were part of the direct tax revenue. As an ongoing process of simplification and rationalisation of the direct tax structure in India, the government repealed the Gift Tax Act in 1998 and the Estate Duty Act in the late eighties.

To understand Income Tax law in India, the first step is to identify what constitutes Income Tax law. Income Tax law in India consists of the following:-

1. The Income Tax Act, 1961

The Indian constitution has empowered only the Central Government to levy and collect Income Tax. The Income Tax Act was enacted in 1961. The Act come into force from the 1st of April 1962 and extends to the whole of India. It consists of over 400 sections and 12 schedules. The Income Tax Act determines which persons are liable to pay tax and in respect of which income. The various sections lay down the law of income tax and the schedules elucidate certain procedures and give certain lists, which are referred to, in the sections. However, the Act does not prescribe the rates of Income Tax.

These rates are prescribed every year by the Finance Act (popularly known as "The Budget") This is done mainly to give incentives for investment in priority sectors, to discourage tax evasion, to remove loopholes in the law and to synchronise the law with the existing economic situation.

2.The Income Tax Rules, 1962

The Income Tax Act empowers the Central Board of Direct Taxes (CBDT) to formulate rules for implementing the provisions of the Act. Income Tax Rules have been kept separate from the Act as the rules can be amended more easily than the Act. Rules can be amended by merely publishing a notification in the Official Gazette of the Government of India whereas to amend the Income Tax Act, Amendment to the Bill has to be passed in the Parliament. However, in case of conflict between the Act and the Rules, the provisions of the Act shall prevail.

3.Circulars issued by the CBDT

For the guidance of the Income Tax Officers and the general public, the CBDT issues circulars on certain taxation matters. These circulars are binding on the Income Tax Officers. However, circulars cannot change the provisions of law; they can merely clarify the law or relax certain provisions in favour of the taxpayers. In event of a dispute, the Courts are not bound by the circulars.

4.Case Laws and Doctrine of Precedents

Decisions of the tax tribunals and courts on disputes pertaining to aspects of the income tax law form case laws. Case laws result in formation of precedents in law. ie in case a similar dispute arising in future, the decision of the court on that point may be used to decide the current dispute. The decisions of the Supreme Court, however, are binding on all lower Courts and tax authorities in India. High Court decisions are binding only in the states, which are within the jurisdiction of that particular High Court. However, decision on one High Court has persuasive power over other High Courts when deciding similar issues.

Basic Concepts

It is essential to understand certain basic concepts in order to understand Income Tax law in India. The Act has defined certain terms, which have been used in the law. The meaning of the terms defined may differ from the commonly understood meaning of that particular term.

For example in ordinary parlance, the meaning of the term "person" would mean an individual. However, under the Income Tax Act, the definition of the term "person" is much wider. U/s 2(31) person includes an individual, a Hindu Undivided Family, a Partnership Firm, a Company, an Association of Persons, a Body of Individual, a Local Authority and every other Artificial Juridical Entity. Obviously, the definition of person is much wider under the income tax law in India as compared to its ordinary meaning and for the purposes of the income tax law, the definition under the Act shall be paramount and not its common meaning. However, in respect of terms not defined in the Act, the ordinary meaning of the term shall prevail.

Let us take up some of the more important and commonly used definitions:-

1.Assessee An Assessee is a person by whom any tax or any other sum of money (for example interest, penalty, fine, etc) is payable under the Income Tax Act and includes:-

i A person in whose respect proceedings for determining income has commenced by the Income Tax Department. Thus, a person may become assessee even if no amount is payable by him under the Income Tax Act.

ii A Deemed assessee ie a person who is himself not an assessee but is treated as an assessee for the purposes of the Income tax Act. for example the trustee of a trust is a deemed assessee in respect of the trust. The income earned is the income of the trust but is assessed in the hands of the trustee as his income.

iii An assessee in default ie. a person on whom certain obligations have been imposed under the Income Tax Act but who has failed to carry out those obligations. for example any person who employees another person has to deduct income tax at source from the taxable salary of the employee and pay the tax deducted at source to the government within the prescribed time as income tax paid on behalf of the employee. In case the employer fails to carry out these obligations, he becomes an assessee in default.

2.Assessment Year

Assessment year (AY) means the period of 12 months commencing on the 1st day of April each year.

3.Previous Year

Previous year (PY) means the financial year immediately preceding the assessment year. In case of a business or profession which is newly started, the previous year commences from the date of commencement of the new business or profession upto the next 31st day of March, unless the person is an existing assessee.

It is essential to understand the difference between assessment year and previous year. The income, which is earned in the previous year, is charged to income tax in the assessment years at the rates applicable for that assessment year. Thus if income of Rs1,00,000 is earned in PY. 1997-98 (which commences on 1/4/97 and ends on 31/3/98), this income is charged to income tax in AY 1998-99 at the rates applicable for AY 1998-99. Similarly income earned in PY. 1998-99 is charged to income tax in AY. 1999-2000, at the rates applicable for that AY.

3.Assessment

4.Income

The definition of income under the Income Tax Act is of an inclusive nature. ie apart from the items listed in the definition, any receipt which satisfies the basic condition of being income is also to be treated as income and charged to income tax accordingly. Income includes:-

Residential status and scope of income         Previous   Main   Next

Having established the `source of income of the `person, the next step is to define the residential status.

Residential Status

Residential status of an assessee is important in determining the scope of income on which income tax has to be paid in India. Broadly, an assessee may be resident or non-resident in India in a given previous year. An individual or HUF assessee who is resident in India may be further classified into (1) resident and ordinarily resident and (2) resident but not ordinarily resident.

Under the Income Tax Act, the incidence of tax is highest on a resident and ordinarily resident and lowest on a non-resident. Therefore, it is in the assessees advantage that he claims non-resident status if he satisfies the conditions for becoming a non-resident.

