Tag: Tax Litigation India

A tax haven is a country that offers foreign businesses and individuals minimal or no tax liability for their bank deposits in a politically and economically stable environment. They have tax advantages for corporations and for the very wealthy, and obvious potential for misuse in illegal tax avoidance schemes.

Companies and wealthy individuals may use tax havens legally as a means of stashing money earned abroad while avoiding higher taxes in the U.S. and other nations.

Tax havens may also be used illegally to hide money from tax authorities at home. The tax haven can make this work by being uncooperative with foreign tax authorities. In recent times, tax havens are under increasing international political pressure to cooperate with foreign tax fraud inquiries.

Different types of Tax Havens:

• Pure Havens: Income or Capital gains are not charged at all (example; Bermuda, Cayman Islands, Vanuatu etc.)
• Tax Havens where the state-approved rate of taxation is low due to the implementation of tax agreements between different countries regarding double taxation (example; Liechtenstein, Switzerland, Republic of Ireland etc.)
• Tax Havens where tax payers are exempted from paying taxes for cross-border transactions (example; Costa Rica, The Philippines, Panama etc.)
• Tax Havens that engage in a preferential treatment towards offshore and holding companies (example; Austria, Luxembourg, Thailand etc.)
• Tax Havens that offer exemptions for industries that have been made for the development of exports (example; Ireland, Madeira in Portugal etc.)
• Tax Havens that provide financial benefits and privileges to companies classified as ‘Offshore Companies’ (example; Bahamas, Antigua & Barbuda, British Virgin Islands etc.)
• Tax Havens that provide specific benefits to banking companies or financial companies which engage in offshore activities (example; Anguilla, Grenada, Jamaica etc.)

Reduction of Tax liability by the usage of Tax Havens also interferes with the Indian government’s efforts to implement its economic policies. Though the economic policies have been structured by the government for the benefit of the people, Tax Havens have served as a significant barrier towards the proper execution/implementation of the former. This, too, occurs due to a shortage of funds in the hands of the government.

Tax evasion by the usage of Tax Havens to store “Black Money” also dismantles the equity attribute of any tax system. In India, specifically, reduction of their tax liability by many leads to an increase in the rates of taxes as charged by the government for every assessment year (for the purpose of increasing its revenue) and the burden of that unfortunately ends up falling upon the honest tax payers. As a consequence of this, even the tax payers who always pay their taxes honestly end up engaging in practices such as tax evasion in order to reduce an already incremental burden.

Though the policies of the government aim at the redistribution of wealth and a decrease in the income/financial margin between the various economic classes of people within the country, Tax Havens have majorly constricted such efforts. Redistribution of Wealth is considered one of the most important pillars on which the Law of Taxation was developed. Today, the redistribution of wealth and reduction of income disparity is a very essential need for a country like India, where the gap between the wealthy and the poor is increasing significantly on a daily basis. Under such circumstances, the need for the proper implementation of government policies aimed at such are required in utmost urgency. However, Tax Havens and its usage to reduce tax liability restricts such policies and in fact, manages to increase the income disparity present in India. It leads to the concentration of economic power in the hands of a few, which is a threat to the economy itself. As a result of this, the rich in India become richer day by day whereas the poor in India get poorer day by day.

Tax Avoidance

Tax avoidance schemes may take advantage of low or no-income tax countries known as tax havens. Corporations may choose to move their headquarters to a country with more favorable tax environments. In countries where movement has been restricted by legislation, it might be necessary to reincorporate into a low-tax company through reversing a merger with a foreign corporation (“inversion” similar to a reverse merger). In addition, transfer pricing may allow for “earnings stripping” as profits are attributed to subsidiaries in low-tax countries.

For individuals tax avoidance has become a major issue for governments worldwide since the 2008 recession. These tax directives began when the United States introduced the Foreign Account Tax Compliance Act (FATCA) in 2010, and were greatly expanded by the work of The Organisation for Economic Co-operation and Development (OECD). The OECD introduced a new international system for the automatic exchange of tax information known as the Common Reporting Standard (CRS) to which around 100 countries have committed. For some taxpayers, the CRS is already “live”; for others it is imminent. The goal of this worldwide exchange of tax information is tax transparency, and has aroused concerns about privacy and data breaches due to the sheer volume of information that is going to be exchanged.

Expanded Worldwide Planning (EWP) is an element of international taxation created in the wake of tax directives from government tax authorities after the worldwide recession beginning in 2008. At the heart of EWP is a properly constructed Private placement life insurance (PPLI) policy that allows taxpayers to use the regulatory framework of life insurance to structure their assets. These assets can be located anywhere in the world and at the same time can be brought into compliance with tax authorities worldwide. EWP also brings asset protection and privacy benefits that are set forward in the six principals of EWP.

