This article is written by Pratap Alexander Muthalaly, from Government Law College, Trivandrum. It details the fiscal and revenue laws that are present in India. It also looks at the working of the tax mechanism and also how tax exemptions work.

Introduction

Taxation is a key fiscal policy instrument of the modern-day nation-state. Taxation is essentially the main source of revenue for the government. That is, everything ranging from basic amenities and services to wider national programmes is funded through taxes paid to the government.

Overview

Taxation in India is divided into two,- direct and indirect taxes. Direct taxes are imposed on the incomes and profits of individuals and corporates. Meanwhile, indirect tax is levied on goods and services as opposed to individual taxpayers. Some examples of indirect tax include service tax and customs duty.

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The taxation system in India is such that the taxes are levied by the Central Government and the State Governments. Some minor taxes are also levied by the local authorities such as the Municipality and the Local Governments. 

Major Tax Laws

Some of the major tax legislation in India include the Income Tax Act, the Income tTax Rules, the finance act, various case laws, circulars issued by the Central Board of Direct Tax (CBDT) and of course the most recent legislation pertaining to GST. Other than these we also have the provisions stated in our constitution.

Income Tax Act, 1961

This Act extends to the whole of India and consists of 298 sections, numerous subsections and 12 schedules. It deals with computation of income, powers of the tax authority, procedures for assessment, appeal, penalties and prosecution, refund and rectification of proceedings.

Income Tax Rules, 1962

The Finance Act is passed by parliament every year. It fixes the rate of income tax among other things.

Case Laws

Whenever there is a dispute between the department and the assessee, he goes to the court and the court lays down case laws from time to time. These judgments play a huge role in the development of tax law.

Circulars

These circulars are issued to deal with specific problems. The Central Board of Direct Taxes issues circulars from time to time, for the guidance of officials and also the general public. The CBDT however only has the power to issue circulars related to administrative matters.

Goods and Services Tax (GST)

The Goods and Services Tax (GST), is an indirect tax which has replaced many of the earlier indirect taxes in India such as the excise duty, VAT, services tax, etc. The Goods and Service Tax Act was passed in Parliament on 29th March 2017 and came into effect on 1st July, 2017. Various subsidiary organisations like the GST council and the GST network have been set up to navigate and effectively implement GST.

Goods and Service Tax (GST) is essentially levied on the supply of goods and services. Goods and Services Tax Law in India is a comprehensive, multi-stage, destination-based tax that is levied on every value addition. In essence, GST functions as the single domestic indirect tax law for the entire country.

Constitutional Tax provisions

Here are some of the constitutional provisions in place to regulate and govern fiscal and revenue law in this country.

  • Article 246(1) of the Constitution of India states that Parliament has exclusive powers to enact laws regarding any and all matters enumerated in List I of the Seventh Schedule of the  Constitution, that is the  Union list.
  •  Article 246(3) lists out that the State Government has exclusive powers to create laws for the state regarding any matter stated in List II of Seventh Schedule of the Constitution that is the State List.

There are also certain restrictions which have been imposed in our Constitution on the powers of State Governments and also the union government. At the moment, indirect tax especially the tax on sale and purchase of goods is imposed with certain restrictions enumerated in the Constitution as follows:

  • Article 286(1) – This provision enumerates that the state government is not allowed to place a tax on sale or purchase during imports or exports or for that matter tax on sale outside the state.
  • Article 286(2) – It is listed in this clause that the parliament is authorized to create a framework for deciding when a sale or purchase takes place (a) outside the State (b) in the course of import or export. [sections 3 ,4, 5 of CST Act, 1956 have been legislated under these powers].
  • Article 286(3) – It is stated here that the parliament can impose limits on tax on sale or purchase of goods listed out as goods of special importance and also the state government can tax the aforementioned goods subject to some  restrictions [section 14, 15 of CST Act, 1956 imposes restrictions and conditions on the power of State Governments to levy a tax on declared goods.]
  • Article 301– In accordance with this article, trade, commerce and intercourse throughout the territory of India shall be free, keeping in mind the provisions of Article 302 to 304 of the Constitution. [Entry tax in Haryana was held as ultra vires of Article 301 by the Punjab & Haryana High Court in the case of Jindal Strips Ltd. v State of Haryana and others, (2007) 29 PHT 385 (P&H)].
  • Article 302 – This article states that restrictions can be placed on trade or commerce by parliament, keeping in mind public interest.
  • Article 303(1) and 303(2) – These two provisions explicitly state that no discrimination can be made between one state and the other or for that matter providing preferential treatment to one state over the other. This aforementioned discrimination or preference can be made only by Parliament to resolve situations arising from the scarcity of goods.
  • Article 304 – In accordance with article 304, the state can levy a tax on goods imported from other States or Union territories, however, a State cannot differentiate between goods manufactured in the State and goods brought from other States.