Residential Status of an Individual

Under section 6(1), an individual is said to be resident in India in any previous year if he satisfies any one of the following basic conditions:-

a. He is in India in the previous year for a period of at least 182 days or,

b. He is in India for a period of at least 60 days during the relevant previous year and at least 365 days during the four years preceding that previous year.

The aforesaid rule of residence is subject to the following exceptions:-

1. Where an individual, who is a citizen of India, leaves India in any year for the purpose of employment ( or where an individual, who is a citizen of India, leaves India as a member of the crew of an Indian ship), he is not to be treated as resident in India in that year unless he has been in India in that year for at least 182 Days.

2. Where an Indian citizen or a person of Indian Origin, who has settled abroad, comes on a visit to India in the previous year, he is not to be treated as resident in India in that year unless he has been in India in that year for at least 182 Days.

In other words, such individuals do not become resident in India if they are less than 182 days in India. For such individuals, the conditions mentioned in clause (b) above do not apply. Therefore, such individuals may stay in India upto 181 days in a given previous year without becoming resident in India for that previous year.

An individual who does not satisfy neither condition (a) nor condition (b) is non-resident for that previous year.

A resident individual may either be an "Ordinarily Resident" OR "Not Ordinarily Resident" in India for a given previous year. In order to determine whether a resident individual is ordinarily resident (ROR) or not ordinarily resident (RNOR), the tests laid down under section 6(6) have to be applied.

A resident individual is treated as ROR in India in a given previous year if he satisfies the following additional conditions:-

1. He has been resident in India in at least 9 out of 10 previous years (according to basic conditions noted above) preceding the relevant previous year; and

2. He has been in India for a period of at least 730 days during 7 years preceding the relevant previous year.

In brief it can be said that an individual becomes resident and ordinarily resident in India if he satisfies at least one of basic conditions and both the two additional conditions.

An individual who is resident in India but does not satisfy both the additional conditions is RNOR for that previous year.

Let us understand the above provisions with the help of a simple example. Mr. X, resident of Mumbai left India for the first time for USA for higher studies on 7th June, 1996 and returned on 25th March, 1997. For the previous year 1996-97 (Assessment Year 1997-98), X was in India for 73 days ( From 1st April, 96 to 6th June, 96 and 26th March, 97 to 31st March, 97) X has satisfied the condition of being at least 60 days in India in P. Y. 1996-97 and of being at least 365 days in the preceding four previous years (i.e. P. Y. 1992-93, 1993-94, 1994-95 and 1995-96) Therefore, he is resident in India for previous year 1996-97. Since he has gone outside India for the first time, he satisfies the additional two conditions also for becoming ROR. Accordingly, he is resident in India for P. Y. 1996-97.

Let us take another example. Mr. X, a citizen of India goes abroad for employment on 15th August, 1996 and comes back on 10th June, 1997. For the previous year 1996-97, X was in India for 136 days ( From 1st April, 1996 to 14th August, 1996) Since X was not in India for at least 182 days in PY. 1996-97, he is non-resident in India for PY. 1996-97. The second condition of 60 days in the relevant PY and 365 days in the preceding four previous years is not applicable to him since he is an Indian 2citizen who has gone abroad for employment.

The following points are very important in determining the residential status of an assessee:-

1.The residential status may change from year to year depending on whether the condition for residency is satisfied in that year or not.

2.The residential status under the Income Tax Act, 1961 have no connection with the provisions for residency under the Foreign Exchange Regulation Act or any other law in India. A person may be resident under FERA and yet be non-resident under the Income Tax Act and vice versa.

3.Residential status must not be confused with the nationality or citizenship of the assessee. These are entirely different concepts.

Residential Status of a Hindu Undivided Family (HUF)

A Hindu undivided family is said to be resident in India if control and management of its affairs is wholly or partly situated in India.

A resident Hindu undivided family is ordinarily resident in India if the karta or manager of the family is a ROR in India in the relevant previous year.

If karta or manager of a resident Hindu undivided family does not satisfy the two additional conditions, the family is treated as resident but not ordinarily resident in India.

By implication, an HUF becomes non-resident if the control and management of its affairs is entirely from outside India in the given previous year.

Residential Status of Partnership Firms or Association of Persons

A partnership firm or an association of persons are is said to be resident in India if control and management of their affairs are wholly or partly situated within India during the relevant previous year. By implication, they will be treated as non-resident in India if control and management of their affairs are situated wholly outside India.

Residential Status of company

An Indian company is always resident in India irrespective of where the control or management of the company is situated.

A foreign company is resident in India only if, during the previous year, control and management of its affairs is situated wholly in India.

By implication, a foreign company is treated as non-resident if, during the previous year, control and management of its affairs is either wholly or partly situated out of India.

Residential status of "every other person"

Every other person is resident in India if control and management of his affairs is wholly or partly situated within India during the relevant previous year. On the other hand, every other person is non-resident in India if control and management of its affairs is wholly situated outside India.

Scope of Total Income and Incidence of Tax

As already discussed, the incidence of income tax is highest in the case of ROR and lowest in case of NR. While the residential status of an assessee will determine the scope of his income the legal status (i.e. individual, HUF, firm, company, AOP, etc) will determine the rate of income tax applicable to the assessee. The following chart indicates the tax incidence on income in different situations depending on the residential status of the assessee:-

Whether tax incidence arises in the case of

ROR

RNOR

NR

Income received in India

Yes

Yes

Yes

Income deemed to be received in India

Yes

Yes

Yes

Income accruing or arising in India

Yes

Yes

Yes

Income deemed to accrue or arise in India

Yes

Yes

Yes

Income received/ accrued outside India from a business in India

Yes

Yes

No

Income received/ accrued outside India from a business controlled outside India

Yes

No

No

Income deemed to be received refers to income, which is not actually received in the hands of the assessee but is nevertheless his income and is to be treated as if it has been actually received by him. The following incomes are deemed to have been received in India:-

1.Income Tax deducted at source from income received by the assessee

2.Annual accretions to the balance of an employee-assessee with a recognized Provident Fund to the extent such accretions are taxable. Any contribution by the employer in excess of 12 per cent of the employee's salary to the PF and interest payable on the balance in excess of 12 per cent paid accordingly deemed to be received in India and taxed though there is no actual receipt.

