Meaning of Income

In the context of the Income Tax Act, 1961, the term "Income" is the starting point for determining tax liability. The Act does not provide a restrictive definition of income; instead, it provides an inclusive and wide-ranging definition under Section 2(24). This means that the list provided in the section is not exhaustive, and any receipt that has the character of income can be taxed, even if it is not explicitly mentioned.

Essentially, income is a periodical monetary return coming in with a certain degree of regularity or expected regularity, from a definite source. However, even a one-time receipt can be considered income if it is in the nature of "profits and gains."

Key characteristics of income include:

• It must come from an outside source. A person cannot earn income from themselves.
• It can be received in cash or in kind. If received in kind (e.g., perquisites), its value is determined as per the rules.
• It can be legal or illegal. Income from illegal activities (e.g., smuggling) is also subject to tax.
• A voluntary receipt can also be income (e.g., voluntary contributions received by a trust).

Income includes profits and gains

The definition of income under Section 2(24) explicitly begins with "income includes— (i) profits and gains;". This is the most significant component of income. "Profits and Gains" primarily refers to the income earned from carrying out a business or profession. It is the surplus that results from business or professional activity.

The term is not limited to business and profession. It also covers:

• Capital Gains: Profits or gains arising from the transfer of a capital asset (like property, shares, or gold). This is a tax on the appreciation in the value of an asset.
• Winnings from Lotteries, Crossword Puzzles, Races, etc.: These are considered gains and are taxed at a special flat rate of 30% under Section 115BB.
• Dividends: Profits distributed by a company to its shareholders are considered income in the hands of the shareholders.

In essence, any receipt that can be described as a profit or a gain, whether from a regular business activity or a one-off transaction like the sale of an asset, falls within the ambit of "income" and is potentially taxable, subject to other provisions of the Act.

Previous Year and Assessment Year

The Income Tax Act follows a specific timeline for earning and taxing income. This timeline is defined by two key concepts: the Previous Year and the Assessment Year. The fundamental principle is that the income earned in one year is taxed in the next year.

Definition and Distinction

Previous Year (PY) [Section 3]: The 'Previous Year' is the financial year in which the income is earned by the assessee. In India, a financial year begins on 1st April and ends on 31st March of the following calendar year.

Assessment Year (AY) [Section 2(9)]: The 'Assessment Year' is the financial year immediately following the Previous Year, in which the income earned in the Previous Year is assessed to tax (i.e., computed and paid). It is always a period of 12 months starting from 1st April.

Answer:

Distinction Table

Exceptions to the Rule

In certain exceptional cases, the income of the Previous Year is taxed in the Previous Year itself. These include:

• Income of non-residents from a shipping business.
• Income of persons leaving India permanently or for a long duration.
• Income of bodies formed for a short duration (e.g., an AOP or BOI formed for a specific event).
• Income of a person trying to alienate their assets to avoid tax.
• Income of a discontinued business.

Residential Status of Assessee (Section 6)

The tax liability of a person in India depends not on their citizenship but on their residential status during the previous year. Residential status determines which income is to be taxed in India. For tax purposes, an individual can be classified into one of three categories.

The determination is a two-step process: First, determine if the individual is a Resident or a Non-Resident. Second, if they are a Resident, determine if they are Ordinarily Resident or Not Ordinarily Resident.

Step 1: Determining Resident vs. Non-Resident

An individual is considered a Resident in India for a previous year if they satisfy at least one of the following basic conditions under Section 6(1):

1. They have been in India for a period of 182 days or more during that previous year.
2. They have been in India for a period of 60 days or more during that previous year AND for 365 days or more during the 4 years immediately preceding that previous year.

An individual who does not satisfy either of the above conditions is a Non-Resident (NR) for that year.

Step 2: Determining ROR vs. RNOR for a Resident

Once an individual is determined to be a Resident (by satisfying one of the basic conditions), we need to check two additional conditions under Section 6(6) to classify them further.

A Resident will be an Ordinarily Resident (ROR) if they satisfy both of the following additional conditions:

1. They have been a Resident in India in at least 2 out of the 10 previous years immediately preceding the relevant previous year.
2. Their total stay in India has been for 730 days or more during the 7 previous years immediately preceding the relevant previous year.

A Resident who fails to satisfy even one (or both) of the above additional conditions is classified as a Resident but Not Ordinarily Resident (RNOR).

Resident and Ordinarily Resident (ROR)

This is a person who has a substantial connection with India. They are a Resident for the year and also satisfy both the additional conditions of long-term residency. Their global income is taxable in India.

Resident but Not Ordinarily Resident (RNOR)

This is an intermediate category for a person who is a Resident for the year but does not have a long-term residency history (fails one or both additional conditions). This status is typically for individuals returning to India after a long stay abroad or for foreign nationals who stay in India for a considerable period. Their tax liability is lower than an ROR but higher than an NR.

