Direct Taxes ICWAI Notes

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directorate of studies the institute of cost and works accountants of india

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syllabus objectives to gain knowledge about the tax laws in force for the relevant accounting year and to provide an insight into procedural aspects for filing tax returns for various assesses learning aims the syllabus aim totest the student s ability to · · · · · explain the basic principles underlying the income tax act and wealth tax act compute the income of an individual and business under various heads of income understand procedure for tax return preparation filing assessment and tax refund for various assesses understand the powers of various assessing authorities understand appellate procedure under various provisions of these acts skill set required level b requiring the skill levels of knowledge comprehension application and analysis 1 direct taxes comprehensive study 50 · · · · · overview of direct tax laws direct versus indirect taxes taxable person basic concepts a comprehensive study of the income-tax act 1961 case laws governing capital andrevenue expenditure deemed income residence concept special problems centering on the concept of assessees registered firm hindu undivided association of persons and trust minors cooperatives non-resident indians and avoid ance of double taxation salaries perquisites gratuity and retirement benefits income from house property capital gains income from other sources income from business and profession problems arising from aggregation of income and set off and carry forward of losses computation of income and return of income tax filing procedure principles of valuation of movable and immovable property advance payment of tax deduction and collection of tax at source tax incentives and export promotion schemes other benefits and tax exemptions assessment appeals revisions review rectification and application to central board of direct taxes penalties ,fines and prosecution refunds securities transaction tax fringe benefit tax banking cash transaction tax wealth tax · · · · · · · · · · · 2 practical problems and case studies under direct taxes 50

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paper 7 applied direct taxation contents study note particulars page no 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 types of taxes the source of income tax law residential status and tax incidence income from salaries income from house property profits and gains of business or profession capital gains income from other sources clubbing of income set off or carry forward and set off of losses deduction in computing total income incomes which do not form part of total income agricultural income and aggregation of incomes minimum alternate tax mat return of income assessment procedure assessment of various entities grievances redressal procedure interest advance payment of tax collection and recovery of tax deduction and collection of tax at source penalties prosecution refund settlement of cases tax administration taxation of international transactions double taxation relief wealth tax 1 3 12 28 77 96 166 204 216 222 233 287 321 330 334 341 351 491 405 412 319 423 433 439 443 450 455 463 470

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study note 1 types of taxes this study note includes · · basis for taxation direct taxes and indirect taxes 1.1 basis for taxation india is a socialist democratic and republic state constitution of india is supreme law of land all other laws including the income-tax act are subordinate to the constitution of india the constitution provides that `no tax shall be levied or collected except by authority of law the constitution includes three lists in the seventh schedule providing authority to the central government and the state governments to levy and collect taxes on subjects stated in the lists powers of central or state government to levy tax article 2461 2461 2463 empowers central or state government central government state government central and state government levy of various taxes levy taxes in list i of the severnth schedule of the constitution levy taxes in list ii of the seventh schedule of the constitution list iii of seventh schedule for list i union list entry no 82 entry no 83 entry no 84 entry no 85 income tax other than tax on agricultural income customs duties including export duties union excise duty other than liquor opium etc corporation tax entry no 92a taxes on inter-state sales cst entry no 92b tax on inter-state consignment of goods not yet considered by goi entry no 92c taxes on services entry no 97 any other matter not included in list ii or list iii [levy of service tax through finance act 1994 list ii state list entry no 46 entry no 51 entry no 52 entry no 54 agricultural income tax state excise duty tax on entry of goods into local area for consumption or use or sale called octroi tax on intra state sales local/general sales tax applied direct taxation 1

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types of taxes list iii state list entry no 17a forests entry no 25 education 1.2 direct taxes and indirect taxes tax direct tax indirect tax income tax wealth tax central excise duty customs duty tax service tax purchase tax central excise duty basic of difference between indirect tax and direct tax 1 taxable event 2 levy collection purchase sale manufacture of goods and provision of services levied collected from the consumer but paid deposited to the exchequer by the assessee dealer tax burden is shifted to the subsequent ultimate user at the time of sale of purchases or rendering of services taxable income taxable wealth of the assessees levied and collected from the assessee 3 shifting of burden 4 collected directly borne by the assessee hence cannot be shifted after the income for a year is earned or valuation of assets is determined on the valuation date 2 applied direct taxation