Income deemed to accrue refers to income, which has not actually accrued in the hands of the assessee but is nevertheless his income and is to be treated as if it has actually accrued in his favor. The following types of incomes are deemed or assumed to accrue or arise in India:

For example: A has the following income during financial year 1999-2000. Compute his taxable income if he is (i) ROR (ii) RNOR (iii) NR for that year.

Taxable Income in India will be as follows:-

ROR

RNOR

NR

Interest from Bank Deposit in UK

6000

2000

2000

Rent from property in UK

12000

0

0

Pension from Indian employer

50000

50000

50000

Income from business in UK and controlled from UK

25000

0

0

Income from business in UK but controlled from India

50000

50000

0

143000

102000

52000

Incomes exempt from income tax    Previous  Next   Main

Section 10 of the Income Tax Act, 1961 specifies those income which are exempt from income tax. i.e. incomes on which no income tax is payable. Let us understand such incomes:-

General exemptions

A. Agricultural income

Under the constitution of India, taxation of agricultural income is the right of state governments. The Central Government cannot levy tax on such income. Section 2(1A) gives a detailed definition of agricultural income. Income derived from agricultural operation from land, which is situated in India, will be exempt agricultural income. Income from agriculture upto and exclusive of the processing state will be agricultural income. Income from processing stage and onwards will be taxable income. Similarly, income from a farmhouse used for agricultural purposes will be treated as agricultural income.

Thus income from basic operations on land like cultivation, growing crops, etc. and secondary operations like removal, digging, etc. can be classified as agricultural income and is exempt from tax.

However, income from sale of trees, breeding of livestock, fishing activities, poultry farming cannot be classified as agricultural income and is not exempt from income-tax.

B.Receipt by a member out of HUF income

Any sum received by a member of a Hindu Undivided Family from out of the income of the family as well as the income received by an individual member from out of the income of the impartible estate is exempt. Impartible estate means property which cannot be disposed off or divided by the holder of the property.

An HUF is separately taxed on its income. The rate of tax levied on a Hindu Undivided Family is quite high. Therefore, in order to avoid the same income from being taxed twice, distribution of HUF income amongst members is exempt from Income Tax.

C.Share of income of a partner from a firm

Any sum received by a partner from a firm as his share in the total income of the firm is exempt from tax. The logic of such exemption is similar to that for granting exemption to income as share from HUF.

D.Casual or non - recurring receipts

Any receipts which are of casual or non-recurring nature are exempt upto a sum of Rs. 5000 ( Rs. 2500 in case of winnings from races ) in each previous year. Casual income is income which is accidental, received without stipulation or a receipt which is of a fortuitous nature and which cannot be foreseen. for example Prize won for taking part in a competition, reward for finding a lost child, etc

However, the following income will not be treated as casual or non-recurring:-

E.Amount received under a life insurance policy - including the bonus allocated on such policy

Any amount received under a life insurance policy including bonus either on maturity of the policy, of otherwise, is exempt from tax. However, this exemption is not available to receipts under a Keyman Insurance Policy.

F.Payments from Public Provident Fund

Any payments received from The Public Provident Fund (PPF) are exempt from tax.

G.Any scholarship granted to meet the cost of education is exempt.

H.Income of a minor upto Rs. 1,500

Any income which arises to a minor child of an assessee is added or clubbed to the parent's income under Section 64(1A) of the Act. Section 10(32) however gives exemption from such clubbing upto a maximum of Rs1,500 annually per child.

I.Dividend received by a shareholder

Any income received by way of dividend from a domestic company, or from UTI or from a recognised mutual fund by a shareholder/unit holder is fully exempt from tax.

J.Awards & rewards

Any award or reward, whether in cash or kind from Central or any state Government or any other approved body in public interest is exempt from income tax.

K.Pensions received by gallantry award winners

Family pension received by individual who has been in the service of the Central or State Goverment and has been awarded "Param Vir Chakra" or "Maha Vir Chakra" or "Vir Chakra" or other notified gallantry award or by members of his family is exempt from income tax.

Interest incomes of certain types

The following interest income is exempt from income tax:-

Exemptions available to non-residents

A. Travel concession to non-citizen of India [Section 10 (6) (i)]

Travel Fare or the value of any free or concessional passage received by an individual, who is not a citizen of India is exempt provided it is received:-

This exemption is available only on respect of travelling for home leave and not for mid term passages on for compensation granted for refraining from availing of home leave. In determining whether a passage of the spouse or children has been in connection with the home leave of the employee, the passage of the employee himself, either along with his family or within 6 months either way alone, must be considered.

B.Remuneration of foreign state representatives [section 10(6)(ii)]

Remuneration received by an individual who is a citizen of the foreign country as an official of an embassy, high commission, legation, commission, consulate or trade representation of a foreign state or as a member of the staff of any of these offices, for services in such capacity is exempt provided Indians are accorded similar benefits in that foreign country.

C.Remuneration of employees of a foreign enterprise [section 10(6)(vi)]

Remuneration received by such non-citizen individual as an employee of a foreign enterprise for service rendered in India during stay in India is exempt, subject to the following conditions:

D.Certain income of a foreign technician [services commencing on or after 1/4/1993] [section 10 (5B)]

This exemption is available only in respect of the tax paid by the employer on the salaries of the technician upto a period of 48 months from the date of his arrival in India. It is not available after the expiry of such 48 months. This exemption is available to an individual who renders services as a technician as an employee of the government or of a local authority or of any corporation set up for carrying on approved scientific research or in any business carried on in India. This is subject to the following conditions :

The word "technician" used above means :

A person having a specialised knowledge and experience in

who is employed in a capacity in which such specialised knowledge and experience is actually utilised.

