ABSTRACT
This paper provides an in-depth examination of the computation process for total income, a fundamental aspect of financial analysis for individuals, businesses, and organizations. The computation of total income is a critical process in financial management and taxation, entailing a comprehensive aggregation of all income sources to determine an individual’s or entity’s gross earnings. It outlines the various components that contribute to total income, including residential status, heads of income, aggregation of income, Gross Total Income, deductions and other sources. Key to this computation are the principles and regulations set forth by tax authorities, which stipulate what constitutes taxable income and allowable deductions. The methodology involves meticulous data collection, accurate categorization of income types, and the application of specific tax codes to ensure compliance and accuracy. Advanced computational tools and software have significantly enhanced the efficiency and precision of this process, providing robust frameworks for data integration and error minimization. The paper discusses the methodologies, formulas, and considerations involved in accurately calculating total income, considering factors such as deductions, exemptions, tax implications and methods of accounting of heads of income. Additionally, it explores the importance of understanding total income in financial planning, budgeting, and decision-making processes. Through a systematic review of relevant literature and practical examples, this paper aims to enhance understanding and facilitate effective computation of total income for diverse stakeholders.
INTRODUCTION
Albert Bushnell Hart: “Taxation is the price which civilized communities pay for the opportunity of remaining civilized.”
Albert Einstein: “the hardest thing in the world to understand is the income tax.”
Taxes are mandatory contributions levied on individuals or corporations by a government entity to help to build/ boost the economy of a country by meeting various public expenses.[1]It is a financial burden imposed on a person by the government. Tax is imposed on us so that the facilities and benefits can be provided to us.
TYPES OF TAX
1. Direct tax
2. Indirect tax
DIRECT TAX: Direct taxes are imposed on income and profits. It is imposed on persons income, tax is paid by the person who is earning. It is directly paid to the government.
INDIRECT TAX: It is imposed on goods and services which are consumed by the person. If such goods are consumed in India then GST Act is applied on it. But when these goods are consumed outside India then Custom law is applied.
In Indirect tax, tax is paid by the person to the supplier and supplier acts as a mediator and pays it to the government. India had several erstwhile indirect taxes such as service tax, value added tax (VAT), Central Excise, etc., which used to be levied at multiple supply chain stages. Some taxes were governed by the states and some by the Centre. There was no unified and centralized tax on both goods and services. Hence, GST was introduced. Under GST, all the major indirect taxes were subsumed into one. It has greatly reduced the compliance burden on taxpayers and eased tax administration for the government.[2]
MISCELLANEOUS TAX: Means any tax other than an income tax or a transfer tax. Such as stamp duty, motor vehicle duty, electricity duty, other miscellaneous tax.
DIRECT TAX (Income Tax Law)
1. Income Tax Act,1961 (as amended by Finance Act, 2021): Charge of income tax is governed by the Income Tax Act, 1961, which came into force w.e.f.1st April, 1962. Only rules and provisions are mentioned in it.
Income tax Act, 1961 tells us about our total income/ actual income after all the deductions.
2. Income Tax Rules, 1962: section 295 of the Act empowers the Central Board of Direct Taxes to make rules. Tells us how to implement the rules and provisions mentioned in Income Tax Act,1961 and how to pay the tax and how to escape from it.
3. Government Notifications: through official gazette we can bring changes and can even amend Income Tax Act and Rules.
4. Finance Act – Annual: Every year on 1st of Feb our Finance Minister presents a Finance bill. As soon as the bill is passed by both the houses of parliament and thereafter receives the assent of the president of India, it becomes the Finance Act. The amendments proposed therein are then incorporated in the Income Tax Act, which are applicable from the very first day of the next financial year. For example: Amendments by Finance Act, 2021 are effective from 1st of April, 2022.
5. Circular and Clarification by (CBDT) Central Board of Direct Tax: section 119 of the Act empowers the CBDT to issue orders, instructions and directions for the proper administration of the Act.
6. Judicial Decisions: any changes brought by the judiciary and the government with respect to Income Tax then it is considered as judicial decisions.
Direct tax is levied on the total income of the person or individual.