Furthermore, the proviso to Article 304 says that the state legislature can put reasonable restrictions on freedom of trade and commerce within the state keeping in mind one’s public interest. However, such a bill cannot be introduced in the State Legislature without the previous sanction of the President.

  • Article 265 – No tax shall be levied or collected except by authority of law.
  • Article 300A – No person shall be deprived of its property save by authority of law.

Tax Mechanism

Not everyone is taxed at the same rate in India or for the same reasons, different entities have different tax burdens in India.

Individual

Essentially, individuals get taxed on the basis of tax slabs at different rates. The incidence of taxation in the case of individuals is primarily based on their residential status in the relevant tax year. The residential status of an individual is determined independently for each tax year and is calculated taking into account their actual physical presence in the country during the tax year in question and also any past years.

Residents in India can be broadly classified into three:

  • Resident and ordinarily resident (ROR).
  • Resident but not ordinarily resident (RNOR).
  • Non-resident in India (NR).

Under the ambit of India’s tax laws, the scope of taxation differs with the residential status of an individual:

  • The worldwide income of RORs is taxable in India irrespective of where it is received.
  • Meanwhile, in the case of RNORs, there is taxation only in the case of income that is received in India, or from a business or profession that is primarily based in India.
  • Similarly, NRIs are taxed only for income that arises from or is received in India.

Companies

Corporate Income Tax (CIT) is basically the income-tax paid by domestic companies, and foreign companies on income they have generated in India. The CIT is set at a specific rate as prescribed in the income tax act subject to the variations in the rates with each yearly union budget.

While a domestic company is taxed on its universal income, a foreign company is only taxed on the income it earns in India, basically that which is being generated or received in India. For the purpose of calculation of taxes under the Income-tax Act, the types of companies can be defined as domestic companies. Basically, a domestic company is one that is registered under the Companies Act of India it further includes companies registered in foreign countries wherein the base of operations is primarily in India… Meanwhile, a foreign company is one which is not registered under the companies act of India and for all purposes is controlled and managed outside India.

Private Limited Companies

There is a 30% tax on all income generated in a private limited company. Furthermore, by law a Private Limited Company is designated as a separate legal entity, from its shareholders. Along with the filing of income tax, the private limited company is also required to pay a  surcharge of 5% whenever their taxable income exceeds the minimum threshold limit that is Rs. 1 crore. Companies of this nature need to navigate the secondary and higher education cess of 1% as well. In addition to this, a private limited company has the following taxation charges.

  • Education and Higher Education Cess: Private limited companies have to pay secondary education cess at the rate of 2% and higher education cess at 1%.
  • When the Turnover exceeds one crore: Surcharge of 5% will be applicable when the company generates an income of more than Rs. 1 cr of taxable income.
  • Dividends declaration: A dividend tax at 15% is applicable whenever the Private ltd company declares the dividend. A surcharge of 10% is also relevant in this case.

Limited Liability Company (LLC)

The taxation norms for a Limited Liability Partnership are almost identical to that of a partnership firm. Given that partnership firms are legally considered separate taxable entity, they are required to pay income tax at 30% along with education cess at 2% and also secondary and higher education cess at 1%. Similar requirements are expected from a private limited company too.

In addition to the aforementioned details, a partner also has the option to claim interest on capital and also take deductions as remuneration for work rendered by them to the LLP. This however is only possible if there are provisions explicitly mentioning this in the company’s agreement.

Liaison Office

Owing to the fact that it is a foreign entity, a Liaison Office (LO) is generally not subject to Income Tax in India, as it cannot conduct business activities and earn profits on account of the Indian exchange control regulations. It is required to obtain an Indian tax registration number (PAN) and also a tax registration number (TAN). Furthermore, it is required to file an annual statement of its financial affairs and an annual activity certificate (AAC) Given that a Liaison Office cannot generally earn any profits, repatriation taxes do not apply in their case. This is the case even in situations where there are any unutilized funds available at the time of closure, these too can be repatriated without exit taxes.