Regulatory Mechanisms Adopted by The Government of India

In order to limit the practices of Base Erosion and Profit Shifting, the Organisation for Economic Co-operation and Development (OECD) introduced a set of action plans. These plans, collectively named as the BEPS Action Plan, were discussed and subsequently approved by all members of the G20. The BEPS Action Plan consists of 15 different action plans, each for a different issue relating to Base Erosion and Profit Shifting. India, like many other countries, have adopted these action plans in order to resolve complications arising out of the various number of issues discussed above. Provided below is the list of 15 action plans and what objective each plan is sought to achieve:

• ACTION 1 (DIGITAL ECONOMY): The primary aim of the Action 1 is to identify and address the main challenges that the digitalization of the economy poses for the existing tax laws and rules.
• ACTION 2 (HYBRIDS): The primary aim of the Action 2 is to countervail the effects of hybrid mismatch arrangements by making changes to the model tax convention and providing recommendations with regards to making changes to the various existing domestic taxation laws and rules.
• ACTION 3 (CONTROLLED FOREIGN COMPANIES): The primary aim of the Action 3 is to provide recommendations with regards to the strengthening of international as well as domestic laws/rules pertaining to Controlled Foreign Companies (CFCs). It also aims at identifying and addressing various issues relating to tax avoidance by resident corporations through a non-resident affiliate.
• ACTION 4 (INTEREST DEDUCTIONS): The primary aim of the Action 4 is to limit the base erosion practice of corporations by deducting the rate of interest as well as by introducing other financial payments. This Action Plan had been introduced by the OECD primarily in order to address issues relating to the various domestic tax laws of different countries.
• ACTION 5 (HARMFUL TAX PRACTICES): The primary aim of the Action 5 is to identify and defy various harmful tax practices. Through this Action Plan, the OECD attempted to extend its recommendations regarding the restructuring of laws to non-OECD members as well.
• ACTION 6 (PREVENTION OF TREATY ABUSE): The primary aim of the Action 6 is to prevent treaty abuse by providing recommendations to countries with regards to restructuring its domestic laws/rules in such a manner so as to prevent the granting of treaty benefits to parties in unbecoming circumstances.
• ACTION 7 (PERMANENT ESTABLISHMENT): Action 7 aims at the restructuring/redefining of the threshold to prove Permanent Establishment (“PE”) in order to put a hurdle on the practices of Base Erosion and Profit Shifting.
• ACTION 8, 9 & 10 (TRANSFER PRICING): Transfer Pricing, in simply words, can be defined as an accounting practice whereby the price that one division of a corporation charges another for its goods and services are represented. This, in turn, aids in the determination of the price of goods/services exchanged between subsidiaries, affiliates and CFCs (all which are part of the same holding company). Transfer Pricing is a very common method of tax base reduction and is commonly used by many companies. The primary and common aim of the Action Plans 8, 9 and 10 is to ensure that the transfer pricing outcomes (as represented) are proportional with the value creation of the goods/services. The same can only be done the ensuring that the value for tax is accordant to the economic activity that generates that value. The Action Plans 8, 9 and 10 are aimed at addressing issues/concerns relating to intangible assets, risks & capitals and high risk transactions respectively.
• ACTION 11 (DATA COLLECTION): The primary aim of the Action 11 is to ensure the proper collection and analysis of data relating to Base Erosion and Profit Shifting for the purpose of redressal.
• ACTION 12 (DISCLOSURES RELATING TO AGGRESSIVE TAX PLANNING): Action 12 aims at the development of mandatory disclosure rules by parties if they are engaging in aggressive tax planning (includes aggressive/abusive transactions, structures or arrangements). The same has been done in order to reduce the administrative costs relating to tax administration by the authorities.
• ACTION 13 (DOCUMENTATION OF TRANSFER PRICING): The primary aim of the Action 13 is to re-analyse and restructure the process relating to the documentation of transfer pricing arrangements in order to install a greater transparency to it.
• ACTION 14 (DISPUTE RESOLUTION): The Action 14 aims in making the existing dispute resolution mechanisms and procedures more effective and systematic in nature. Through the introduction of Action 14, the OECD has clearly shown demur upon the practice of countries to engage in mutual agreement procedures (MAPs) to resolve treaty-related disputes.
• ACTION 15 (MULTILATERAL INSTRUMENTS): Last but not the least, the Action 15 focuses on the amendment of bilateral treaty agreements in order to resolve issues arising out of Base Erosion and Profit Shifting.

Under the Income Tax Act, 1961, agriculture income is defined and treated uniquely compared to other forms of income. This special treatment is rooted in the importance of agriculture to the Indian economy and the large population dependent on it for their livelihood.

Definition of Agricultural Income:

Section 2(1A) of the Income Tax Act, 1961 defines agricultural income as:

1. Any rent or revenue derived from land which is situated in India and is used for agricultural purposes.
2. Any income derived from such land by agricultural operations including processing of the agricultural produce, raised or received as rent-in-kind so as to render it fit for the market, or sale of such produce.
3. Income derived from buildings on or identified with agricultural land. The crucial requirement here is that the building should be occupied by the cultivator or the receiver of rent or revenue of the land.

The interpretation of what constitutes “agricultural operations” includes all activities starting from basic operations like plowing and sowing to subsequent processes such as weeding, digging the soil around the growth, removal of undesirable undergrowths, and all operations which foster the growth and preservation of the same produce.

Tax Exemption of Agricultural Income

Agricultural income is exempt from income tax under Section 10(1) of the Income Tax Act, 1961. This exemption is pivotal in supporting the agricultural sector by alleviating the tax burden on farmers. However, the calculation of tax on non-agricultural income of individuals receiving agricultural income is influenced by the agricultural income in a manner that effectively raises the tax rate on non-agricultural income.

Integration of Agricultural and Non-Agricultural Income for Tax Calculation

Although agricultural income is exempt from tax, it plays a role in determining the tax rate applicable to non-agricultural income if the total income, including agricultural income, exceeds the basic exemption limit. This is done through a method called “partial integration” under Sections 2(1A) and 10(1). The steps are as follows:

1. Calculate the total income excluding agricultural income.
2. Add the basic exemption limit to the agricultural income.
3. Add the above result to the non-agricultural income.
4. Calculate tax on the total amount from step 3.
5. Subtract the tax calculated on the sum of the basic exemption limit and agricultural income from the tax computed in step 4.