TOTAL INCOME = TAXABLE INCOME
COMPUTATION OF TOTAL INCOME
FIRST STEP: Determination of Residential Status.
a. Resident of India
b. Non resident
Resident- if you are living in India, generating your income from India, then you have to pay taxes in India as well.
Residential status changes every year. It is to be determined for calculating tax payable by resident or non-resident.
If a resident of India, tax is levied on the global income of the individual.
If a non-resident, tax is only levied upon the income generated from /in India.
RESIDENTIAL STATUS – INDIVIDUAL
Individual has a unique single identity, under section 6(1)- two basic conditions are given foe a person to be resident. If an individual fulfills at least one condition among them, then he is “Resident”, otherwise he becomes a Non-“Resident”.
CONDITIONS
1. If the individual / person stays or resides in India for a period of 182 days or more in the relevant previous year or,
2. If the individual / person stays or resides in India for a period of 60 days or more in the relevant previous year and has stayed in India for at least 365 days in the immediately preceding four years from the relevant previous year.
· NOTE: Residential status can be different for each previous year.
· Residential and citizenship is different.
EXCEPTIONS
For these two individual/ persons only 1st basic condition is applicable:
1. Indian citizen who left India for the purpose of employment outside India, OR
Indian citizen who left India during the previous year as a member of a crew Indian ship.
2. Indian citizen or person of Indian origin who comes on a visit to India during the previous year having total income (Indian income) other than foreign income exceeding 15 lacs during the previous year.
ADDITIONAL CONDITIONS
To classify whether a resident individual is ROR or RNOR.
FOR ROR (RESIDENT BUT ORDINARY RESIDENT)—
a. The person has been a resident for at least two years in the past ten years from and before the relevant previous year.
b. The person has resided in India for 730 days or more during the 7 years immediately preceding the relevant previous year.
If he satisfy just one condition (and not both the given conditions), he will still be a RNOR (Resident but not ordinary resident). He needs to satisfy both the conditions to become ROR.
EXCEPTIONS—
Following resident is always an RNOR—
a. Indian citizen who is deemed-to-be a resident in India (deemed resident).
b. Indian citizen and person of Indian origin who comes on a visit to India during the previous year having total income, other than Foreign income, exceeding rupees 15 lacs during the previous year.
RESIDENTIAL STATUS –HINDU UNDIVIDED FAMILY (HUF)
PLACE OF CONTROL (the place where the Karta or co-parceners in certain cases, takes the decision.) | RESIDENTIAL STATUS |
1. Control and management of the HUF is wholly in India. | Resident in India.
|
2. Control and management of the HUF is wholly outside India. | Non-resident.
|
3. Control and management of HUF is partially in India and partially outside India (even if 99% of the decision is taken from outside India and only 1% of the decision is taken from India then the HUF is considered as “resident”. For example; decision to sell the property is taken from Canada, but the computation of its value, it’s registry etc. is done by the Karta after returning to India, then it will be considered as a resident of India.
| Resident |
FOR ROR AND RNOR—
Same as the additional conditions for “Resident”.
But, the second condition must be fulfilled by Karta only, however, the first condition may be fulfilled by Karta as well as the co-parceners.
RESIDENTIAL STATUS – COMPANY
RESIDENT: Must be an Indian company ( does not include domestic foreign company).
OR
Place of effective management is at any time in that year, in India. (example; board of directors meeting, even if just for one time in that year, held in India then even a Foreign company ill be treated as a resident).
NON-RESIDENT: if not a Resident, the company will be non-resident.
RESIDENTIAL STATUS – OTHER PERSONS
a. Control and management of affairs of a firm and other person is 100% in India: Resident.
b. Control and management of affairs of a firm and other person is 100% outside India: Non-Resident.
c. Control and management of affairs of a firm and other person is partially in and partially outside India: Resident.
NOTE:
i. A firm or other person can not be Ordinary Resident or Not Ordinary Resident.
ii. The residential status of a person, member of a firm, member of association is not relevant in determining the status of the firm.
iii. Control and management is situated at a place where the decisions concerning affairs are taken.
SECOND STEP: CLASSIFICATION OF INCOME UNDER VARIOUS HEADS.
a) Salary
b) House property
c) PGBP (Profit and Gain from Business and Profession)
d) CG (Capital Gains)
e) Other sources
A. INCOME FROM SALARAY (SEC.15)
A salary is a form of compensation given to a person for performing work during a specified period.
