Scope of Total Income (Section 5)

Section 5 of the Indian Income Tax Act, 1961, plays a pivotal role in delineating the scope of total income, which serves as the basis for levying income tax on individuals, Hindu Undivided Families (HUFs), companies, firms, Association of Persons (AOPs), Body of Individuals (BOIs), and other artificial juridical persons. This section lays down the principles governing the taxation of income earned or deemed to be earned in India during a specific previous year. In essence, it establishes the territorial and residence-based framework for determining the tax liability of assessees.

Section 5 of Income Tax Act, 1961 provides Scope of total Income in case of of person who is a resident, in the case of a person not ordinarily resident in India and person who is a non-resident which includes. Income can be Income from any source which (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year; or (c) accrues or arises to him outside India during such year.

• Territorial Scope:

Section 5(a) of the Income Tax Act elucidates that the total income of any previous year of an assessee includes all income accruing or arising, whether directly or indirectly, through or from any business connection in India or from any property in India or through or from any asset or source of income in India or through the transfer of a capital asset situated in India. This provision embodies the principle of territorial taxation, whereby income derived from sources within the geographical boundaries of India is subject to taxation. It encompasses various scenarios, such as income earned by a non-resident through a business connection in India, rental income from property situated in India, income generated from assets or sources located in India, and capital gains arising from the transfer of assets situated in India.

• Residential Scope:

In addition to income earned or accruing in India, Section 5(b) extends the scope of total income to include income received or deemed to be received in India during the previous year. This provision captures income received within India’s jurisdiction, regardless of its source. It applies not only to residents but also to non-residents who receive income in India. Moreover, the concept of deemed receipt broadens the scope of total income by including certain incomes that are not actually received but are deemed to have been received under the provisions of the Income Tax Act. For instance, interest credited to a non-resident’s account in India is deemed to be received in India, even if it’s not withdrawn.

• Accrual or Arising in India:

Section 5(c) further expands the ambit of total income by incorporating income accruing or arising, whether directly or indirectly, in India during the previous year. This provision encompasses income that may not have been received but has accrued or arisen to the taxpayer in India. It applies to residents as well as non-residents, ensuring that income arising within India’s territorial jurisdiction is subject to taxation. Various types of income, such as salaries for services rendered in India, dividends declared by Indian companies, and interest income from Indian sources, fall within the purview of this provision.

• Deemed Accrual or Arising in India:

Additionally, Section 5(d) of the Income Tax Act introduces the concept of deemed accrual or arising of income in India, thereby further broadening the scope of total income. This provision deems certain incomes to accrue or arise in India, notwithstanding their actual place of accrual or arising. For instance, royalties, fees for technical services, and certain other incomes derived by non-residents are deemed to accrue or arise in India if they are payable by a person who is a resident in India or by a person who carries on business or profession in India. This deeming provision prevents the erosion of the tax base by ensuring that income generated from Indian assets or activities is subject to taxation in India, even if the recipient is a non-resident.

• Taxation of Global Income:

One of the fundamental principles of taxation is that residents are liable to pay tax on their global income, i.e., income earned both within and outside India’s territorial jurisdiction. Section 5(e) of the Income Tax Act enshrines this principle by including the total income of a resident taxpayer, irrespective of its source. This provision ensures that residents are taxed on their worldwide income, thereby preventing tax evasion through the shifting of income to jurisdictions with lower or no tax rates. However, certain relief provisions, such as double taxation relief under Section 90 or Section 91, mitigate the burden of taxation on income earned in foreign jurisdictions.

• Exceptions and Exemptions:

While Section 5 delineates the broad contours of total income, certain exceptions and exemptions carve out specific categories of income that are either wholly or partially excluded from the purview of taxation. Various provisions under the Income Tax Act provide exemptions for certain types of income, such as agricultural income, income of charitable institutions, dividends from domestic companies, long-term capital gains on specified assets, etc. These exemptions serve policy objectives, such as promoting agricultural development, encouraging charitable activities, fostering investment, and stimulating economic growth.

• Business Connection:

Section 5(a) refers to income accruing or arising directly or indirectly from any business connection in India. Understanding the concept of “Business connection” is crucial as it determines the taxability of income earned by non-residents. A business connection exists when a non-resident has a significant presence in India, such as a branch, office, factory, or agent acting on behalf of the non-resident. Income attributable to such business connection, whether directly earned in India or indirectly connected to Indian operations, is subject to taxation.

• Property in India:

The reference to income arising from property in India under Section 5(a) encompasses various types of income, including rental income, lease income, capital gains from the sale of immovable property, and other income derived from property situated in India. This provision ensures that income generated from Indian real estate assets, whether owned by residents or non-residents, is subject to taxation in India.

• Source of Income in India:

Section 5(a) also covers income derived from any asset or source of income in India. This broad provision encompasses diverse sources of income, including interest income from Indian bank accounts, dividends from Indian companies, royalties from Indian sources, fees for technical services provided in India, and other income streams connected to Indian assets or activities. It ensures that income generated from Indian sources, regardless of the recipient’s residency status, is subject to taxation.

• Transfer of Capital Assets:

The inclusion of income arising from the transfer of a capital asset situated in India under Section 5(a) implies that capital gains arising from the sale or transfer of immovable property, securities, or other assets located in India are subject to taxation. Capital gains tax is levied on the profit earned from the transfer of capital assets, with specific provisions for computing gains, determining the holding period for classification as short-term or long-term, and allowing deductions or exemptions under certain conditions.

• Treaty Provisions:

Section 5(f) of the Income Tax Act empowers the Central Government to enter into agreements with foreign countries or specified territories for the avoidance of double taxation and prevention of fiscal evasion. These bilateral or multilateral treaties, commonly known as Double Taxation Avoidance Agreements (DTAA), override the provisions of the Income Tax Act to the extent they are more beneficial to the taxpayer. They provide relief from double taxation by allocating taxing rights between jurisdictions, providing for lower withholding tax rates, and allowing taxpayers to claim tax credits or exemptions.

• Anti-avoidance Provisions:

To prevent tax evasion and abuse of tax laws, the Income Tax Act incorporates anti-avoidance provisions, such as General Anti-Avoidance Rules (GAAR), Specific Anti-Avoidance Rules (SAAR), and Transfer Pricing Regulations. These provisions empower tax authorities to disregard transactions or arrangements that are primarily undertaken for tax avoidance purposes and recharacterize them to reflect their substance. By curbing aggressive tax planning strategies and enforcing the principle of substance over form, these provisions ensure the integrity and effectiveness of the tax system.

Table explaining Scope of total Income under section 5 of Income Tax Act, 1961

Note:

1. Residential status is as per section 6 of Income Tax Act, 1961.
2. Deemed income is not actually accrued but is supposed to be accrued notionally.
3. The income accrued is when the assessee obtains the rights to receive it.
4. Previous year means the financial year immediately preceding the assessment year.