The outcome ensures that a taxpayer with agricultural income does not pay more tax on non-agricultural income than a taxpayer with a similar amount of non-agricultural income but without any agricultural income.

Special Provisions and Considerations:

1. Lease Land for Agriculture:

Income derived from land given on lease for agricultural purposes can also be considered agricultural income if the land is being used directly for agricultural operations.

2. Composite Rent:

Where the rent received is partly agricultural and partly non-agricultural, the income needs to be appropriately apportioned.

3. Income from Farm Buildings:

Necessary farm buildings that are on or near the agricultural land and are used as dwellings for those employed on the land or for storing produce also qualify under agricultural income.

Judicial Interpretations and Rulings

Various rulings and judicial interpretations have clarified aspects of what constitutes agricultural income. For instance, income from dairy farming, poultry farming, stock breeding, or sale of spontaneously grown trees is not considered agricultural income. However, income from operations such as breeding and rearing of livestock, which are essentially agricultural operations, is considered agricultural.

Challenges and Criticisms

While the exemption of agricultural income under the Income Tax Act is aimed at supporting farmers, it is often criticized for enabling tax evasion, especially when high-income earners exploit this provision to shield their income from taxes by reclassifying it as agricultural. This has led to calls for more stringent definitions and perhaps limits on what can be exempted under this head.

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

Sr. No	Particulars	Resident Ordinary Resident (ROR)	Resident Not Ordinary Resident (RNOR) – 5(1)	Non Resident (NR)– 5(2)
1	Income received in India	Taxed	Taxed	Taxed
2	Income Deemed to be receive in India	Taxed	Taxed	Taxed
3	Income accrues or arises in India	Taxed	Taxed	Taxed
4	Income deemed to accrues or arises in India	Taxed	Taxed	Taxed
5	Income accrues or arises outside India	Taxed	NO	NO
6	Income accrues or arises outside India from business/profession controlled/set up in India	Taxed	Taxed	NO
7	Income Other than Above (No Relation In India)	Taxed	NO	NO

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.

Understanding the concepts of Gross Total Income (GTI) and Total Income is essential for effective financial management and tax compliance. These terms are often used in the context of individual and corporate taxation, reflecting the different stages of income calculation before applying taxes.

Gross Total Income (GTI)

Gross Total Income refers to the aggregate of all incomes earned by an individual or entity before any deductions under the Income Tax Act are applied. It encompasses all sources of income as recognized by tax laws.

Components of Gross Total Income: GTI is broadly categorized into five heads of income:

1. Income from Salaries:

• Basic Salary: Fixed monthly pay excluding allowances and benefits.
• Allowances: Housing rent allowance, dearness allowance, etc.
• Perquisites: Benefits like a company car, rent-free accommodation, etc.
• Bonus and Commissions.

2. Income from House Property:

• Rental Income: Income from renting residential or commercial property.
• Self-Occupied Property: Notional rent for tax purposes.

3. Profits and Gains from Business or Profession:

• Business Income: Earnings from business activities.
• Professional Income: Income from professional services like consultancy, legal services, etc.

4. Capital Gains:

• Short-Term Capital Gains:

Gains from the sale of assets held for a short period.

• Long-Term Capital Gains:

Gains from the sale of assets held for a longer period.

5. Income from Other Sources:

• Interest Income:

Earnings from bank deposits, bonds, etc.

• Dividends:

Earnings from shareholdings.

• Gifts and Lottery Winnings:

Non-recurring income sources.

Computation of Gross Total Income:

GTI is computed by summing up the income under each of the above heads. The formula can be represented as:

GTI = Income from Salaries + Income from House Property + Profits and Gains from Business or Profession + Capital Gains + Income from Other Sources

Example Calculation: Consider an individual with the following income components:

• Salary: Rs.50,000
• House Property Income: Rs.10,000
• Business Income: Rs.20,000
• Short-Term Capital Gains: Rs.5,000
• Interest Income: Rs.2,000

GTI would be:

GTI = 50,000 + 10,000 + 20,000 + 5,000 + 2,000 = Rs.87,000

Total Income

Total Income is derived from Gross Total Income after allowing for deductions under Chapter VI-A of the Income Tax Act. It is the income on which tax is calculated.

Deductions under Chapter VI-A:

Various sections under Chapter VI-A provide for deductions from GTI. Some common deductions include:

1. Section 80C:

• Investments: Life insurance premiums, Public Provident Fund (PPF), National Savings Certificates (NSC), etc.
• Maximum Deduction: Up to Rs. 150,000.

2. Section 80D:

• Medical Insurance Premiums: Premiums paid for health insurance for self, spouse, children, and parents.
• Maximum Deduction: Up to Rs. 25,000 (additional Rs. 25,000 for senior citizens).

3. Section 80E:

• Education Loan Interest:

Interest paid on loans for higher education.

• No upper limit on deduction.

4. Section 80G:

• Donations:

Donations to specified funds and charitable institutions.

• Deduction varies based on the type of donation.

5. Section 80TTA:

• Savings Account Interest:

Interest earned on savings accounts.

• Maximum Deduction:

Up to Rs.10,000.