E.Remuneration on foreign ship : [Section 10 (6) (viii)]

Salaries received by any non-resident individual for services rendered in connection with employment on a Foreign Ship are exempt provided that his total stay in India does not exceed 90 days in the aggregate in the previous year.

F.Remuneration of foreign government employee during training in India [section 10(6)(xi)]

Any remuneration received by any individual, who is not a citizen of India, as an employee of the Government of a foreign state during his stay in India is exempt, if the stay is in connection with his training in any establishment, office or undertaking which is owned by:

G.Tax on royalty and technical fees paid to a foreign company. [section (10)(6A)]

Where, under an agreement entered after 31 March 1976 between a foreign company and the Government or an Indian concern, the tax on royalty or fees payable to them for technical services, is to be borne by the Government or the Indian concern the tax so paid is exempt.

H.Tax on other payments :[section 10(6B)]

Where under an approved agreement between the Central Government and the Foreign Government or an international organisation, the tax on income (other than salary, royalty or fees for technical services) derived by a non-resident or a foreign company from the government or the Indian concern, is borne by the said government or Indian concern, the tax so borne is exempt.

I.Tax on income derived by the government of a foreign state or a foreign enterprise as consideration for acquiring an aircraft or an aircraft engine on lease [section 10 (6BB)]

Where the government of a foreign state or a foreign enterprise derives income from an Indian company as a consideration for acquiring an aircraft or an aircraft engine on lease and tax on such income is payable by the Indian company, the tax so paid is exempt from tax. The other conditions to be satisfied for getting this exemption are :

J.Income of notified foreign companies. [section 10(6C)]

Any income of a notified foreign company, by way of fees for technical services received under an agreement for providing services in or outside India in the projects connected with the security of India, is exempt.

Exemptions in respect of salary incomes

A.Travel concession to a citizen of India :[section 10(5)]

Any travel concession or assistance received by an individual,

will be exempt to the following extent:-

1.In case of journey by air, air economy fare of the national carrier by the shortest route will be exempt.

2.In case of journey by rail, air-conditioned first class rail fare by the shortest route will be exempt.

3.In case of journey by other means where rail link exists between place of origin of journey and place of destination, air-conditioned first class rail fare by the shortest route will be exempt.

4.In case of journey by other means where rail link does not exists between place of origin of journey and place of destination, but a recognised public transport system exists, first class or deluxe class fare on such transport system will be exempt. Where no such public transport system exists, air-conditioned first class rail fare by the shortest route will be exempt.

For this purpose, family means:-

The exemption will be available to an individual in respect of 2 journeys performed in a block of 4 calendar years. Where such travel concession is not availed of by the employee during such block of 4 calender years, he will be entitled to additional exemption of travel concession in the first year of the next block of 4 years. eg an employee has undertaken 3 journeys between 1994 and 1998. He is entitled to travel concession exemption only in respect of 2 journeys. However, if he had not performed any journey during this period, then for the next block 1999 to 2003, he would be entitled to exemption in respect of 3 journeys provided the first journey takes place in 1999.

B.Allowances and perquisites outside India : [section 10(7)]

Any allowances or perquisites which are paid outside India by the Indian government to a citizen of India for rendering services outside India are exempt from Income Tax in India. It must be carefully noted that this exemption is available only to the Government employees.

C.Retrenchment compensation [section 10(10B)]

Any compensation received by a workmen under the Industrial Dispute Act, 1947 or under any other Act or Rules thereunder or under any agreement, at the time of his retrenchment is exempt.

This exemption is limited to,

whichever is less.

It has been provided that the above-referred limit will not apply at all, in respect of any compensation received by a workman in accordance with the scheme approved by the Central Government.

D.Payments to persons under the Bhopal Gas Leak Disaster (Processing of claims) Act [section 10(10BB)] are exempt.

E.Amounts received on voluntary retirement by certain employees [section 10(10C)]

Any amount received on voluntary retirement by an employee under any scheme of voluntary retirement is exempt from tax. This exemption is available only to employees of :

This exemption is limited to a maximum of Rs. 5 lakhs only. This exemption is available only once to any individual employee.

The scheme for voluntary retirement to avail this exemption should be framed in accordance with the guidelines, which may be prescribed by the Central Government. The scheme should also approved by the chief Commissioner.

It may be noted here that the above exemption is not available to any employee other than those specified above. Thus if an employee of a partnership firm receives any amount on voluntary retirement, the same shall not be exempt under this clause.

The mains conditions for such a scheme are as follows:-

1. It applies to an employee who has completed 10 years of service or completed 40 years of age;

2. It applies to all employees including workers and executives of a company or of an authority or of a co-operative society, as the case may be, excepting directors of a company or of a co-operative society;

3. The scheme of voluntary retirement has been drawn to result in overall reduction in the existing strength of other employees;

4. The vacancy caused by the voluntary retirement is not be filled up;

5. The retiring employee of a company shall not be employed in another company or concern belonging to the same management;

6. The amount receivable on account of voluntary retirement of the employee does not exceed the amount equivalent to three months salary for each completed year of service or salary at the time of retirement multiplied by the balance months of service left before the date of his retirement on superannuation.

F.Payments from Provident Funds [section 10(11)]

Any payment from a Provident Fund to which Provident Fund Act, 1925, applies is exempt. The principal as well as interest is exempt from tax.

Payments from recognised Provident Fund: [section 10(12)]

Receipts from a recognised provident fund are exempt from income tax.

Exemptions in respect of Institutions and Associations

A.Income of a local authority [Section 10(20)]

The following incomes of a Local authority are exempt :

i Income which is taxable under the head

ii Income from a trade or business carried on by it and which accrues or arises from

B.Income of a Housing Authority [section 10(20A)]

Any income of an authority constituted in India by or under any law enacted for the purpose of dealing with and satisfying the need for housing accommodation or for the purpose of planning, development or improvement of cities, towns and villages is exempt.