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study note 2 the source of income tax law this study note includes basic concepts rates of income tax for a.y 2010-11 definition heads of income · · · · 2.1 basic concepts the elements sources of income tax law 1 the income tax act 1961 a income tax in india is governed by the income tax act,1961 b c d e it came into force w.e.f.1.4.1962 the act contains 298 sections and xiv schedules the finance act shall bring amendment to this act the law provides for determination of taxable income tax liability and procedure for assessment appeal penalties and prosecutions 2 finance act a b c d finance minister presents this as finance bill in both the houses of parliament part a of the budget contains proposed policies of the government in fiscal areas part b contains the detailed tax proposals once the finance bill is approved by the parliament and gets the assent of the president it becomes the finance act e the rate of tax at which income shall be charged is prescribed in the schedule i of finance act f the finance act brings amendments to both the direct tax laws i.e income tax wealth tax etc and indirect tax laws i.e law relating to central excise customs duty service tax etc 3 the income tax rules 1962 a the administration of direct taxes is vested with central board of direct taxes cbdt b under section 295 of it act cbdt is empowered to frame rules from time to time to carry out the purpose and proper administration of the act c all forms procedures and principles of valuation of perquisites prescribed under the act are provided in the rules framed by cbdt 4 circulars notifications from cbdt a in exercise of the powers u/s 119 cbdt issues circulars and notifications from time to time b c d e these circulars clarify doubts regarding the scope and meaning of the various provisions of the act these circulars act as guidance for officers and assesses these circulars are binding on assessing officers but not on assesses and courts the circulars issued by the cbdt shall not be in contrary to the provisions of the act applied direct taxation 3

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the source of income tax law subordinate legislation the government enacts the law in the parliament there e.g income tax act central excise act etc where is a need for detailed rules and regulations the enactment is to be done by either cbdt or cbec the rules and regulations enacted by cbdt or cbec i.e income tax rules cenvat credit rules the notifications and circulars issued by cbdt cbec is called subordinate legislation 5 supreme court and high court decisions a the supreme court and the high court can give judgment only on the question of law b the law laid down by the supreme court is the law of the land c the decision of high court will apply in the respective states within its jurisdiction determining the rates of tax under the income tax act 1961 1 income tax shall be charged at the rates fixed for the year by the annual finance act 2 the first schedule to the finance act provides the following rates of taxation part i part ii part iii the tax rates applicable to income of various types of assessees for the assessment year rates of tds for the current financial year rates of tds for salary and advance tax which becomes part i of the next assessment year 2.2 rates of income-tax for assessment year 2011-12 2.2.1 a for woman resident in india and below the age of 65 years at any time during the previous year upto 1,90,000 rs 1,90,001 to 5,00,000 5,00,000 to 8,00,000 above 8,00,000 nil 10 20 30 b for an individual man or woman resident in india who is of the age of 65 years or more at any time during the previous year upto 2,40,000 2,40,001 to 5,00,000 5,00,000 to 8,00,000 above 8,00,000 nil 10 20 30 c individuals [other than those mentioned in para 2.2.1a and b above huf aop/boi other than cooperative societies whether incorporated or not upto 1,60,000 1,60,001 to 5,00,000 5,00,000 to 8,00,000 above 8,00,000 nil 10 20 30 note surcharge nil `education cess 2 and `secondary and higher education cess shec 1 on income tax shall be chargeable 4 applied direct taxation

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2.2.2 other assessees assessee rate of tax total income × 30 ec 2 shec 1 total income × 30 ec 2 shec 1 surcharge surcharge nil surcharge 7.5 if the total turnover exceeds 1 crore surcharge 2.5 if the total turnover exceeds `1 crore for firms including limited liability partnership domestic companies foreign companies total income x 40 ec other income 2 shec 1 royalty received from indian government or an indian concern in pursuance of an agreement made by it with the indian concern after march 31 1961 but before april 1 1976 or fees for rendering technical services in pursuance of an agreement made by it after february 29 1964 and where such agreement has in either case been approved by the central government for local authorities for co-operative societies total income × 30 ec 2 shec 1 for first 10,000 10 for next 10,000 20 for the balance 30 ec 2 and shec 1 are applicable 18 of book profit ec 2 shec 1 surcharge is not applicable nil surcharge is not applicable nil surcharge if book profits exceed 1 crore mat minimum alternate tax 2.3 definition assessee means [section 27 any person who is liable to pay any tax or any other sum under the income tax act 1961 and assessee includes a every person in respect of whom any proceedings has been taken for the assessment of · his income or fringe benefits or of the income of any other person · loss sustained by him or other person · refund due to him or such other person b every person who is deemed to be an assessee under the act c every person who is deemed to be an assessee in default under the act assessment year [section 2 9 1 assessment year means the period of twelve months commencing on the 1st day of april every year 2 the year for which tax is paid is called assessment year the present assessment year is 2011-12 relating to previous year 2010-11 applied direct taxation 5