According to sec.15, the following income shall be chargeable to income tax under the head “salaries”[3].
1. Any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not.
2. Any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, though not due or before it became due to him.
3. Any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.
An explanation to sec.15 declares that where any salary paid in advance is included in the total income of any person for any previous year, it shall not be included again in the total income of the person when the salary becomes due.
After analyzing sec.15, following points are found to be notable:
· There should be employer- employees relationship or master servant relationship between the payer and payee.[4] Every servant is an employee but an agent may not be an employee.[5]
· Employer and payer can control the working hours of it’s employee’s and receiver’s.
· Employees are bound to follow the instructions given by the employer.
· Controlling and managing power lies in the hands of the employers.
A few examples when there is no control of the payer over the receiver.
1. Partner of the firm: any salary, bonus etc. received by a partner from the firm shall not be regarded as a salary.
2. A director of a company.
3. Member of a parliament.
4. Lecturers
B. INCOME FROM HOUSE PROPERTY:
Under section.22, house property means buildings and lands appurtenant thereto. The property other than buildings and land appurtenant to the buildings have been excluded from the operation of the section.[6]
Where a company is incorporated with the object to develop market consisting of shops and stalls, etc; the income derived by the company by letting out the market shops and stalls may be taxed under this head.[7]
In Chelmsford Club v. C.I.T.[8]the Supreme Court has made it clear that the tax is levied under section.22 is a tax on income and on property.
when you put your house on rent, this will be computed under House property since the income is generated from it after some intervals, for example: rent is being generated every month, hence amounting to monthly income.
However, when you sell your house, it isn’t included in house property, but in capital gains since it becomes capital asset when you sell it.
C. PROFIT AND GAINS FROM BUSINESS AND PROFESSION:
The word “business” denotes an activity capable of producing a profit which may be taxed.[9]
The word “profession” involves the idea of an occupation requiring either purely intellectual skill (lawyers, doctors, engineers etc.) or of any manual skill (services rendered in painting, sculpture), skill controlled by the intellectual skill of the operator as distinguished from an occupation which is substantially the production or arrangements for the production or sale of commodities.[10]
For example; you established a shop and generate some profit from it, it will be covered under this criteria.
D. CAPITAL GAINS:
Capital gains should be taken to mean profits or gains arising to the assessee from the transfer of a capital asset. Such capital gain is added to the total income of the previous year in which the transfer of the assets took place.[11]
When you sell your house, it isn’t included in house property, but in capital gains since it becomes capital asset when you sell it.
Capital Assets: something or some property which you can sell only one time and generate a one time lump sum amount from it. Example; you can not sell your house again and again. Therefore, income generated from house sale is covered under capital gains. Other examples are, shares, jewellery etc.
E. OTHER SOURCES:
Income which cannot be covered under the above four heads (salary, house property, PGBP, Capital gains), then it will be covered under this head. For example income gained from: dividends (income includes dividends also.)[12] Winning from betting, lotteries, gambling, crossword puzzles, races including horse races, card games etc.
THIRD STEP: AGGREGATION OF INCOME
A. Clubbing provision: when separate income of two individuals is clubbed together for the computation of taxable income.
for example: Mr. R makes an F.D in the name of his wife (a housewife) and when the F.D matures, the wife gets a profit of 10%. Now, since the wife is a housewife and is not generating any income then where did the money for the F.D came from? It is from the husband’s (Mr. R) income. Therefore, the couple would have to pay taxes on the profit gained by them even though the receiver (wife) is a non-assessee.
B. Set-off and Carry Forward: when the loss is deducted from the taxable income the same year for the computation of income it is called “set-off”.
When the loss suffered this year, is deducted from the income of the next year for the computation of income of that next year, it is called “carry forward”, since the loss of previous year is carried forward.
FORTH STEP: GROSS TOTAL INCOME (GTI)
After following all the above three steps, the total income of the individual is generated (by clubbing, setting-off, and carry forwarding all his classified income), such total income is called “Gross Total Income”.
FIFTH STEP: DEDUCTIONS UNDER SECTION 80C- 80U
After the computation of the Gross total income (GTI), deductions in such income are done as per section 80C to 80 U of the Act.