C.Income of a Scientific Research Association [section 10(21)] is exempt provided it satisfies the following conditions:-

a. it applies its income or accumulates it for application wholly and solely for the objects for which it is established.

b. it invests or deposits its funds in the prescribed manner.

This exemption will not be available in relation to any business income unless the business is incidental to the attainment of its objectives and separate books of accounts are maintained for such business.

D.Income of a News Agency in India [section 10(22B)]

Any income of a notified news agency set up in India solely for collection and distribution of news is exempt. The exemption is available for the period which shall be notified. The maximum period which the government can notify at any one time is three years.

The exemption is further subject to the conditions that the news agency applies its income or accumulates it solely for collection and distribution of news and does not distribute its income in any manner to its members.

E.Income of a Sports Association [section 10(23)]

Any income of a notified association or institution established in India, which has its object the control, supervision, regulation or encouragement in India of the games of cricket, hockey, football, tennis or other notified games. However, this is subject to the following conditions:-

This exemption will not be available in relation to any business income unless the business is incidental to the attainment of its objectives and separate books of account are maintained for such business.

F.Income of a professional association :[section 10(23A)]

Any income of an association or institution established in India for control, supervision, regulation or encouragement of the profession of law, medicine, accountancy, engineering, architecture or such other profession, as the Central Government may specify from time to time is exempt.

The following two conditions must be satisfied for availing of this exemption:-

G.Income of Regimental Fund or Non-Public Fund established by Armed Forces. [section 10(23AA)].

Any income of any Regimental Fund or Non-Public Fund established by the armed forces for the welfare of the past and present members of such forces or their dependents is exempt.

H.Income of any person on behalf of a Notified Fund for Welfare of Employees or their Dependents. [section 1023AAA)]

Any income of any person on behalf of a fund (notified by the CBDT) for welfare of employees or their dependents (if the employees are members of such a fund) is exempt from tax.

The following two conditions must be satisfied for availing this exemption:-

I.Income of a fund set up by the Life Insurance Corporation of India under a Pension Scheme. [section 10(23AAB)]

Any income of a fund set up by the LIC of India on or after 1st August, 1996 under a Pension Scheme is exempt. The fund should be such:-

K.Income of Khadi and Village Industries Board [section 10(23BB)]

Any income of an authority, whether known by the above name or any other name, established in a state or under a State Act for the development of Khadi and Village Industries in the state, is exempt.

L.Income of certain funds and institutions [section 10(23C)]

Income of the following types of funds and institutions is exempt provided certain conditions are satisfied:-

1. Prime Minister's National Relief Fund

2. Prime Minister's Fund (Promotion of Folk Art)

3. Prime Minister's Aid to Students Fund

4. National Foundation for Communal Harmony

5. Approved University or Educational Institution

6. Approved Hospital

7. Approved Charitable Fund or Institution

8. Approved Public Religious Trust or Charitable Trust

M.Income of Mutual Fund and Unit Trust of India [section10(23D)] is exempt subject to the provision that the Mutual Fund or UTI shall pay tax on income distributed by it at the rate of 10per cent if it is a debt oriented fund. In case of open ended equity oriented fund, such taxes need not be paid.

N.Income of a Venture Capital fund [section 10(23FA)]

Any income by way of dividends or long-term capital gains of a venture capital fund or a venture capital company from investments made by way of equity shares in a venture capital undertaking is exempt from tax.

Venture Capital Fund or Company refers to the entity which is making the investment and which is entitled to the exemption in this section. For this purpose, the venture capital fund or venture capital company has to be approved by the Central Government on application made in the prescribed manner in accordance with rules made in this behalf. Such approval shall not be for a period exceeding 3 years at a time. Venture Capital Fund means a fund operating under a trust registered under the Registration Act, 1908 established to raise monies for investments mainly by way of acquiring equity shares of a venture capital undertaking in accordance with the prescribed guidelines. Venture Capital Company means a company which has made investments by way of acquiring equity shares of a venture capital undertaking in accordance with the prescribed guidelines.

Venture Capital Undertaking refers to the entity in which investment is made. Venture Capital Undertaking means a domestic company whose shares are not listed on a recognised stock exchange in India and which is engaged in:-

1.The business of software, information technology, production of basic drugs in the pharmaceutical sector, bio-technology, agriculture and allied sectors and other notified sectors; or

2.The production or manufacture of any article or substance for which patent has been granted to the National Research Laboratory or any other scientific research institution approved by DoT.

O.Income of an Infrastructure Capital Fund or an Infrastructure Capital Company [section 10(23G)]

Any income by way of dividends, interest or long term capital gains of an infrastructure capital fund or an infrastructure capital company from investments made by way of shares or long term finance in any enterprise wholly engaged in the business of (i) developing, (ii) maintaining and operating, (iii) developing, maintaining and operating any infrastructure facility approved by the Central Government in this connection is exempt from tax.

Infrastructure Capital Company means a company which has made investments in shares or long term finance to an enterprises wholly engaged in the business of developing, maintaining and operating infrastructure facility.

Infrastructure Facility means:-

P.Income of trade union [section 10(24)]

Any income taxable under the head "Income from house property," and "Income from other sources," of a Trade Union registered under the Indian Trade Union Act, 1926 or an association of such Trade Unions and formed primarily for the purpose of regulating the relations between workmen and employers or between workmen and workmen, is exempt.

Q.Income of a marketing authority : [section 10(29)]

In the case of an authority constituted under any law for the marketing of commodities, any income derived from letting of godowns or warehouses for storage, processing or facilitating the marketing of commodities is exempt.

R.Income of the Coffee Board, Rubber Board, Tea Board, Tobacco Board, Marine Products Export Development Authority, Agricultural and Processed Food Products Export Development Authority and Spices Board. [Section 10(29A)]. is exempt.