Computation of Total Income:

Total Income is calculated by subtracting the allowable deductions from the GTI. The formula can be represented as:

Total Income = Gross Total Income − Deductions under Chapter VI-A

Example Calculation:

Using the GTI from the previous example (Rs.87,000), assume the individual has the following deductions:

• Section 80C: Rs.10,000
• Section 80D: Rs.5,000
• Section 80E: Rs.3,000

Total Deductions = Rs.10,000 + Rs.5,000 + Rs.3,000 = Rs.18,000

Total Income would be:

Total Income = 87,000−18,000=Rs.69,000

Importance of GTI and Total Income

1. Tax Calculation:

• Gross Total Income:

Helps in understanding the overall earnings from different sources before any tax-saving measures are considered.

• Total Income:

This the basis for determining the tax liability after accounting for eligible deductions.

2. Financial Planning:

Knowing the GTI helps in identifying potential areas for tax saving. Helps in planning investments and expenditures to optimize tax liabilities.

3. Compliance:

Accurate calculation of GTI and Total Income is crucial for filing tax returns. Ensures adherence to tax laws and avoids legal consequences.

Challenges in Calculating GTI and Total Income

• Accurate Reporting:

Ensuring all sources of income are reported accurately can be challenging, especially for individuals with multiple income streams.

• Understanding Deductions:

Not all taxpayers are fully aware of the deductions available under Chapter VI-A, which may lead to higher tax liabilities than necessary.

• Documentation:

Maintaining and presenting the necessary documentation for deductions can be cumbersome.

• Changing Tax Laws:

Keeping up with changes in tax laws and regulations requires continuous learning and adaptation.

Practical Tips

• Maintain Records:

Keep detailed records of all sources of income and related documents for deductions.

• Consult Tax Professionals:

Seek professional advice to ensure all eligible deductions are claimed and to stay updated with the latest tax laws.

• Use Tax Software:

Utilize tax software for accurate calculation and filing of tax returns.

• Review Regularly:

Regularly review income and expenditure to optimize tax planning strategies throughout the year.

Residential Status plays a crucial role in determining an individual’s tax liability in India under the Income Tax Act, 1961. The Act classifies individuals into three categories based on their residential status for a particular financial year: Resident, Non-resident, and Resident but Not Ordinarily Resident (RNOR). Each category entails different tax implications, especially regarding the scope of total income and the taxation of global income.

Determination of Residential Status:

The determination of an individual’s residential status is primarily based on the physical presence in India during the relevant financial year (April 1 to March 31) and preceding years. Section 6 of the Income Tax Act lays down the following criteria for determining residential status:

1. Resident:

An individual is considered a resident if they satisfy any of the following conditions:

• They are present in India for 182 days or more during the relevant financial year.
• They are present in India for 60 days or more during the relevant financial year and 365 days or more in the preceding four years.

2. Non-resident:

An individual who does not meet any of the criteria mentioned above is classified as a non-resident.

3. Resident but Not Ordinarily Resident (RNOR):

An individual is categorized as RNOR if they are a resident but do not qualify as an ordinarily resident. This status applies when the individual has been a non-resident in India for nine out of ten preceding financial years, or they have been in India for a total of 729 days or less during the preceding seven financial years.

Taxation of Resident Individuals:

Residents are subject to tax on their global income, which includes income earned within and outside India’s territorial jurisdiction. Their total income encompasses income accruing or arising in India, income received or deemed to be received in India, and income accruing or arising to them globally. Residents are liable to pay tax at applicable rates on their total income, after claiming deductions and exemptions allowed under the Income Tax Act.

Taxation of Non-resident Individuals:

Non-residents are taxed only on income earned or received in India or deemed to be earned or received in India. Their total income is restricted to income derived from Indian sources, such as salaries for services rendered in India, interest income from Indian investments, capital gains from the sale of Indian assets, etc. Non-residents are subject to tax at applicable rates on their Indian-sourced income, with certain exemptions or concessions available under the Income Tax Act or applicable Double Taxation Avoidance Agreements (DTAA).

Taxation of Resident but Not Ordinarily Resident (RNOR) Individuals:

RNOR individuals enjoy a more favorable tax treatment compared to ordinary residents. They are taxed in a manner similar to non-residents, i.e., only on income earned or received in India or deemed to be earned or received in India. Their global income is not taxable in India unless it is derived from a business controlled or profession set up in India. This status provides relief to individuals transitioning between non-resident and resident status, allowing them to organize their affairs without immediate tax consequences.

Special Provisions for Returning Indians:

Income Tax Act incorporates special provisions for returning Indians or individuals of Indian origin who resume residency in India after a prolonged period abroad. These provisions offer certain tax reliefs or exemptions for a specified period to encourage the repatriation of funds and skills. Returning Indians may avail benefits such as exemption from taxation on foreign income for a specific period, relaxation in the taxation of specified assets acquired abroad, and other concessions to facilitate their reintegration into the Indian tax system.

Taxability of Foreign Income for Residents:

Residents are taxed on their global income, which includes income earned both within and outside India’s territorial jurisdiction. This means that residents are liable to pay tax in India on income generated from foreign sources, such as salaries earned abroad, income from investments in foreign assets, rental income from properties located overseas, etc. However, residents may avail relief from double taxation through provisions such as Foreign Tax Credit or Double Taxation Avoidance Agreements (DTAA) to avoid being taxed twice on the same income in India and the foreign country.

Exemptions and Deductions for Non-residents:

While non-residents are taxed only on income earned or received in India, certain exemptions and deductions may be available to them under the Income Tax Act. For example, non-residents may be eligible for exemptions on specific types of income, such as interest on certain bonds or securities, capital gains on certain investments, etc. Additionally, deductions for expenses incurred in earning Indian-sourced income may be allowable to non-residents, subject to specified conditions.

