Tag: Income Tax Osmania University B.com Notes

Recovery against any Allowance or Deduction Allowed earlier [Section 41(1)]

(A) Recovery by the same assessee [Section 41(1)(a)]:

Where an allowance or deduction has been made in the assessment for any year in respect of

• Loss
• Expenditure
• Trading Liability

incurred by the assessee and subsequently, during any previous year, he (the same assessee) has obtained, whether in cash or in any other manner, whatsoever:

• Any amount in respect of such loss or expenditure; or
• Some benefit in respect of such trading liability by way of remission or cessation thereof,

then, the amount obtained by the assessee or the value of benefit accruing to him shall be deemed to be profit and gains of business or profession and accordingly chargeable to income-tax as the income of that previous year.

It may be mentioned that the business or profession, in respect of which the allowance or deduction has earlier been made, may or may not be in existence in the previous year in which such amount is obtained or the benefit accrued to him.

(B) Recovery by the Successor in Business or Profession [Section 41(1)(b)]:

If in the above case, instead of the assessee, the successor in business has obtained, whether in cash or in any other manner whatsoever:

• Any amount in respect of which loss or expenditure was incurred by the predecessor; or
• Some benefit in respect of trading liability referred to in clause (a) above by way of remission or cessation thereof,

the amount obtained by successor in business or the value of benefit accruing to the successor in business shall be deemed to be income under the head profits and gains from business or profession of the successor of that previous year.

Sale of Assets used for Scientific Research [Sec. 41(3)]:

Where any capital asset used in scientific research is sold without having been used for other purposes and the sale proceeds, together with the amount of deduction allowed under section 35, exceeds the amount of the capital expenditure, such surplus or the amount of deduction allowed, whichever is less, is chargeable to tax as business income in the year in which the sale took place.

Recovery of Bad Debts [Sec. 41(4)]:

Where any bad debt has been allowed as deduction under section 36(1)(vii) and the amount subsequently recovered on such debt is greater than the difference between the debt and the deduction so allowed, the excess realisation is chargeable to tax as business income of the year in which the debt is recovered.

Amount withdrawn from Special Reserve created and maintained by certain Financial Institutions [Sec. 41(4A)]:

Where a deduction has been allowed in respect of any special reserve created and maintained under section 36(1)(viii), by certain financial institution, etc. if any amount is subsequently withdrawn from the special reserve, it shall be deemed to be the profits and gains of business or profession and accordingly be chargeable to income-tax as the income of the previous year in which such amount is withdrawn, whether the business is in existence in that previous year or not.

Recovery of any sum in case of Discontinued Business [Section 176(3A)]:

Where any business is discontinued in any year, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the person who carried on the business had such sum been received before such discontinuance.

Recovery of any sum in case of Discontinued Profession [Section 176(4)]:

Where any profession is discontinued in any year on account of the cessation of the profession by, or the retirement or death of, the person carrying on the profession, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the aforesaid person had it been received before such discontinuance.

According to section 29, the profits and gains of a profession are to be computed in accordance with the provisions contained in sections 30 to 43 D. It must, however, be remembered that in addition to the specific allowances and deductions stated in sections 30 to 36, the Act further permits allowance of items of expenses under the residuary section 37(1), which extends the allowance to items of expenditure not covered by sections 30 to 36, where these are allowable according to accepted commercial practices.

Profession means exploitation of ones skills and knowledge independently. Profession includes vocation.

Professional Income is income from exercise of any profession or vocation which calls for an intellectual or manual skill. It covers doctor, lawyers, accountants, consulting engineers, artists, musicians, singers etc.

The expression ‘Profession’ has been defined in Section 2(36) of the Act to include any vocation. In the case of a profession, the definition given in the Act is very much inadequate since it does not clearly specify what activities constitute profession and what activities do not.

According to the generally accepted principles, the meaning of the term ‘profession’ involves the concept of an occupation requiring either intellectual skill or manual skill controlled and directed by the intellectual skill of the operator.

For instance, an auditor carrying on his practice, the lawyer or a doctor, a painter, an actor, an architect or sculptor, would be persons carrying on a profession and not a business.

The common feature in the case of both profession as well as business is that the object of carrying them out is to derive income or to make profit. The process of making the profit would be the main area of difference between the two while the ultimate object is common to both

Profession [Section 2(36)]

A profession is an occupation requiring purely intellectual skill or manual skill controlled by the intellectual skill of the operator, e.g., lawyer, accountant, engineer, surgeon, author etc. So, profession refers to those activities where the livelihood is earned by the persons through their intellectual or manual skill. Under section 2(36) profession includes vocation.