Income of units in Free Trade Zones [Section 10A].

Income of an industrial undertaking situated in a Free Trade Zone such as Kandla Free Trade Zone, Santacruz Electronics Export Processing Zone, Falta Export Processing Zone, Madras Export Processing Zone, Cochin Export Processing Zone, Noida Export Processing Zone, or situated in an Electronic Hardware Technology Park or in a Software Technology Park is exempt provided it is a new unit and exports at least 75per cent of its production. This exemption is available for a period of five consecutive years falling within a block of eight years beginning from the year in which the unit commenced production.

Income of 100per cent Export Oriented Units [Section 10B].

Income of 100per cent Export Oriented Units is exempt provided it is a new unit and exports at least 75per cent of its production. This exemption is available for a period of five consecutive years falling within a block of eight years beginning from the year in which the unit commenced production.

Salaries                         Previous    Next  Main

Introduction

The term "Salaries" includes remuneration in any form for personal service, under an expressed or implied contract of employment or service. Section 17 of Income Tax Act defines salary to include:-

Therefore "salary" includes basic salary, encashment of leave salary, advance of salary, arrears of salary, various allowances such as dearness allowance, entertainment allowance, house rent allowance, conveyance allowance and also includes perquisites by way of free housing, free car, free schooling for children of employees, etc.

The following are the essential conditions for income to be treated as salary income:-

Salary is taxable in the year of receipt or in the year of earning of the salary income, whichever is earlier. i.e. if the salary has been received first, then it will be taxable in the year of receipt. If it has been earned first but not yet received then it will be taxable in the year of earning. Salary income is taxable in the hands of individuals only. No other type of person such as a firm or HUF, companies can earn salary income.

Encashment of Leave Salary

Encashment of leave salary is fully taxable in the year of receipt in the hands of the employee. However, when encashment of leave salary is received at the time of termination from employment on account of retirement or superannuation, etc, from the total leave salary encashment received, certain exemptions are made available to the employee. According in the case of a Central or State Government employee, the amount of leave salary encashment received as per service rules at the time of termination of employment is fully exempt from income tax. In case of other employees, the least of the following is exempt and only the balance is taxable:-

1. Notified Amount (Currently Rs2,40,000)

2. 10 months average salary

3. Leave encashment salary received on termination

4. (Leave Entitlement - Leave Availed) * Average Monthly Salary

Salary for the purpose of calculating the exempt leave encashment is the total of basic salary, dearness allowance and commission on sales achieved by salesmen. Average salary is 10 months average salary.

Determine the amount of exemption of encashment of leave salary in the following cases:-

Date of retirement

1/6/99

Basic Salary for 10 months preceding 1/6/99

Rs5, 000 p.m.

Duration of service

15 years 9 months

Leave entitlement as per service rules

2 months p.a.

Actual leave availed

15 months

Leave encashment paid [5000*((15.75*2)-15)]

Rs82,500

Exempt amount will be the least of the following:

Amount received

Rs82,500

Notified amount

Rs2,40,000

10 months average pay

Rs50,000

[5000*((24*1)-15)]

Rs45,000

Therefore, amount exempt will be Rs45,000 and the balance Rs37,500 will be taxable. Please note tat in calculating exception amount, service rendered in fractions of a year are ignored (24 years are taken instead of 24.75 years) Also note that under income tax rules, leave entitlement cannot exceed one month.

Would it make any difference in the above case if the employee was a Central Government employee. In such a case, since Rs82,500 would be the amount payable under the rules of employment, the entire amount would be exempt.

Gratuity

Gratuity received by employees on termination of employment is taxable. However, the following exemptions are available to employees in this connection:-

In case of employees of Central or State Government employees or employees of a local authority, the total gratuity received on termination as per service rules will be exempt.

In case of other employees where the Payment of Gratuity Act is applicable, from the total gratuity received on termination, the least of the following will be exempt:-

In case of other employees where the Payment of Gratuity Act is not applicable, from the total gratuity received on termination, the least of the following will be exempt:-

For example A retired on 15/6/99 and got a sum of Rs400,000 as gratuity. The Payment of Gratuity act is not applicable to him. His average salary for the last 10 months was Rs35,000 and he had rendered service for 22 years. Amount of exempt gratuity is the least of the following:-

Therefore, Rs350,000 would be exempt and Rs50,000 would be taxable gratuity.

Pensions

Pensions paid on a recurring basis, whether monthly or annually are taxable in the hands of all employees. However, where such recurring pensions are commuted into a lumpsum one time receipt certain exemptions are available to employees.

In case employees of the Central or State Government or employees of a Local Authority or employees of a Statutory Corporation such lumpsum pensions received in accordance with service rules is exempt from Income-tax.

In case of other employees receiving such lumpsum pension, half of the total value of pension will be exempt if the employee had not received any gratuity on termination of employment. Besides one third of the total value of pension will be exempt if he had received gratuity on termination of employment.

Determine the amount of taxable pension in the following cases:-

1.A received a monthly pension of Rs50,00 from the government. In this case a sum of Rs60,000 will be taxable.

2.A retires from government service on 1/6/99. He gets a pension of Rs2,000 p.m. till 31/12/99. Latter on he opts for commutation of 40 per cent of the value of his pension for Rs400,000 and continues receiving Rs1,200 (60 per cent of 2,000) on a monthly basis upto 31/3/2000.

In such a case, recurring pension of Rs17,600 (2,000*7 + 1,200*3) will be taxable. However, the commuted pension will not be taxable in his hands.

3.A retires from XYZ Ltd, a private sector company on 1/6/99. He gets a pension of Rs2,000 p.m. till 31/12/99 whereafter he opts for commutation of 60 per cent of the value of his pension for Rs100,000 and continues receiving Rs. 800 (40 per cent of Rs2,000) on a monthly basis upto 31/3/2000. He does not get any gratuity on retirement. Would it make any difference if he gets a gratuity of Rs50,000 also.