Tax Residency Certificate (TRC):

For claiming benefits under Double Taxation Avoidance Agreements (DTAA) or foreign tax credits, non-residents often need to obtain a Tax Residency Certificate (TRC) from the tax authorities of their home country. The TRC serves as proof of residency for tax purposes and helps in availing treaty benefits or claiming relief from double taxation. Non-residents should ensure compliance with TRC requirements to optimize their tax position and avoid disputes with tax authorities.

Tax Planning Opportunities for RNORs:

Resident but Not Ordinarily Resident (RNOR) individuals have a unique tax status that provides opportunities for tax planning. Since their global income is not taxable in India unless derived from a business controlled or profession set up in India, RNORs can structure their affairs to minimize tax liabilities during the RNOR period. They may strategically time the repatriation of foreign income, plan investments in tax-efficient instruments, and utilize available exemptions and deductions to optimize their tax position.

Impact of Dual Residency:

In certain cases, individuals may qualify as residents of more than one country under their domestic tax laws, leading to dual residency. Dual residency can give rise to complex tax implications, including the risk of double taxation on the same income. In such cases, taxpayers may need to rely on the tie-breaker rules provided in tax treaties or the domestic laws of the countries concerned to determine their tax residency status and allocate taxing rights between jurisdictions.

Income from Salaries represents one of the primary heads of income under the Indian Income Tax Act, 1961. It encompasses earnings received by an individual in consideration for services rendered to an employer, whether in the form of wages, salaries, bonuses, commissions, allowances, or perquisites. Understanding the tax treatment of income from salaries is essential for both employers and employees to ensure compliance with tax laws and optimize tax planning strategies.

SECTION I: Understanding Your Payslip

1. Basic Salary

This is a fixed component in your paycheck and forms the basis of other portions of your salary, hence the name. For instance, HRA is defined as a percentage (as per the company’s discretion) of this basic salary. Your PF is deducted at 12% of your basic salary. It is usually a large portion of your total salary.

2. House Rent Allowance

Salaried individuals, who live in a rented house/apartment, can claim house rent allowance or HRA to lower tax outgo. This can be partially or completely exempt from taxes. The income tax laws have prescribed a method for computing the HRA that can be claimed as an exemption.

Also do note that, if you receive HRA and don’t live on rent your HRA shall be fully taxable.

3. Leave Travel Allowance

Salaried employees can avail exemption for a trip within India under LTA. The exemption is only for the shortest distance on a trip. This allowance can only be claimed for a trip taken with your spouse, children, and parents, but not with other relatives. This particular exemption is up to the actual expenses, therefore unless you actually take the trip and incur these expenses, you cannot claim it. Submit the bills to your employer to claim this exemption.

4. Bonus

The bonus is usually paid once or twice a year. Bonus, performance incentive, whatever may be its name, is 100% taxable. Performance bonus is usually linked to your appraisal ratings or your performance during a period and is based on the company policy.

5. Employee Contribution to Provident Fund (PF)

Provident Fund or PF is a social security initiative by the Government of India. Both employer and employee contribute a 12% equivalent of the employee’s basic salary every month toward employee’s pension and provident fund. An interest of about 8.55% from FY 2017-18 (earlier it was 8.65%) gets accrued on it. This is a retirement benefit that companies with over 20 employees must provide as per the EPF Act, 1952.

6. Standard Deduction

Standard Deduction has been reintroduced in the 2018 budget. This deduction has replaced the conveyance allowance and medical allowance. The employee can now claim a flat Rs. 50,000 (Prior to Budget 2019, it was Rs. 40,000) deduction from the total income, thereby reducing the tax outgo.

7. Professional Tax

Professional tax or tax on employment is a tax levied by a state, just like income tax which is levied by the central government. The maximum amount of professional tax that can be levied by a state is Rs 2,500. It is usually deducted by the employer and deposited with the state government. In your income tax return, professional tax is allowed as a deduction from your salary income.

Broadly your CTC will are:

1. Salary received each month.
2. Retirement benefits such as PF and gratuity.
3. Non-monetary benefits such as an office cab service, medical insurance paid for by the company, or free meals at the office, a phone provided to you and bills reimbursed by your company.

Your take-home salary will are:

1. Gross salary received each month.
2. Minus allowable exemptions such as HRA, LTA, etc.
3. Minus income taxes payable (calculated after considering Section 80 deductions).

SECTION III: Retirement Benefits

1. Exemption of Leave Encashment

Check with your employer about their leave encashment policy. Some employers allow you to carry forward some amount of leave days and allow you to encash them while others prefer that you finish using them in the same year itself. The amount received as compensation for leave days accumulated is referred to as leave encashment and it is taxable as salary.

Exemption of leave encashment from tax:

It is fully exempt for Central and State government employees. For non-government employees, the least of the following three is exempt.

1. 10 months average salary preceding retirement or resignation (where average salary includes basic and DA and excludes perquisites and allowances)
2. Leave encashment actually received. (this is further subject to a limit of Rs 3,00,000 for retirements after 02.04.1998)
3. Amount equal to salary for the leave earned (where leave earned should not exceed 30 days for every year of service)

The amount chargeable to tax shall be the total leave encashment received minus exemption calculated as above. This is added to your income from salary.

Relief Under Section 89(1)

You are allowed tax relief under Section 89(1), when you have received a portion of your salary in arrears or in advance, or have received a family pension in arrears.