Vocation simply means a way of living for which one has special fitness. A vocation does not involve any organized or systematic activity like business. So vocation simply means any type of activity in which a person is engaged and he earns his livelihood from such activity. The practice of a religion may also amount to vocation. Writing of articles in the magazines is also a vocation.

Profession involves an exercise of intellect and skill based on learning and experience. It requires purely intellectual skill or manual skill on the basis of some special learning.

Profession includes services provided by the professionally qualified or technically qualified person according to their qualification.

There are certain basic rules that apply when you are assessing your taxable income from profession, these are as follows:

(i) Continuation of Profession

The chargeability to tax under Section 28 is based primarily upon the condition that the assessee must have carried on a profession at any time during the accounting year, though not necessarily throughout the accounting year.

(ii) Existence of continuity in the business or profession is not an essential condition

The existence of continuity in the profession is not an essential condition for making the assessee liable to tax under this head. Thus, receipts arising from the exercise of a profession would still be chargeable to tax under this head although they may be both casual and non-recurring in nature.

(iii) Profession must be carried on during the previous year

Income is chargeable under the head “Profits & gains of business or profession” only if the business is carried on by the assessee during the previous year. It is not necessary that the business should continue throughout the year or till the end of previous year.

Maintenance of books of accounts

Every person carrying on legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or any other profession as is notified by the Board in the Official Gazette shall keep and maintain such books of account and other documents as may enable the Assessing Officer to compute his total income in accordance with the provisions of this Act. [Section 44AA(1)]

Professionals carrying on the professions are required to maintain books of accounts in accordance with Rule 6F of the Income tax Rules.

Books of account [Rule 6F]

BOOKS OF ACCOUNT AND OTHER DOCUMENTS TO BE KEPT AND MAINTAINED UNDER SECTION 44AA(3) BY PERSONS CARRYING ON CERTAIN PROFESSIONS.

6F. (1) Every person carrying on legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or authorised representative or film artist shall keep and maintain the books of account and other documents specified in sub-rule (2):

Provided that nothing in this sub-rule shall apply in relation to any previous year in the case of any person if his total gross receipts in the profession do not exceed one lakh fifty thousand rupees in any one of the three years immediately preceding the previous year, or, where the profession has been newly set up in the previous year, his total gross receipts in the profession for that year are not likely to exceed the said amount.]

(2) The books of account and other documents referred to in sub-rule (1) shall be the following, namely:

Explanation : In this rule,—

Professionals in legal, medical, engineering, architecture, accountancy, technical consultancy and interior decoration have to maintain books of accounts. Sec 44AA casts an obligation on an individual or HUF carrying on business or profession, other than these professions, to maintain books of accounts and documents provided that the income and total sales, turnover or gross receipts, exceeds Rs 2.5 lakh and Rs 25 lakh, respectively.

Compulsory Audit: Sec. 44AB

Individuals and HUFs have to get their accounts audited if their total sales, turnover or gross receipts from their business exceed Rs 2 crore and gross receipts from his profession exceed Rs 50 lakh. Penalty leviable u/s 271B for failure to get accounts audited or to furnish a report of such audit is up to Rs 1.5 lakh.

Sec 271J provides for a penalty on an accountant, merchant banker or registered valuer who furnishes incorrect information in a report or certificate. The amount of penalty is Rs 10,000 for each such inaccurate report or certificate.

The section 44ADA is as follows:

44ADA. (1) Notwithstanding anything contained in sections 28 to 43C, in the case of an assessee, being a resident in India, who is engaged in a profession referred to in sub-section (1) of section 44AA and whose total gross receipts do not exceed fifty lakh rupees in a previous year, a sum equal to fifty per cent of the total gross receipts of the assessee in the previous year on account of such profession or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the assessee, shall be deemed to be the profits and gains of such profession chargeable to tax under the head “Profits and gains of business or profession”.

(2) Any deduction allowable under the provisions of sections 30 to 38 shall, for the purposes of sub-section (1), be deemed to have been already given full effect to and no further deduction under those sections shall be allowed.

(3) The written down value of any asset used for the purposes of profession shall be deemed to have been calculated as if the assessee had claimed and had been actually allowed the deduction in respect of the depreciation for each of the relevant assessment years.