The final income after the deductions will be the “taxable income” of the individual.
Deductions in respect of certain payments is mentioned under section.80C, 80CC (omitted), 80CCA, 80CCB, 80CCC, 80CCD, 80CCE, 80CCF, 80CCG, 80D, 80DD, 80DDB, 80E, 80EE, 80G, 80GG, 80GGA, 80GGB, 80GGC. Deductions in respect of certain incomes is mentioned under section 80HH- 80RRB. Deductions in respect of other incomes is mentioned under section 80TTA-80TTB. Other Deductions are mentioned under section 80U of the Income Tax Act, 1961.[13]
Income tax exemption v/s tax deduction:[14]
Income tax exemptions are provided on particular sources of income and not on the total income. It can also mean that you do not have to pay any tax for income coming from that source. For example, income from agriculture is exempted under tax. In addition, long-term capital gains arising from the sale of a property can be reinvested in a real estate property or specified bonds within a certain time period to get tax exemption. Salaried individuals get house rent allowance (HRA) as a component of their salary. This component can be used to claim tax exemption under certain conditions.
In contrast, income tax deductions can be claimed on the gross total income. Certain specified investments and expenditure are considered to claim deductions. For example, investment in specified mutual funds, interest repayment of education loan, and premium payment for medical insurance can be considered for deductions. Also, salaried taxpayers can claim a standard deduction of Rs.40,000 from the gross salary. This standard deduction has been enhanced to Rs.50,000. This reduces their total taxable income and, in turn, reduces the tax payable.
ACCOUNTATION OF INCOME (METHOD OF ACCOUNTING OF HEAD OF INCOME):
Income is accounted in two ways:
1. Accrual basis (income is in existence, but hasn’t been received yet).
2. Cash basis (income which is received).
ACCRUAL BASIS: In accrual basis, the expenditure and revenue income belongs to a particular year in which it is accrued.
For example: you bought a land amounting to rupees 5,00,000 this year. The registry and formalities are done, however you haven’t paid the amount yet. It’ll be counted as your “expenditure” for the year as the amount has come into existence, i.e; the amount is accrued even though you haven’t made the payment yet.
Similarly, the amount which is supposed to be received by you (revenue generated) will also be counted, even though we haven’t received it yet (and no matter whether we receive such amount in 2 years or 10 years).
CASH BASIS: In the expenditure column, we will write the details of the expenditure which we have done in a particular year let say 2018-19.
In the revenue column, we will write the details of the revenue received.
Tax is imposed on the basis of the income which has been received in a particular year, even though it is the payment which was supposed to be received two years ago. For example: you sold your house for 3,00,000 in 2019. But due to some circumstances, the payment is made to you in 2020, then this revenue will be counted as the revenue generated in 2020 (the year in which payment is received), instead of 2019 (the year in which payment was supposed to be made).
METHOD OF ACCOUNTING: SALARY
Salary is always taxable either on due basis or on receivable basis whichever is earlier.
Due basis: taxable from the date on which the salary was due, i.e, was supposed to be received.
Receivable basis: taxable from the date on which the salary is received.
METHOD OF ACCOUNTING: HOUSE PROPERTY
No matter whether you’ve been paid the rent by your tenant or not, you have to pay tax on the rent which you were supposed to receive.
The object is to prevent the evasion from paying tax (tax evasion).
METHOD OF ACCOUNTING: INCOME FROM BUSINESS AND PROFESSION (PGBP):
Either on cash basis or on accrual basis, the option is on the assessee (businessman).
METHOD OF ACCOUNTING: INCOME FROM CAPITAL GAINS
Taxable during the previous year in which the capital asset is transferred, i.e; the year of the accrual. Here, the “transfer” means “sale”.
Taxable from the moment the sale is made no matter the payment is exchanged or not between the parties.
METHOD OF ACCOUNTING: INCOME FROM OTHER SOURCES
Either on cash basis or on accrual basis, the option is on the assessee (businessman).