Calculate the Tax Relief Yourself

1. Calculate the tax payable on the total income, including additional salary in the year it is received.
2. Calculate the tax payable on the total income, excluding additional salary in the year it is received
3. Calculate the difference between Step 1 and Step 2
4. Calculate the tax payable on the total income of the year to which the arrears relate, excluding arrears
5. Calculate the tax payable on the total income of the year to which the arrears relate, including arrears
6. Calculate the difference between Step 4 and Step 5
7. The excess amount at Step 3 over Step 6 is the tax relief that shall be allowed.

Note that if the amount at Step 6 is more than the amount at Step 3, no relief shall be allowed.

3. Exemption on Receipts at the Time of Voluntary Retirement

Any compensation received on voluntary retirement or separation is exempt from tax as per the Section 10(10C). However, the following conditions must be fulfilled

1. Compensation received is towards voluntary retirement or separation
2. Maximum compensation received does not exceed Rs 5,00,000.
3. The recipient is an employee of an authority established under the Central or State Act, local authority, university, IIT, state government or central government, notified institute of management, or notified institute of importance throughout India or any state, PSU, company or a cooperative society.
4. The receipts are in compliance with Rule 2BA.

No exemption can be claimed under this section for the same AY or any other if relief under Section 89 has been taken by an employee for compensation of voluntary retirement or separation or termination of services. 
Note: Exemption can only be claimed in the assessment year the compensation is received.

4. Pension

Pension is taxable under the head salaries in the income tax return. Pension is paid out periodically on a monthly basis usually. You may also choose to take pension as a lump sum (also called commuted pension) instead of a periodical payment. At the time of retirement, you may choose to receive a certain percentage of your pension in advance.

Commuted and Uncommuted Pension Commuted pension or lump sum received may be exempt in certain cases. For a government employee, commuted pension is fully exempt. Uncommuted pension or any periodical payment of pension is fully taxable as salary.

5. Gratuity

Gratuity is a retirement benefit that employers provide for their employees. The employee is entitled to receive gratuity when he completes five years of service at that company. It is, however, only paid on retirement or resignation. Gratuity received on retirement or death by a central, state or local government employee is fully exempt from tax for the employee or his family. The tax treatment of your gratuity is different, depending on whether your employer is covered by the Payment of Gratuity Act. Check with your company about its status, and then proceed to calculate.

If your employer is covered by the Payment of Gratuity Act, then the least of the following three is tax-exempt.

1. 15 days salary based on the salary last drawn for every completed year of service or part thereof in excess of 6 months.

For simplicity sake, this is calculated as last drawn salary x number of years in employment x 15/26 (where last drawn salary is Basic salary and DA and number of years in service is rounded off to the nearest full year)

2. Rs 20,00,000
3. Gratuity actually received

If your employer is not covered under the Payment of Gratuity Act, the least of the following three is tax-exempt.

1. Half month’s salary for each completed year of service. While calculating completed years, any fraction of a year shall be ignored.

SECTION IV: Basics of Income Tax

1. Income Chargeable to Tax

Your income is not equal to your salary. You could earn income from several other sources other than your salary income. Your total income, according to the Income Tax Department, could be from house property, profit or loss from selling stocks or from interest on a savings account or on fixed deposits. All these numbers get added up to become your gross income.

Income from Salary	All the money you receive while rendering your job as a result of an employment contract
Income from house property	Income from house property you own; property can be self-occupied or rented out.
Income from other sources	Income accrued from fixed deposits and savings account come under this head.
Income from capital gains	Income earned from the sale of a capital asset (mutual funds or house property).
Income from business and profession	Income/loss arising as a result of carrying on a business or profession. Freelancers income come under this head.

2. Tax Rates

Add up all your income from the heads listed above. This is your gross total income. From your gross total income, deductions under Section 80 are allowed to be claimed. The resulting number is the income on which you have to pay tax.

3. TDS on Salary

TDS is tax deducted at source. Your employer deducts a portion of your salary every month and pays it to the Income Tax Department on your behalf. Based on your total salary for the whole year and your investments in tax-saving products, your employer determines how much TDS has to be deducted from your salary each month.

For a salaried employee, TDS forms a major portion of an employee’s income tax payment. Your employer will provide you with a TDS certificate called Form 16 typically around June or July showing you how much tax was deducted each month.
Your bank may also deduct tax at source when you earn interest from a fixed deposit. The bank deducts TDS at 10% on FDs usually. A 20% TDS is deducted when the bank does not have your PAN information.

4. Form 16

Form 16 is a TDS certificate. Income Tax Department mandates all employers to deduct TDS on salary and deposit it with the government. The Form 16 certificate contains details about the salary you have earned during the year and the TDS amount deducted.

It has two parts: Part A with details about the employer and employee name, address, PAN and TAN details and TDS deductions.

Part B includes details of salary paid, other incomes, deductions allowed, tax payable.

5. Form 26AS

Form 26AS is a summary of taxes deducted on your behalf and taxes paid by you. This is provided by the Income Tax Department. It shows details of tax deducted on your behalf by deductors, details on tax deposited by taxpayers and tax refund received in the financial year. This form can be accessed from the IT Department’s website.

6. Deductions

The lower your taxable income, the lower taxes you ought to pay. So be sure to claim all the tax deductions and benefits that apply to you. Section 80C of the Income Tax Act can reduce your gross income by Rs 1.5 lakhs. There are a bunch of other deductions under Section 80 such as 80D, 80E, 80GG, 80U etc. that reduce your tax liability.