Non-Resident (NR)

This is a person who does not satisfy any of the basic conditions for being a resident. Their connection with India is minimal, and as such, only their Indian-sourced income is taxable in India.

Incidence of Income Tax

The incidence of tax or the scope of total income refers to the range of incomes that are taxable in the hands of a person in India. This scope is entirely dependent on the person's residential status for the previous year, as determined under Section 6.

Scope of total income based on residential status

The relationship between residential status and tax incidence is summarized in the following table:

Summary of Taxability

• ROR: An ROR is taxed on their global income. All income, whether earned in India or outside India, is taxable.
• NR: An NR is taxed only on their Indian income. This includes income received in India or income earned (accrued) in India. Their foreign income is not taxed in India.
• RNOR: An RNOR is taxed on their Indian income (like an NR) plus one specific category of foreign income: income from a business controlled from India or a profession set up in India. All other foreign income is not taxed.

Answer:

Computation of Total Income**

Process of Computing Taxable Income

The computation of taxable income under the Income Tax Act, 1961, is a systematic, step-by-step process. It involves classifying all income under specific heads, aggregating them, adjusting for any losses, and finally applying deductions to arrive at the income on which tax is levied. This structured approach ensures that all sources of income are accounted for and taxed as per the specific provisions applicable to them.

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Aggregating incomes from all heads

The first step in computing taxable income is to classify and compute income under five distinct heads as specified in Section 14 of the Income Tax Act. Each head has its own set of rules for computation, including specific allowances and deductions.

1. Income from Salaries (Sections 15-17): This includes salary, wages, pension, gratuity, and any other form of remuneration received by an employee from an employer. Deductions like Standard Deduction are allowed from the gross salary.
2. Income from House Property (Sections 22-27): This refers to the income earned from owning a property, which can be in the form of rent received (for a let-out property) or the notional rent (for a property deemed to be let out). Deductions for property tax, a standard deduction of 30% of Net Annual Value, and interest on home loans are allowed.
3. Profits and Gains of Business or Profession (PGBP) (Sections 28-44D): This includes income earned from any trade, commerce, manufacturing activity, or profession. All business-related expenses are allowed as deductions from the gross receipts to arrive at the net profit.
4. Capital Gains (Sections 45-55A): This refers to the profit earned from the sale or transfer of a capital asset (e.g., land, building, shares, gold). The gains are classified as Short-Term Capital Gain (STCG) or Long-Term Capital Gain (LTCG) based on the period of holding, and they are taxed differently.
5. Income from Other Sources (Sections 56-59): This is a residuary head. Any income that does not fall into the first four heads is taxed here. Examples include interest from savings accounts and fixed deposits, dividends, and winnings from lotteries.

After computing the income under each head, the positive and negative figures (profits and losses) are aggregated.

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Set-off and Carry Forward of Losses

If the computation under any head of income (except salaries) results in a loss, the Act provides a mechanism to adjust this loss against other incomes. This process is called set-off of losses. If a loss cannot be fully set off in the same year, it can be carried forward to be set off against future incomes.

Set-off of Losses (Sections 70 & 71)

1. Intra-Head Set-off (Section 70): A loss from one source under a particular head of income can be set off against income from another source under the same head.
   • Example: Loss from Business A can be set off against Profit from Business B.
   • Exceptions:
     • Loss from a speculation business can only be set off against profit from another speculation business.
     • Long-Term Capital Loss (LTCL) can only be set off against Long-Term Capital Gain (LTCG). It cannot be set off against STCG.
     • Loss from the activity of owning and maintaining racehorses can only be set off against income from the same activity.
2. Inter-Head Set-off (Section 71): After intra-head adjustments, any remaining loss under one head can be set off against income under another head in the same year.
   • Example: Loss from House Property can be set off against Salary income.
   • Exceptions:
     • Loss under the head "Profits and Gains of Business or Profession" cannot be set off against "Salaries" income.
     • A Capital Loss (whether short-term or long-term) cannot be set off against income under any other head.
     • No loss can be set off against casual income like winnings from lotteries.
     • The maximum loss from House Property that can be set off against other heads is limited to ₹2,00,000 per year.

Carry Forward and Set-off of Losses

If a loss cannot be fully set off in the same year due to the above rules or lack of sufficient income, it is carried forward to subsequent assessment years.

Type of Loss	Can be set off against (in future years)	Maximum Period of Carry Forward
Loss from House Property (Sec 71B)	Only against 'Income from House Property'.	8 Assessment Years
Normal Business Loss (Sec 72)	Only against 'Profits and Gains of Business or Profession'.	8 Assessment Years
Speculation Business Loss (Sec 73)	Only against 'Profit of a Speculation Business'.	4 Assessment Years
Short-Term Capital Loss (STCL) (Sec 74)	Against both Short-Term Capital Gain (STCG) and Long-Term Capital Gain (LTCG).	8 Assessment Years
Long-Term Capital Loss (LTCL) (Sec 74)	Only against Long-Term Capital Gain (LTCG).	8 Assessment Years