In such a case, recurring pension of Rs16,400 (2,000*7 + 800*3) will be taxable. He will be entitled to an exemption of Rs83,333 (i.e. amount received of Rs100,000 or 1/2 of full value of pension, whichever is less. Full value of pension is Rs166,667 i.e. 100,000/60per cent ) and the balance Rs16,667 will be taxable.

In case gratuity is also given, exemption of pension will be Rs. 55556 (i.e. amount received of Rs. 100000 or 1/3 of full value of pension, whichever is less)

The employer pays allowances to the employee for meeting certain specific expenses. The employer may give different types of allowances to the employee in the course of his employment. Some of the more common allowances and their tax treatment are as follows:-

Dearness Allowance

Dearness Allowance, as the name suggests is the allowance given by the employer to the employee to meet the increased cost of living. In the hands of the employee, such dearness allowance is taxable as salary income.

House Rent Allowance

Such allowance is given by employer to the employee to meet the housing expenses of the employee. Such HRA is also taxable in the hands of the employee. However certain exemptions have been made in the Income Tax Act in calculating the amount of taxable HRA. The least of the following 3 will be allowed at a deduction in calculating taxable HRA:

Salary for the purpose of calculating the amount of deduction from HRA means the aggregate of Basic Salary, Dearness Allowance and Commission received by salesman on sales achieved by him. It does not#include other receipts such as overtime pay, conveyance allowance, etc.

For example: Basic Salary is Rs100,000, HRA received Rs25,000 and the employee has paid a rent of Rs15,000 in Delhi. Exemption of HRA will be the least of Rs25,000, Rs5,000 and Rs50,000. ie Rs5,000. Consequently, taxable HRA will be Rs20,000.

Entertainment Allowance

Entertainment allowance is given by an employer to the employee for entertaining various business relations of the employer. Such entertainment allowance is also taxable in the hands of the employee in the year of receipt. However, here again certain benefits and exemption are given by the Income Tax Act to the employee. If the employee is a government servant, the least of following 3 will be allowed as a deduction from total entertainment allowance by the employer:-

If the employee is a non-government employee, the amount of exemption will be the least of the following:-

Transport Allowance

Transport allowance is given in order to meet conveyance expenses of the employee from place of residence to place of work and back. Such transport allowance is also taxable in the hands of the employee. However a sum of Rs800 per month is allowed as an exemption from the taxable transport allowance. For example if the amount of transport allowance is Rs1,000 per month, the amount taxable will not be Rs1,000 but will be Rs1,000 -Rs800 i.e. Rs200 per month. Therefore in a year of 12 month, the taxable amount will be Rs2,400 only.

Education Allowance

Such allowance is given by an employer to employees to meet the education expenses of his children. It is taxable in hands of employee. Here again certain exemptions have been made available to the employee. Accordingly, a sum of Rs50 per month per child subject to maximum of 2 children is allowed as exemption from total education allowance received by the employee in a given year. If the children of the employee are residing in a hostel, an additional exemption of Rs150 per month per child subject to maximum of 2 children is made available to the employee. Therefore if the employee has 2 children and who are residing in a hostel and the employee is giving total education allowance of Rs500 per month, the taxable amount will be (500-200) ie Rs300 per month only.

Other Allowances

All other allowances received by the employee from the employer are taxable in the hands of the employee. However if those allowances are given for official purposes, deduction of amount actually spent from those allowances by the employee in meeting the official expenses will be allowed at a deduction from the total amount of allowances received. For example if the employer pays uniform allowance to an employee for meeting the cost of uniform and the employee has actually spent the allowance for purchasing the uniform, then no amount of such uniform allowance will be taxable in the hands of the employee. If say the allowance granted is Rs500 and the employee has spent only Rs400, then Rs100 will be taxable in the hands of the employee.

Perquisites

Perquisites (commonly known as "perks") may be defined as casual remuneration or benefits attached to an office or position in addition to the salary and allowance. Perquisites are normally given in kind and not in cash.

Perquisites may broadly be divided into 3 categories:-

The following perquisites are taxable in the hands of all type of employees:-

a. Value of rent-free housing accommodation provided by the employer to employee

b. Value of Concessional housing accommodation provided by employer to employee.

c. Amount paid by an employer in respect of an obligation which had the employer not paid, the employee would be liable to pay i.e. where the primary liability of payment is that of the employee and not of the employer. For example School fees of employee's children are the primary liability of the employee and not the employer. However if the employer pays the school fees of the employees children, it will be taxable perquisite in the hands of the employee concerned.

d. Amount paid by employer, directly or indirectly, to effect a life insurance policy of the employee or for obtaining the benefits of an annuity in favour of the employee.

e. Difference between fair market value and actual cost in the hands of the employee of any shares or other securities alloted free or at a concessional rate to an employee under a stock option or sweat equity scheme. This amount will be taxable in the year in which the option is exercised by the employee.

Perquisites not taxable at all.

The following perquisites are not taxed at all in the hands of any employee i.e. they are exempt from income tax:-

a. Refreshment provided by an employer to the employee during working hours in office environment

b. Recreational facilities extended not to a particular employee but to a class of employees

c. Amount spent on training of employee or fees paid for refresher course

d. Telephone provided to an employee at his residence

Perquisite taxable only in the hands of specified employees.

Before understanding such perquisites, let us understand who specified employees are. The following employees will be treated as specified employees:-

a. A Director employee ie an employee who is also a director of the employer company.

b. An employee who has substantial interest in the employer company. A person who has more than 20per cent voting power in the company is said to have substantial interest in the employer company.

c. An employee who is drawing more than Rs24,000 per annum in cash ie. any employee whose monetary remuneration other than perquisites is more than Rs24,000 will be treated as specified employee.