Income from capital gains represents a significant source of income for investors and individuals engaged in the sale or transfer of capital assets such as stocks, real estate, mutual funds, and other investments. Understanding the tax treatment of capital gains is essential for investors to optimize their investment decisions, comply with tax laws, and minimize tax liabilities.

Definition of Capital Gains:

Capital gains arise when a capital asset is transferred or sold, resulting in a profit or gain. Capital assets include various types of assets such as land, buildings, securities, jewelry, artwork, and any other property held for investment purposes. The difference between the sale consideration received and the cost of acquisition of the asset determines the capital gain or loss.

Classification of Capital Gains:

Capital gains are classified into two categories based on the holding period of the capital asset:

• Short-term capital gains (STCG):

Gains arising from the sale or transfer of capital assets held for a period of up to 36 months (24 months for certain assets such as immovable property and unlisted shares) are considered short-term capital gains.

• Long-term capital gains (LTCG):

Gains arising from the sale or transfer of capital assets held for more than 36 months (24 months for certain assets) are classified as long-term capital gains.

Taxation of Capital Gains:

The tax treatment of capital gains differs for short-term and long-term gains:

• Short-term capital gains are taxed at applicable slab rates applicable to the taxpayer’s total income. For individuals, Hindu Undivided Families (HUFs), and other non-corporate taxpayers, short-term capital gains are taxed at the respective slab rates applicable to their total income.
• Long-term capital gains are subject to tax at specified rates depending on the type of asset and the applicable indexation benefit. As of the current tax regime, long-term capital gains on listed equity shares and equity-oriented mutual funds are taxed at a flat rate of 10% without indexation, provided the gains exceed Rs. 1 lakh in a financial year. For other long-term capital assets, such as real estate and debt mutual funds, gains are taxed at 20% with indexation benefit.

Cost of Acquisition and Indexation:

The cost of acquisition of a capital asset is the amount paid to acquire the asset, including purchase price, expenses incurred in acquiring the asset (such as brokerage, stamp duty, and registration charges), and any improvement costs. In the case of inherited or gifted assets, the cost of acquisition is determined based on the previous owner’s acquisition cost or fair market value as on specific valuation dates. Indexation allows taxpayers to adjust the cost of acquisition and improvement cost for inflation using the Cost Inflation Index (CII) published by the Central Board of Direct Taxes (CBDT). Indexation helps in reducing the taxable capital gains by accounting for the impact of inflation on the asset’s value over time.

Exemptions and Deductions:

The Income Tax Act provides certain exemptions and deductions to reduce the tax burden on capital gains:

• Exemption under Section 54:

Individuals can claim exemption from long-term capital gains tax on the sale of a residential property if the proceeds are reinvested in purchasing or constructing another residential property within specified timelines.

• Exemption under Section 54F:

Similar to Section 54, this provision allows exemption from long-term capital gains tax on the sale of any capital asset (other than a residential property) if the proceeds are reinvested in purchasing or constructing a residential property.

• Deduction under Section 80C:

Taxpayers can avail deductions for investments made in specified instruments such as Equity Linked Savings Schemes (ELSS), Public Provident Fund (PPF), National Savings Certificates (NSC), and other eligible investments, subject to the overall limit of Rs. 1.5 lakh per financial year.

Capital Gains from Equity Investments:

Special provisions apply to capital gains from the sale of listed equity shares and equity-oriented mutual funds:

• Long-term capital gains from listed equity shares and equity-oriented mutual funds held for more than one year are taxed at a concessional rate of 10% without indexation, provided the gains exceed Rs. 1 lakh in a financial year.
• Short-term capital gains from listed equity shares and equity-oriented mutual funds held for one year or less are taxed at the applicable slab rates.

Tax Planning Strategies:

Investors can implement various tax planning strategies to optimize their capital gains tax liability:

• Tax Loss Harvesting:

Selling investments with unrealized losses to offset gains and reduce tax liability.

• Timing of Sales:

Strategically timing the sale of assets to qualify for long-term capital gains tax rates or exemptions.

• Rebalancing Portfolio:

Adjusting investment allocations to optimize tax efficiency and diversification.

• Availing Exemptions and Deductions:

Leveraging available exemptions, deductions, and tax-saving investments to reduce taxable capital gains.

The term “house property” includes any building or land appurtenant thereto, owned by the taxpayer and used for residential or commercial purposes. It covers a wide range of properties, including residential houses, apartments, commercial buildings, shops, offices, warehouses, and vacant land. Income from house property may arise from rental income, self-occupied property, deemed let-out property, or capital gains from the sale of property.

When a property is used for the purpose of business or profession or for carrying out freelancing work – it is taxed under the ‘income from business and profession’ head. Expenses on its repair and maintenance are allowed as business expenditure.

1. Self-Occupied House Property

A self-occupied house property is used for one’s own residential purposes. This may be occupied by the taxpayer’s family parents and/or spouse and children. A vacant house property is considered as self-occupied for the purpose of Income Tax.

Prior to FY 2019-20, if more than one self-occupied house property is owned by the taxpayer, only one is considered and treated as a self-occupied property and the remaining are assumed to be let out. The choice of which property to choose as self-occupied is up to the taxpayer.

For the FY 2019-20 and onwards, the benefit of considering the houses as self-occupied has been extended to 2 houses. Now, a homeowner can claim his 2 properties as self-occupied and remaining house as let out for Income tax purposes.

2. Let Out House Property

A house property which is rented for the whole or a part of the year is considered a let out house property for income tax purposes

3. Inherited Property

An inherited property i.e. one bequeathed from parents, grandparents etc again, can either be a self-occupied one or a let out one based on its usage as discussed above.