(4) Notwithstanding anything contained in the foregoing provisions of this section, an assessee who claims that his profits and gains from the profession are lower than the profits and gains specified in sub-section (1) and whose total income exceeds the maximum amount which is not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-section (1) of section 44AA and get them audited and furnish a report of such audit as required under section 44AB.

Eligible Profession: The presumptive taxation scheme under section 44ADA for estimating the income of an assessee:

• who s engaged in any profession referred to in section 44AA(1 ) such as legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or any other profession as is notified by the Board in the Official Gazette; and
• whose tota gross receipts does not exceed fifty akh rupees in a previous year

Profession referred to u/s 44AA(1): Every person carrying on:

• Legal
• Medical
• Engineering
• Architectural Profession
• The Profession of Accountancy
• Technical Consultancy
• Interior Decoration
• Any Other Profession as Is Notified by The Board In The Official Gazette

Other notified professions:

(a) The profession of authorized representative; and

(b) the profession of film artist (actor, cameraman, director, music director, art director, dance director, editor, singer, lyricist, story writer, screen play writer, dialogue writer and dress designer)

(c) the Profession of Company Secretary

(d) the Profession of Information Technology

Meaning of authorised representative:

Explanation to Rule 6F

Authorised representative means a person who represents any other person, on payment of any fee or remuneration before any Tribunal or authority constituted or appointed by or under any law for the time being in force, but does not include an employee of the person so represented or a person carrying on legal profession or a person carrying on the profession of accountancy.

Eligible Business-Financial consultancy

EXAMPLE : An Individual who is doing financial consultancy business and the service receiver while he is paying service charge, he is deducting TDS u/s 194 J. Whether he can offer income u/s 44ADA?

1. No. Sec. 44ADA will be applicable only to the Notified Professions. It is a inclusive definition, it doesn‘t cover financial consultancy business, hence he can‘t offer income u/s 44ADA.

Presumptive rate of income: Presumptive rate of income would be a sum equal to 50% of the total gross receipts, or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the assessee.

No further deduction would be allowed:  Section 44ADA (2): Under the scheme, the assessee will be deemed to have been allowed the deductions under section 30 to 38. Accordingly, no further deduction under those sections shall be allowed.

Written down value of the asset:  Section 44ADA(3):The written down value of any asset used for the purpose of the profession of the assessee will be deemed to have been calculated as if the assessee had claimed and had actually been allowed the deduction in respect of depreciation for the relevant assessment years.

Maintenance of books of accounts and audit:

A very interesting issue is that whether a professional who has opted presumptive system of taxation has to maintain books of account also. To resolve this issue firstly we have to see the provisions of section 44AA(1) of the Act given earlier in this book.

From the perusal of above section, it is clear that it is mandatory for the professional who is covered under Section 44ADA to maintain books of accounts even though he has opted for the presumptive taxation scheme. Although, the Memorandum to the Finance Bill, 2016 provides that an assessee opting for Section 44ADA would not be required to maintain books of account under Section 44AA(1), the same has not been brought out clearly in the Section 44AA. Section 44AA is silent in relation to the assessee who is covered by Section 44ADA. Moreover the provisions of Sec 44ADA overrides sec 28 to 43C and not sec 44AA of the Act. Hence, on combined reading of 44AA(1), 44AA(3) read with Rule 6F, the specified professionals would need to maintain books of account even if they opt for section 44ADA.

However, as per the FAQs on presumptive taxation issued by Income Tax Department provides that if assessee declares income u/s 44ADA, there is no need to maintain books of account. The FAQ issued is provided here

“If a person adopts the presumptive taxation scheme of section 44ADA, then he is required to maintain books of account as per section 44AA?

In case of a person engaged in a specified profession as referred in sections 44AA(1) and opts for presumptive taxation scheme of sections 44ADA, the provision of sections 44AA relating to maintenance of books of account will not apply. In other words, if a person opts for the provisions of sections 44ADA and declares income @50% of the gross receipts, then he is not required to maintain the books of account in respect of Specified profession.

From the above FAQ it can be concluded that person opting for sec 44ADA would not be required to maintain books of account. However, the FAQs do not have any legal backing and it may change in future.

Option to claim lower profits:Section 44ADA(4): An assessee mayclaim that his profits and gains from the aforesaid profession are lower than the profits and gains deemed to be his income under section 44ADA(1); and if such total income exceeds the maximum amount which is not chargeable to income-tax, he has to maintain books of account under section 44AA and get them audited and furnish a report of such audit under section 44AB.