Project/Branch Office

A Project Office (PO)/ Branch Office (BO) is considered as the Indian Permanent Establishment (PE) of its Foreign headquarter. As a result, it is taxable with regard to its Indian profits at a rate of 40% Also, POs are required to obtain a PAN and TAN, file annual income returns and also an AAC. PO/ BO is not subject to any additional taxes or Repatriation of surplus or at the time of closure.

Major Tax Incentives in India

Export promotion

This is in reference to Special Economic Zone units (SEZ) in operation prior to the 1st of April 2020. There are a host of benefits that such parties operating in SEZ units can avail of. This includes a deduction of 100% of profits/gains made from the export business in the first 5 years since the commencement of operations. This same type of business can also be exempt from 50% of profits and gains derived for the next 5 years.

Research and Development

This is with regard to Companies that have any expenditure on R&D in an approved in-house facility. Weighted tax deduction of 200% granted to such companies.

Startups

Tax incentives granted to eligible start-ups in the startup India scheme. Benefits include a tax holiday for any consecutive 3 years (from initial 5 years) in respect to 100% of their profits, including fast-tracking of patent applications with an 80% rebate.

Tax Exemptions For Individuals

There are numerous different tax exemptions available to individuals.

House Rent Allowance

A salaried individual having a rented accommodation can avail of HRA (House Rent Allowance) benefits. This could be totally or partially exempted from income tax. However, if the individual has chosen not to live in rented accommodation and continues to receive HRA, then it will for all purposes be deemed taxable.

Standard Deduction

The Indian Finance Minister, while presenting the Union Budget 2018, announced a standard deduction amounting to Rs. 40,000 for salaried employees. This was taking into consideration various expenses like transport allowance (Rs.19,200) and medical reimbursement (Rs. 15,000). Due to these factors, salaried people are able to avail of an additional income tax exemption of Rs. 5,800.

Leave Travel Allowance (LTA)

Within the ambit of the income tax law, there is a provision for an LTA exemption to salaried employees, however, is reserved for travel expenses incurred during leave periods. However, it must be kept in mind that the exemption is not inclusive of costs incurred for the entirety of the trip such as shopping, food expenses, entertainment and leisure among others. A person is eligible to claim LTA twice in a four-year time span. There are of course some limitations with regard to this tax exemption. One of these is that it covers the cost of domestic travel Furthermore, it is requisite that the mode of travel must be either railway, air travel, or public transport.

                  

Section 80C, 80CCC and 80CCD(1)

Section 80C is one of the most commonly used options to save on income tax payments. Basically, an individual or a HUF (Hindu Undivided Families) who invests or spends on stipulated tax-saving ventures is applicable to claim tax deductions of up to Rs. 1.5 lakh. The Indian government also provides direct support in the form of certain tax-saving instruments like the Public Provident Fund and National Payment System to name a few. This is with the intention to encourage citizens to engage in responsible financial practices like saving and investing towards retirement. This however is not applicable in the case of Expenditures/investment arising from income due to capital gains. That is, if the income of an individual arises from capital gains alone, then the provisions of Section 80C cannot be utilized for saving tax. 

Other than the exemptions mentioned above there are numerous others like the one for Medical Insurance Deduction (Section 80D), Interest on Home Loans (Section 80C and Section 24), Deduction for Loans taken for Higher Studies (Section 80E), Deduction for Donations (Section 80G), Deduction on Savings Account Interest (Section 80TTA) and the Additional Deduction for Interest on Home Loan (Section 80EE).

Conclusion

The law governing fiscal policy and revenue in India is undoubtedly complex, with a variety of complications and details. This is why there has been increased effort in recent times to simplify the Indian tax regime. The most recent example of this is of course the Goods and Services Tax of 2017, which harmonized several indirect taxes under one banner. Similar changes are required in the other areas to truly make the law of tax understandable to all laymen and not just leave it as something for expert hands. A better understanding of tax exemptions and tax incentives could result in people moving away from the illegal practice of tax evasion to the more reasonable option of tax avoidance, so as to use and control their finances better. This in turn would result in more responsible tax paying.

References

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