LITIGATION MANAGEMENT- ADDRESSING THE TRUST DEFICIT[15]
Another major issue impacting the Indian tax system is the high level of litigation and resultant blocked tax revenue. According to figures published by the Central Board of Direct Taxes (CBDT), the number of appeals pending with the Commissioner of Income Tax (Appeals)[16] was 5,00,030 as on 1 April 2021. Further, 53,000 appeals were pending in 63 Tribunal benches located at 30 places across India.[17] Such high levels of litigation have an adverse impact on tax certainty, which is of fundamental importance for any tax system. Moreover, it is now well accepted that the evaluation of tax risks is an important factor in making investment decisions, and a competitive tax regime must offer a high level of tax certainty.
Various dispute resolution schemes (such as the Vivad se Vishwas scheme in 2020) have succeeded only to some extent in reducing the quantum of litigation and amount in dispute. Further, the Central Government has tried to settle certain long pending issues by bringing in amendments to the law through the budget. However, the overall level of litigation continues to increase and the revenue blocked in appeals has assumed humongous proportions (the statement of tax revenues raised but not realised published as part of the Receipt Budget 2022-23 shows an amount of INR 10,576,390 million [USD 135,595 million] as disputed corporate and income tax as at the end of 2020–21). In addition, increasing costs of litigation for taxpayers and higher administrative costs for the Revenue have increased the perception of tax uncertainty and widened the trust deficit between taxpayers and the Revenue.
Litigation abounds also in the sphere of indirect taxation. According to the Economic Survey 2018, nearly INR 7,580,000 million (USD 97,179 million) of tax (including direct as well as indirect tax), which was about 4.7% of the total Indian GDP, was involved in litigation at all levels of judiciary (i.e. Appellate Tribunal and above).
Despite being a nascent law, GST has had more than its fair share of disputes relating to issues such as transitional credit, input credit matching and supply between distinct persons. The conflicting rulings by different Advance Ruling Authorities as well as the non-constitution of the GST Tribunal have overburdened the High Courts with avoidable litigation. There is a dire need to curtail wasteful expenditure on litigations, especially by the tax departments, while streamlining the entire dispute resolution process.
CONCLUSION:
In conclusion, the computation of total income is a crucial aspect of personal or business finance management and tax compliance. It involves meticulously aggregating all sources of income, including salaries, business profits, investment returns, rental income, and any other earnings. The advent of advanced computational tools has significantly improved the accuracy and efficiency of income computation, reducing errors and enhancing data integration capabilities. Deductions, exemptions, and allowances must be carefully considered to arrive at the final taxable income figure. It's imperative to maintain accurate records and stay updated on tax laws and regulations to ensure compliance and optimize tax efficiency. Seeking professional advice from tax experts or financial advisors can provide valuable insights and guidance in navigating the complexities of income computation, ensuring financial health and legal compliance.
[3]Dr. kailash Rai, Taxation laws ( law of income tax and wealth tax), ninth edition 2007.
[4] C.I.T. v. R. Johnstone, (1934) 2 I.T.R. 390 (Rang.); Lakshminarayan Ram Gopal & sons Ltd. V. The Government of Hyderabad (1954) 25 I.T.R. 499 (S.C.); C.I.T. v. L.W. Russel, (1964) 58 I.T.R. 91 (S.C.)
[5] Lakshminarayan Ram Gopal & sons Ltd. V. The Government of Hyderabad, Ibid.
[6] Probhat Chandra Barua v. emperor, A.I.R. 1930 P.C. 209.
[7] East India Housing and Land Development Trust Ltd. V. C.I.T; (1961) 42 I.T.R. 49 (S.C.) see also Commercial Properties Ltd. V. C.I.T. 31 T.C. 23.
[8] A.I.R. 2000 S.C. 1092.
[9] C.I.T. V. Lahore Electric Supply Co. Ltd. (1966) 60 I.T.R. 1 (S.C.).
[10] C.I.T. v. Manmohan Das, (1966) 59 L.T.R. 699 (S.C.)
[11] Income Tax Act, 1961, section 45.
[12] Income Tax Act,1961, Section.2 (24).
[13] Income tax act,1961, sec.80U.
[15]https://www.pwc.in/research-and-insights-hub/immersive-outlook/addressing-the-tax-gap-in-india.html#:~:text=Another%20major%20issues%20impacting%20the,as%20on%201%20April%202021.
[16] Central Action Plan 2021-22,CBDT, Ministry of Finance,2021
[17] Media Article, theprint
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