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the source of income tax law previous year [section 3 1 previous year means financial year immediately preceding the assessment year 2 the year in respect of the income of which tax is levied is called previous year the present previous year 2010-11 and its assessment year is 2011-12 note previous year for newly established business from the date of setting up of the business to the end of the financial year in which business was set up example x ltd started business on 1.11.10 so for x ltd previous year will be considered as 1.11.10 to 31.3.11 income [section 224 includes 1 profits or gains of business or profession 2 dividend 3 voluntary contribution received by a charitable religious trust or university education institution or hospital 4 value of perquisite or profit in lieu of salary taxable u/s 17 and special allowance or benefit specifically granted either to meet personal expenses or for performance of duties of an office or an employment of profit 5 export incentives like duty drawback cash compensatory support sale of licences etc interest salary bonus commission or remuneration earned by a partner of a firm from such firm capital gains chargeable u/s 45 profits and gains from the business of banking carried on by a cooperative society with its members winnings from lotteries crossword puzzles races including horse races card games and other games of any sort or from gambling or betting of any form or nature whatsoever 10 deemed income u/s 41 or 59 11 sums received by an assessee from his employees towards welfare fund contributions such as provident fund superannuation fund etc 12 amount received under keyman insurance policy including bonus thereon 13 amount received under agreement for a not carrying out activity in relation to any business or b not sharing any knowhow patent copyright etc 14 benefit or perquisite received from a company by a director or a person holding substantial interest or a relative of the director or such person 15 gift as defined u/s 56 2 vi w.e.f a.y 2008-2009 any sum of money exceeding 50,000 received by an individual or a huf from any person during the previous year without consideration on or after 1.4.2007 then the whole of aggregate of such sums will be taxable previous year assessment year will be same in the following cases 1 shipping business of nonresident [section 172 2 persons leaving india [section 174 3 aop or boi or artificial juridical person formed for a particular event or purpose 4 persons likely to transfer property to avoid tax [section 175 5 discontinued business [section 176 undisclosed sources of income 1 unexplained cash credits u/s 68 2 unexplained investments u/s69 3 unexplained money bullion or jewel or valuable article u/s 69a [sec 174a 6 7 8 9 6 applied direct taxation

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4 undisclosed investments u/s 69b 5 unexplained expenditure u/s 69c 6 amount borrowed or repaid on hundi other than by way of account payee cheque u/s 69d application of income an obligation to apply income which has accrued or has arisen or has been received amounts to merely the apportionment of income therefore the essentials of the concept of application of income under the provisions of the income tax act are 1 income accrues to the assessee 2 income reaches the assessee 3 income is applied to discharge an obligation whether self-imposed or gratuitous diversion of income an obligation to apply the income in a particular way before it is received by the assessee or before it has arisen or accrued to the assessee results in diversion of income the source is charged with an overriding title which diverts the income therefore the essentials are the following 1 income is diverted at source 2 there is an overriding charge or title for such diversion and 3 the charge obligation is on the source of income and not on thereceiver examples of diversion by overriding title are a right of maintenance of dependants or of coparceners on partition b right under a statutory provision c a charge created by a decree of a court of law total income [sec 245 total income means the total amount of income as referred to in sec 5 and computed in the manner laid down in the act total income constitutes the tax with reference to which income tax is charged gross total income [section 80b gross total income means total income computed in accordance with the provisions of the income tax act before making any deduction under chapter via rounding off total income and tax rounding off income [section 288a the total income computed under this act shall be rounded off to the nearest multiple of 10 rounding off tax [section 288b the amount of tax including tax deducted at source tds and advance tax interest penalty fine or any other sum payable and the amount of refund due under the income tax act shall be rounded off to the nearest ten rupees books of account [sec 212a it includes ledgers day books cash books account-books and other books whether kept in the written form or as printouts or data stored in a floppy disc tape or any other form of electromagnetic data storage device document [sec 222aa it includes an electronic record as defined in clause t of sub-section 1 of section 2 of the information technology act 2000 21 of 2000 applied direct taxation 7