Issues related to Sec 44ADA:

• Applicability of Section 44ADA to a partner of firm receiving remuneration and/or interest from the firm

A very interesting is that whether the provisions of Section 44ADA shall be applicable to the remuneration and other receipts by a partner from a professional services firm? In this connection, it is to be noted that the Income Tax Act, 1961 vide Section 40(b) states that the firm is eligible to claim remuneration as deduction to the extent specified therein and such remuneration is deductible in hands of the firm. The balance amounts are subjected to tax as profits in the hands of the firm. In other words, the eligible remuneration is deductible in the hands of firm and taxable in hands of partners, the remainder (profit) is taxable in hands of the firm and exempted in the hands of partners u/s 10(2A).

Hence, in the hands of the partner, the following will be the impact:

1. Remuneration which was allowed as deduction in firm will be taxable
2. Profit which was taxed in the hands of the firm will be exempt.

Tax is a mandatory fee imposed upon individuals or corporations by the Central and the State Government to help build the economy of a country by meeting various public expenses. Taxes are broadly divided into two categories; Direct and Indirect taxes.

Some of the important direct taxes imposed in India are mentioned below:

• Income Tax: It is imposed on an individual who falls under the different tax brackets based on their earning or revenue and they have to file an income tax return every year after which they will either need to pay the tax or be eligible for a tax refund.
• Estate Tax: Also known as Inheritance tax, it is raised on an estate or the total value of money and property that an individual has left behind after their death.
• Wealth Tax: Wealth tax is imposed on the value of the property that a person possesses.
• Securities Transaction Tax: If you are involved in stock trading, each of your trade also has a small constituent known as the securities transaction tax. Irrespective of whether you made money on the trade or not, you will have to pay this tax. The broker collects this tax from you and passes on to the securities exchange, which then pays it to the government.

• Capital Gains Tax: Every time you make capital gains, you will be required to pay capital gains tax. This capital gain could come from the sale of a property or from investments. Based on the capital gains and the duration for which you held the investment, you will be required to pay either LTCG (Long-Term Capital Gains) tax or STCG (Short-Term Capital Gains) tax.

Advantages

• Social and economic balance: Based on every individual’s earnings and overall economic situation, the Government has well-defined tax slabs and exemptions in place so that the income inequalities can be balanced out.
• It curbs inflation: The Government often increases the tax rate when there is a monetary inflation which in turn reduces the demand for goods and services and as a result of descending demand, the inflation is bound to condense.

Disadvantages of Direct Taxes

• Considered a Burden: As taxpayers are required to pay direct taxes like income tax in a single lump sum every year, they are considered a burden. Moreover, even the documentation process is generally complex and time-consuming.
• Evasion is Possible: While the government has made tax evasion very difficult now, there are still many fraudulent practices through which individuals and businesses can avoid or pay lower taxes than they should.
• Restrains Investments: Due to the imposition of direct taxes like securities transaction tax and capital gains tax, a lot of people avoid investing. So, in a way, direct taxes restrain investments.

Indirect Tax

It is a tax levied by the Government on goods and services and not on the income, profit or revenue of an individual and it can be shifted from one taxpayer to another.

Earlier, an indirect tax meant paying more than the actual price of a product bought or a service acquired. And there was a myriad of indirect taxes imposed on taxpayers.

Used to earlier and still exist:

• Customs Duty: It is an Import duty levied on goods coming from outside the country, ultimately paid for by consumers and retailers in India.
• Central Excise Duty: This tax was payable by the manufacturers who would then shift the tax burden to retailers and wholesalers.
• Service Tax: It was imposed on the gross or aggregate amount charged by the service provider on the recipient.
• Sales Tax: This tax was paid by the retailer, who would then shifts the tax burden to customers by charging sales tax on goods and service.
• Value Added Tax (VAT): It was collected on the value of goods or services that were added at each stage of their manufacture or distribution and then finally passed on to the customer.

GST as Indirect Tax

With the implementation of GST, we have already witnessed a number of positive changes in the fiscal domain of India. The various taxes that were mandatory earlier are now obsolete, thanks to this new reformed indirect tax. Not just that, GST is making sure the slogan “One Nation, One Tax, One Market” becomes the reality of our country and not just a dream.

That said, with the dawning of the ‘Goods & Services Tax (GST), the biggest relief so far is clearly the elimination of the ‘cascading effect of tax’ or the ‘tax on tax’ quandary.

Cascading effect of tax is a situation wherein the end-consumer of any goods or service has to bear the burden of the tax to be paid on the previously calculated tax and as a result would suffer an increased or inflated price.