In the hands of specified employees, all perquisites, whether by way of free housing or confessional housing or whether the primary liability of payment is that of employee or employer and any other perquisites other than those perquisites covered in paragraph 2 above will be taxable income in the hands of employee.

Perquisites are taxable in the hands of the employee. However since they are paid in kind, notional monetary the value of the perquisites must be determined in order to get the taxable amount of perquisites. There are several rules for determining the method of calculation of value of taxable perquisites. In brief theses rules may be stated as follows:

Rule 1 - If the perquisite is entirely for personal benefits, then whatever the employer has spent for providing those perquisites will be added to the salary income of the employee.

Rule 2 - If the perquisite is given by employer to employee for official purposes only, then such perquisites are not be treated as taxable perquisites in the hands of employee.

Rule 3 - Perquisites which are partly used for personal purposes and partly for official purposes - In such cases a reasonable amount of the value of perquisites which is used for personal purposes only will be added to the salary income of the employee.

These are the broad rules for valuation of perquisites. However there are certain specific rules for valuation of specified perquisites: -

Valuation of Housing Accommodation

In case of government employees, the value of free house provided will be the value as determined by the government service rules.

If the employer is a semi-government employee, e.g., an employee of a statutory corporation or of the RBI, then the amount of taxable value of such free housing accommodation is the lower of the following: -

For example if the fair rental value of property is Rs50,000 and the employee's salary during previous year is Rs100,000, then the value of house is Rs50,000 or Rs10,000, whichever is less i.e. Rs10,000

In case of a private sector employee, the valuation of housing perquisite depends on where the house has been provided. If the house is provided in a non-metro city, the taxable value will be as follows :

- If the fair rental value of the house is not more than 10 per cent of salary, then the fair rental value of house will be treated as taxable perquisite.

- If the fair rental value of the house is more than 10per cent of salary but not more than 50 per cent of salary, then 10 per cent of salary will be treated as taxable value of that house.

- If the fair rental value is more than 50per cent of the salary, then the amount of taxable perquisite will be fair rental value less 40per cent of salary. However in case the house is located in any of the four metros Mumbai, Delhi, Chennai or Calcutta, then instead of 50per cent of salary we will have to substitute 60per cent of salary and accordingly the perquisite value of the house will be fair rental value of the house less 60per cent of salary.

For the purpose of valuation of housing accommodation, Salary means the sum total of the following only:-

If along with the house, the employee has been provided free furnishings have been provided by the employer, then to the value the housing perquisite, the following sums will be added to get the perquisite value of furnished housing accommodation.

a. If the furnishings are owned by the employer then 10per cent of the cost will be added to the house value

b. In case the furnishings are not owned by the employer but are obtained by the employer on rent, then the rent paid by the employer for obtaining those furnishings will be added to the perquisite value of empty house.

Furnishing for this purpose#included furniture and fixtures, kitchen utensils and all other electronics and other items provided by the employer to the employee for personal use such as TV, Audio system, VCR etc.

In case the employer recovers from the employee any sum or amount on account of the house provided, then from the value of the housing accommodation calculated by the above aforesaid provisions, the amount paid by the employer to employee will have to be deducted in order to get the value of concessional housing accommodation provided by the employer to the employee.

Valuation of perquisites of car provided by the employer to the employee

a. If a common transport is provided for all the employees, eg a bus, then there is no perquisite in the he hands of the individual employees.

b. If a car is provided only for official use or for the purpose of travel from residence to office there is no perquisite in the hands of the employee and accordingly no such amount will be added to the taxable income.

c. If the car has been provided for personal uses only, then the taxable amount is reasonable expenses on the car maintenance plus depreciation on the car as per income tax rules if the car is owned by the employer.

d. If the car is used for private as well as for official purposes then a reasonable proportion of the above is the valuation of the car perquisite in the hands of the employee. If however it is not possible to find out what proportion of the car has been used for personal and what is used for official purposes, then the following rates will be used for valuation of perquisites of car.

If the horse power of the car is up to 16 or less or if the engine capacity of car is up to 1.88cc or less, a sum of Rs.600 per month will be added to the taxable perquisite value of the car (if the maintenance expenses have been met by the employer) or sum of Rs.200 per month will be treated as perquisite value of car (if the maintenance expenses of the car have been met by the employee)

In case of car having horse power of greater than 16 or engine capacity of greater than 1.88cc, a sum of Rs.800 per month will be the value of car perquisite if the maintenance expense have been met by the employer and Rs.300 per month if the maintenance expenses have been borne by the employee.

In case, a driver has also been provided, to the value of car as per the above rules, a sum of Rs.300 per month will be added to get the perquisite value of car plus chauffeur.

Valuation of perquisite of domestic servant

When a gardener or sweeper or watchman is provided by the employer to the employee for his residence and the salary is borne by the employer, an amount of Rs120 per month per servant will be added to the taxable value of the employees salary.

In case of any other type of servant, such as a cook, whatever is the salary paid by the employer to the servant will be treated as taxable perquisite value of that particular servant in the hands of the employee.

Valuation of perquisite of gas, water or , electricity provided by the employer to the employee The following are the rules applicable in this connection:-

1.If the employer himself is engaged in the business of providing supply of gas, water, or electricity, then there will not be any taxable perquisite in the hands of the employee in respect of such facilities.

2. If the employer is not in the business of supply of gas, water or electricity, then the amount spent by the employee in providing the facilities to the employee will be the taxable value of perquisites in the hands of the employee provided the entire facilities are for the personal use of the employees only. If such facilities are used partly used for official purposes and partly for personal purposes, then 6.25per cent of salary or the amount actually spent by the employer for provision of such facilities to the employee, whichever is less, will be added to as taxable perquisite in the hands of the employee.

Valuation of educational facilities The following are the rules in this connection:-

1. If the employer himself is a school, collage or educational institution, then there will not be any perquisites taxable in the hands of any employee

2. If the employer is not a school, college or educational institution,