Deductions Allowed:

From the annual value of the property, certain deductions are allowed under Section 24 of the Income Tax Act to arrive at the taxable income from house property. These deductions include:

• Standard deduction: A flat deduction of 30% of the annual value is allowed towards repairs, maintenance, and other expenses.
• Interest on housing loan: Deduction is allowed for interest paid on a loan taken for the purchase, construction, repair, or renovation of the property. The maximum deduction allowed is Rs. 2 lakh for self-occupied properties and the actual interest paid for let-out or deemed let-out properties.

Treatment of Losses:

If the net annual value of a property (after allowing deductions) results in a loss, such loss can be set off against income from other heads, such as salary, business income, or capital gains, in the same financial year. Any unadjusted loss can be carried forward for up to eight subsequent years and set off against income from house property in those years.

Taxation of Deemed Let-Out Property:

If a property is not let out or self-occupied but deemed to be let out, it is treated as let-out for taxation purposes. This provision applies when an individual owns more than one house property and chooses to occupy only one property for self-use. In such cases, the other property/properties are deemed to be let out, and income is calculated accordingly.

Taxation of Vacant Property:

Even if a property is vacant and not yielding any rental income, it is still considered to have an annual value for tax purposes. The owner is required to pay tax on the deemed rental income, which is calculated based on the fair market rent that the property would fetch if let out. However, deductions for interest on housing loan and standard deduction are still allowed.

Steps to Calculate Income from House Property

• Determine Gross Annual Value (GAV) of the property:

The gross annual value of a self-occupied house is zero. For a let out property, it is the rent collected for a house on rent.

• Reduce Property Tax:

Property tax, when paid, is allowed as a deduction from GAV of property.

• Determine Net Annual Value (NAV):

Net Annual Value = Gross Annual Value – Property Tax

• Reduce 30% of NAV towards standard deduction:

30% on NAV is allowed as a deduction from the NAV under Section 24 of the Income Tax Act. No other expenses such as painting and repairs can be claimed as tax relief beyond the 30% cap under this section.

• Reduce home loan interest:

Deduction under Section 24 is also available for interest paid during the year on housing loan availed.

• Determine Income from house property:

The resulting value is your income from house property. This is taxed at the slab rate applicable to you.

• Loss from house property:

When you own a self occupied house, since its GAV is Nil, claiming the deduction on home loan interest will result in a loss from house property. This loss can be adjusted against income from other heads.

Note: When a property is let out, its gross annual value is the rental value of the property. The rental value must be higher than or equal to the reasonable rent of the property determined by the municipality.

Income from other sources represents a diverse category of earnings under the Indian Income Tax Act, 1961, encompassing various types of income not specifically covered under other heads such as salaries, house property, business or profession, or capital gains. This head of income includes a wide range of receipts, earnings, and gains, both monetary and non-monetary, that accrue to an individual during a financial year. Understanding the tax treatment of income from other sources is essential for taxpayers to accurately compute their taxable income and fulfill their tax obligations.

1. Definition and Scope:

Income from other sources includes any income that does not fall within the ambit of the other four heads of income—salaries, house property, business or profession, and capital gains. It covers various sources of income, such as interest income, dividend income, rental income from machinery, plant, furniture, or other assets, income from gifts, winnings from lotteries, races, or games of chance, royalties, annuities, and any other income not specifically categorized under other heads.

2. Interest Income:

Interest income earned from savings accounts, fixed deposits, recurring deposits, bonds, debentures, loans, or any other financial instruments is one of the most common types of income from other sources. Interest income is fully taxable and is added to the taxpayer’s total income for the financial year. However, certain exemptions and deductions may be available for specific types of interest income, such as interest from savings accounts or tax-saving bonds.

3. Dividend Income:

Dividend income received from domestic companies, mutual funds, or other investment instruments is also classified as income from other sources. Dividend income is generally exempt from tax in the hands of the recipient shareholder under Section 10(34) of the Income Tax Act. However, dividend income exceeding Rs. 10 lakh is subject to tax at a flat rate of 10% under Section 115BBDA for individual, Hindu Undivided Family (HUF), or firm.

4. Rental Income:

Income derived from renting out machinery, plant, furniture, or any other assets not constituting a house property is taxed as income from other sources. Rental income is taxable at the applicable slab rates, and deductions for expenses incurred in generating rental income may be allowed under Section 57 of the Income Tax Act.

5. Winnings from Lotteries, Races, or Games of Chance:

Income earned from winnings in lotteries, crossword puzzles, races, card games, or other games of chance is considered income from other sources and is subject to tax at a flat rate under Section 115BB. The tax rate varies depending on the nature of the winnings and ranges from 30% to 60% of the income.

6. Royalty Income:

Royalty income received by an individual for the use of intellectual property rights, such as patents, copyrights, trademarks, or industrial designs, is taxable as income from other sources. Royalty income is added to the taxpayer’s total income and taxed at the applicable slab rates.

7. Annuity Income:

Annuity income received from annuity plans, insurance policies, pension schemes, or other financial instruments is categorized as income from other sources. Annuity income is taxable at the applicable slab rates, and certain deductions may be available for specific types of annuities under Section 80CCC of the Income Tax Act.

8. Gift Income:

Gifts received by an individual exceeding Rs. 50,000 in a financial year are taxable as income from other sources under Section 56(2)(x) of the Income Tax Act. However, certain exemptions may be available for gifts received from specified relatives or under specific circumstances, such as gifts received on marriage, through wills, or by inheritance.