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the source of income tax law relative [sec 241 in relation to an individual means the husband wife brother or sister or any lineal ascendant or descendant of that individual resulting company [sec 241a it means one or more companies including a wholly owned subsidiary thereof to which the undertaking of the demerged company is transferred in a demerger and the resulting company in consideration of such transfer of undertaking issues shares to the shareholders of the demerged company and includes any authority or body or local authority or public sector company or a company established constituted or formed as a result of demerger insurer [sec 228bb it means an insurer being an indian insurance company as defined under clause 7a of section 2 of the insurance act 1938 4 of 1938 which has been granted a certificate of registration under section 3 of that act substantial interest [sec 2 32 person who has a substantial interest in the company in relation to a company means a person who is the beneficial owner of shares not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits carrying not less than twenty per cent of the voting power in the case of a non-corporate entity a person can be said to have substantial interest if 20 or more share of profit is held infrastructural capital company [sec.226a infrastructure capital company means such company which makes investments by way of acquiring shares or providing long-term finance to any enterprise or undertaking wholly engaged in the business referred to in subsection 4 of section 80 ­ia or sub-section 1 of section 80-iab or an undertaking developing and building a housing project referred to in sub-section 10 of section 80 ib or a project for constructing a hospital with at least one hundred beds for patients sec 226a infrastructural capital fund [sec.226b infrastructure capital fund means such fund operating under a trust deed registered under the provisions of the registration act 1908 established to raise monies by the trustees for investment by way of acquiring shares or providing long-term finance to any enterprise or undertaking wholly engaged in the business referred to in subsection 4 of section 80-ia or sub-section 1 of section 80 iab or an undertaking developing and building a housing project referred to in sub-section 10 of section 80-ib or a project for constructing a hotel of not less than three star category as classified by the central government or a project for constructing a hospital with at least one hundred beds for patients sec 226b charge of income tax [sec 4 according to sec 4 of the income-tax 1961 the following basic principles are followed while charging incometax i income-tax is a tax on the annual income of an assessee ii usually the income of the previous year py is charged to the following assessment year ay at the prescribed rate fixed by the relevant financial act and iii tax is levied on the total income of every assessee receipt of income deemed income [sec 7 the following income shall be deemed to be received in the previous year i employers contribution to recognized provident fund in excess of 12 of salary and interest credited to the recognized provident fund in excess of 9.5 8 applied direct taxation

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ii the transfer balance in a recognized provident fund to the extent provided in sub rule 4 of rule 11 of part a of fourth schedule dividend income [sec 8 dividend include a any distribution by a company of accumulated profits whether capitalised or not if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company b any distribution to its shareholders by a company of debentures debenture-stock or deposit certificates in any form whether with or without interest and any distribution to its preference shareholders of shares by way of bonus to the extent to which the company possesses accumulated profits whether capitalised or not c any distribution made to the shareholders of a company on its liquidation to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation whether capitalised or not d any distribution to its shareholders by a company on the reduction of its capital to the extent to which the company possesses accumulated profits85 which arose after the end of the previous year ending next before the 1st day of april 1933 whether such accumulated profits have been capitalised or not e any payment by a company not being a company in which the public are substantially interested of any sum whether as representing a part of the assets of the company or otherwise [made after the 31st day of may 1987 by way of advance or loan to a shareholder being a person who is the beneficial owner of shares not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits holding not less than ten per cent of the voting power or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest hereafter in this clause referred to as the said concern or any payment by any such company on behalf or for the individual benefit of any such shareholder to the extent to which the company in either case possesses accumulated profits but dividend does not include i a distribution made in accordance with sub-clause c or sub-clause d in respect of any share issued for full cash consideration where the holder of the share is not entitled in the event of liquidation to participate in the surplus assets ia a distribution made in accordance with sub-clause c or sub-clause d in so far as such distribution is attributable to the capitalised profits of the company representing bonus shares allotted to its equity shareholders after the 31st day of march 1964 ii any advance or loan made to a shareholder [or the said concern by a company in the ordinary course of its business where the lending of money is a substantial part of the business of the company iii any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause e to the extent to which it is so set off iv any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77a of the companies act 1956 1 of 1956 v any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company whether or not there is a reduction of capital in the demerged company explanation 1 the expression accumulated profits wherever it occurs in this clause shall not include capital gains arising before the 1st day of april 1946 or after the 31st day of march 1948 and before the 1st day of april 1956 applied direct taxation 9