Under the GST regime, however, the customer is exempted from the tax they would otherwise pay as a result of the cascading effect.

Benefits of Indirect Tax

• Poor Contributes Too: It is essential for the country that every individual contributes towards its development.As the poor are often exempt from paying direct taxes, the indirect taxes ensure that even poor contribute towards nation-building.
• Convenience: Unlike direct taxes which are generally paid in a lump-sum, indirect taxes like GST are paid in small amounts. When you purchase a product or service, a small amount of GST is already included in the price, and this makes its payment more convenient for the taxpayers.
• The collection is Easy: If you want to know what is the difference between direct and indirect tax, one of the biggest of them is how they are paid. Unlike direct taxes, there are no documents or complex procedures involved in paying indirect taxes. You are required to pay the tax right when you purchase a product or service.

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’. Taxes are the basic source of revenue for the government, which are utilized for the welfare of the people of the country through government policies, provisions and practices.

The Income Tax law in India consists of the following components;

• Income Tax Act, 1961: The Act contains the major provisions related to Income Tax in India.
• Income Tax Rules, 1962: Central Board of Direct Taxes (CBDT) is the body which looks after the administration of Direct Tax. The CBDT is empowered to make rules for carrying out the purpose of this Act.
• Finance Act: Every year Finance Minister of Government of India presents the budget to the parliament. Once the finance bill is approved by the parliament and get the clearance from President of India, it became the Finance Act.
• Circulars and Notifications: Sometimes the provisions of an act may need clarification and that clarification usually in a form of circulars and notifications which has been issued by the CBDT from time to time. It includes clarifying the doubts regarding the scope and meaning of the provisions.

Every statute gains sanction from the law of land, i.e.,the Constitution of India. Similarly, the government is authorised by the Constitution to collect the taxes. According to Article 265 of the Constitution of India, no tax shall be levied or collected except by authority of law.[1] Thus, the tax levied and collected must be within the competency of authority authorised by the legislature.

Entry 82 of List I of Seventh Schedule of the Constitution of India confer power on Parliament to levy taxes on income other than agricultural income. Thus, Income Tax is under the Union list and henceforth Central Government is authorised and responsible for the collection of income tax.

The Central Government enjoys the power to collect taxes on income except for the tax on agricultural income, which is being enjoyed by the State Government. Entry 46 of List II of Seventh Schedule of the Constitution of India provides that the State Government has the power to collect taxes on agricultural income.

“Income Tax is levied on the total income of the previous year of every person”. To understand the basic concept.It is very important to know the various other concepts.

Concept of Income

In common parlance, Income is known as a regular periodic return to a person from his activities. However, the Income has broader classified in Income Tax law. The Income Tax Act, even take consideration of income which has not arisen regularly and periodically. For instance, winning from lotteries, crossword puzzles, income from winning of shows is also subject to tax as per income tax.

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.

Purpose of Taxation

• The money spent on the development of roads, schools, and hospitals, market regulations or legal systems, etc. is raised by the revenue generated by the collection of taxes
• Redistribution of resources by the richer section to the poorer section of the society.
• Taxes are levied on certain products to eliminate externalities such as the taxes on tobacco to discourage smoking.

List 1

• Entry 82: Tax on Income other than the agriculture income.
• Entry 83: Duties of customs including the export duties.
• Entry 84: Duties of excise on tobacco and other goods manufactured or produced in India except for alcoholic liquors for human consumption, opium, narcotic drugs, but including medicinal and toilet preparations containing alcoholic liquor, opium or narcotics.
• Entry 85: Corporation tax
• Entry 92A: Taxes on sale or purchase of goods other than newspapers, where such sale or purchase takes place in the course of interstate trade or commerce.
• Entry 92B: Taxes on consignment of the goods where such consignment takes place during Inter-State trade or commerce.
• Entry 92C: Taxes on services
• Entry 97: Any other matter which is not included in List II, List III and any tax not mentioned in List II or List III.

List 2

• Entry 46: Taxes on agricultural income.
• Entry 51: Excise duty on all alcoholic liquors, opium and narcotics.
• Entry 52: Tax on entry of the goods into a local area for consumption, use or sale therein (usually termed as Octroi or Entry Tax).
• Entry 54: Tax on sale or purchase of goods other than newspapers except for tax on interstate sale or purchase.
• Entry 55: Tax on advertisements except advertisements in newspapers.
• Entry 56: Tax on goods and passengers that are carried by road transport or inland waterways.
• Entry 59: Tax on professionals, trades, callings, and employment.