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the source of income tax law explanation 2 the expression accumulated profits in sub-clauses a b d and e shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses and in sub-clause c shall include all profits of the company up to the date of liquidation but shall not where the liquidation is consequent on the compulsory acquisition of its undertaking by the government or a corporation owned or controlled by the government under any law for the time being in force include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place explanation 3 for the purposes of this clause a concern means a hindu undivided family or a firm or an association of persons or a body of individuals or a company b a person shall be deemed to have a substantial interest in a concern other than a company if he is at any time during the previous year beneficially entitled to not less than twenty per cent of the income of such concern capital and revenue receipts the objective of the income-tax act is to tax only income generally revenue receipts unless specifically exempted on the other hand capital receipts are not chargeable to tax except when specifically provided in the act the distinction between a capital receipt and a revenue receipt should be perceived based on the facts and circumstances of each case there is no specific provision in the act to distinguish between a capital receipt and revenue receipt it may be observed that a receipt in substitution of a source of income is a capital receipt while a receipt in substitution of an income is a revenue receipt an amount received as a compensation for surrender of certain rights under an agreement is a capital receipt whereas an amount received under an agreement as compensation for loss of future profit is a revenue receipt capital and revenue expenditure in computing taxable income normally revenue expenditure incurred for the purpose of earning income is deductible from revenue receipt unless the law provides specific rules to disallow such expenditure wholly or partly on the other hand capital expenditure is not deductible while computing taxable income unless the law expressly so provides neither the capital expenditure nor revenue expenditure has been defined in the act however from the facts and circumstances of each case and from the judicial decisions the following general principles to be kept in mind i capital expenditure is incurred in acquiring extending or improving a fixed asset whereas revenue expenditure is incurred in the normal course of business as a routine expenditure ii capital expenditure incurred for enduring benefits whereas revenue expenditure is consumed within a previous year iii capital expenditure makes improvement with earning capacity of a business whereas a revenue expenditure maintains the profit making capacity of a business iv capital expenditure is a nonrecurring expenditure whereas revenue expenditure is normally a recurring one 2.4 heads of income [sec 14 significance of heads of income 1 the income chargeable under a particular head cannot be charged under any other head 2 the act has self contained provisions in respect of each head of income 3 if any income is charged under a wrong head of income the assessee will lose the benefit of deduction available to him under that head 10 applied direct taxation

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relevance of method of accounting for heads of income heads of income chapter iv-a salaries 15 17 chapter iv-c house property 22 27 chapter iv-d business income 28-44db relevance of method of accounting 1 taxable on due basis or on receipt basis whichever is earlier 2 method of accounting is irrelevant 1 income from house property is taxable only on accrual basis 2 method of accounting is not relevant 1 u/s 145 assessee may follow either cash or mercantile system of accounting regularly employed by the assessee 2 exceptions certain payments are allowable payment basis accrual concept does not hold good only on actual a employer s contribution to pf esi tax duty cess fees to government interest on loans and advances from banks and financial institutions provision for leave encashment bonus or commission etc b telecommunication licence fee is allowable in instalments only from the year of payment c preliminary expenses distributed over five years d amalgamation demerger expenses distributed over five years e amount paid in connection with voluntary retirement scheme distributed over five years chapter iv-e capital gains 45 55a 1 income from capital gains shall be taxable during the previous year capital gains in which the capital asset is transferred i.e year of accrual 2 the method of accounting is not relevant for taxing the income under the head capital gains u/s 145 assessee may follow either on cash or mercantile system of accounting regularly employed by the assessee chapter iv-f othersources 56 59 applied direct taxation 11

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