Tax incidence (or incidence of tax) is an economic term for understanding the division of a tax burden between stakeholders, such as buyers and sellers or producers and consumers. Tax incidence can also be related to the price elasticity of supply and demand. When supply is more elastic than demand, the tax burden falls on the buyers. If demand is more elastic than supply, producers will bear the cost of the tax.

The tax incidence depicts the distribution of the tax obligations, which must be covered by the buyer and seller. The level at which each party participates in covering the obligation shifts based on the associated price elasticity of the product or service in question as well as how the product or service is currently affected by the principles of supply and demand.

Tax incidence reveals which group consumers or producers will pay the price of a new tax. For example, the demand for prescription drugs is relatively inelastic. Despite changes in cost, its market will remain relatively constant.

• Tax incidence is the manner in which the tax burden is divided between buyers and sellers.
• The tax incidence depends on the relative price elasticity of supply and demand. When supply is more elastic than demand, buyers bear most of the tax burden. When demand is more elastic than supply, producers bear most of the cost of the tax.
• Tax revenue is larger the more inelastic the demand and supply are.

Price Elasticity and Tax Incidence

Price elasticity is a representation of how buyer activity changes in response to movements in the price of a good or service. In situations where the buyer is likely to continue purchasing a good or service regardless of a price change, the demand is said to be inelastic. When the price of the good or service profoundly impacts the level of demand, the demand is considered highly elastic.

Examples of inelastic goods or services can include gasoline and prescription medicines. The level of consumption across the economy remains steady with price changes. Elastic products are those whose demand is significantly affected by price. This group of products includes luxury goods, houses, and clothing.

The formula for determining the consumer’s tax burden with “E” representing elasticity is as follows:

• E (supply) / (E (demand)) + E (supply)

The formula for determining the producer or supplier’s tax burden with “E” representing elasticity is as follows:

E (demand) / (E (demand) + E (supply))

Incidence of Tax

The incidence of tax refers to the ultimate economic burden or impact of a tax, determining who bears the actual cost of the tax. In any tax system, there are two main concepts related to tax incidence:

1. Legal Incidence:

Legal incidence refers to the entity or individual legally responsible for remitting the tax to the government. This is the party identified by tax laws as being liable to pay the tax.

2. Economic Incidence:

Economic incidence refers to the actual burden of the tax, indicating who ultimately bears the cost of the tax in economic terms. This may or may not be the same as the legally designated taxpayer.

Tax Incidence Examples:

1. Direct Taxes:
   • Legal Incidence: For direct taxes like income tax, the legal incidence usually falls on individuals or entities with specific types of income.
   • Economic Incidence: The economic incidence depends on factors like the elasticity of demand for the taxed goods or services. For example, if a business faces a highly elastic demand for its products, it may pass on the tax burden to consumers in the form of higher prices, thus shifting the economic incidence to consumers.
2. Indirect Taxes:
   • Legal Incidence: For indirect taxes like the Goods and Services Tax (GST), the legal incidence is on the businesses involved in the production and distribution of goods and services.
   • Economic Incidence: The economic incidence can vary. In some cases, businesses may pass on the tax burden to consumers through higher prices. However, businesses may absorb the tax if the market conditions are competitive and demand is sensitive to price changes.
3. Corporate Taxes:
   • Legal Incidence: Corporations are legally responsible for paying corporate income taxes.
   • Economic Incidence: The economic incidence can be distributed among various stakeholders, including shareholders (in the form of reduced dividends or stock value), employees (in the form of lower wages), and consumers (in the form of higher prices).

Factors Influencing Tax Incidence:

• Elasticity of Demand:

In markets with inelastic demand, businesses are more likely to pass on the tax burden to consumers through higher prices. In contrast, in markets with elastic demand, businesses may absorb the tax to remain competitive.

• Elasticity of Supply:

In markets where the supply of goods or services is elastic, producers can more easily adjust production levels in response to changes in taxes without significant impact on prices.

• Market Structure:

The degree of competition in a market influences the ability of businesses to pass on the tax burden. In competitive markets, businesses may have limited pricing power, affecting their ability to shift the tax burden to consumers.

• Ability to Substitute:

If consumers can easily substitute one product for another, businesses may find it challenging to pass on the tax burden, as consumers can switch to alternatives with lower prices.

• Bargaining Power:

The relative bargaining power of different economic agents, such as employers and employees or buyers and sellers, can influence how the economic burden of taxes is distributed.