Income tax in India

The government of India imposes an income tax on taxable income of individuals, Hindu Undivided Families(HUFs), companies (firms), co-operative societies and trusts. The Income Tax department is governed by the Central Board for Direct Taxes (CBDT) and is part of the Department of Revenue under the Ministry of Finance.

Individual Income Tax

Heads of Income

There are five heads of income that are taxable^[1]:

Income from Salary
Income from House Property
Income from Business and Profession
Income from Capital Gains
Income from Other Sources

Income from Salary

All income received as a salary is taxed under this head. This includes all monies paid by a company to its employees. Employers must withhold tax compulsorily, as Tax Deducted at Source (TDS), and provide their employees with a Form 16 (this is not required from 2007)which shows the tax deductions and net paid income. In addition, the Form 16 will contain any other deductions provided from salary such as:

Medical reimbursement: Up to Rs. 15,000 per year is tax free if supported by bills. (Company pays Fringe Benefit Tax on this amount)
Conveyance allowance: Up to Rs. 800 per month (Rs. 9,600 per year) is tax free if provided as conveyance allowance. No bills are required for this allowance.
Professional taxes: Most states tax employment on a per-professional basis, usually a slabbed amount based on gross income. Such taxes paid are deductible from income tax.

Income from salary is net of all the above deductions.

Capital Gains Long term capital gains tax stands at 20% (for gold, real estate and such) with indexation benefits provided for inflation. All short term gains are clubbed with income in the year the gains occur. Long term is defined as 3 years for some assets (gold, real estate, for instance) and one year for others (Mutual funds, shares).

Long term capital gains arising out of sale of shares in recognised stock exchanges and mutual fund units, is exempt from tax. 10% income tax is applied on short term capital gains (less than 1 year of holding). To qualify for these lower taxes on sale of shares, a Securities Transaction Tax (STT) must have been paid on the sale transaction. STT has been applied on all stock market transactions since October 2004 but does not apply to off-market transactions and company buybacks; therefore, the higher capital gains taxes will apply to such transactions where STT is not paid.

Stock options are only taxed at the time of exercise. For companies listed in Indian stock exchanges, the tax is calculated as regular capital gains with the rules above; purchase dates and prices are as per the time of grant. For companies abroad, the tax liability is 20% of such gains (since STT is not paid).

The effect of indexation is also allowed.

Income Exempt from Tax

Dividends

Dividends paid by Companies and Mutual Funds are exempt from tax. A 15% dividend distribution tax is paid by companies before distribution. Equity mutual funds (with more than 65% of assets invested in equities) do not pay a dividend distribution tax, though other funds do.

Other Exempt Income

The Indian Income tax act specifically exempts certain income from tax:

Money received from an Insurance company as proceeds of an insurance policy (by way of an insurance claim, or by maturity) is generally exempt. However there are three types of payments under life insurance policy that are not tax free . These are :

  1. (a) any sum received under sub-section (3) of section 80DD or sub-section (3) of section 80DDA; or
  2. (b) any sum received under a Keyman insurance policy; or
  3. (c) any sum received under an insurance policy issued on or after the 1st day of April, 2003 in respect of which the premium payable for any of the years during the term of the policy exceeds twenty per cent of the actual capital sum assured

Maturity proceeds of a Public Provident Fund (PPF) account.[source with permission [1]]

Deductions

Section 80 C Deductions

Section 80C of the Income Tax Act allows certain investments and expenditure to be tax-exempt. The total limit under this section is Rs. 100,000 (Rs. 1 lakh) which can be any combination of the below:

Contribution to Provident Fund or Public Provident Fund
Payment of life insurance premium
Investment in pension Plans
Investment in Equity Linked Savings schemes (ELSS) of mutual funds (which usually have "Tax Saving" in their names)
Investment in specified government infrastructure bonds
Investment in National Savings Certificates (interest of past NSCs is reinvested every year and can be added to the Section 80C limit)
Payments towards principal repayment of housing loans.Also any registartion fee or stamp duty paid.
Payments towards tuition fees for children to any school or college or university or similar institution. (Only for 2 children)

Interest on Housing Loans

In case the property that is a self occupied property ('SOP'), payment of interest on a housing loan up to Rs 150,000 per year is exempt from tax. However, this is only applicable for a residence constructed within three financial years after the loan is taken.

In case of a property that is a Let out property ('LOP') payment of interest on a housing loan is allowed dedcution of interest u/s 24 of the I T Act without any upper limit.

It is also provided that even if the house is not occupied on account of employement , even then the house will be taken as self occupied and dedcution of interest upto Rs 150,000 shall be allowed.

==== Income From House popertyr Income from House property is computed by taking what is called Annual Value. The annual value may be maxmimum of the following 1.Rent received or ; 2.Municipal Valuation; 3.Market Value.

From this , deduct Municapal Tax paid

That will give you , Net Annual Value

From the Net Annual Value , Deduct

1. 30% of Net value as repiar cost(This is mandatory dedcution) 2.Interest paid or payable on the fund borrowed for the purpose of purchase/construction of house

The balance is charged to tax source

Tax Rates

In India, Individual income tax is a progressive tax with three slabs.

No income tax is applicable on all income up to Rs. 110,000 per year. (Rs. 145,000 for women and Rs. 195,000 for senior citizens)
From 110,001 to 150,000 : 10% of amount greater than Rs. 110,000 (Lower limit Rs. 145,001 for women and n/a to senior citizens)
From 150,001 to 250,000 : 20% of amount greater than Rs. 150,000 + Rs. 4,000 (For women: Rs. 500) (For senior citizens, the lower limit is Rs. 195,000)
Above 250,000 : 30% of amount greater than Rs. 250,000 + Rs. 24,000 (Rs. 20,500 for women and Rs. 11,000 for senior citizens)
Above 1,000,000 : 10% surcharge is also levied on tax paid, bringing the effective rate to 33%

Surcharge

A 10% surcharge (tax on tax) is applicable for incomes above Rs. 10 lakh (Rs. 1 million). Deductions and rebates are provided for housing purchases, rent, long term savings and insurance.

Education Cess

All taxes in India are subject to an education cess, which is 3% of the total tax payable. and will be applicable from 01.03.07 except in case of service tax, where it will be applicable with enactment of finance bill.

Fringe Benefit Tax

Newly added to safegaurd against companies paying salary in the form of Fringe Benefits. Applicable to all entities paying out salaries.

Corporate Income tax

For companies, income is taxed at a flat rate of 30% for Indian companies, with a 10% surcharge applied on the tax paid by companies with gross turnover over Rs. 1 crore (10 million). Foreign companies pay 40%.^[2].An education cess of 3% (on both the tax and the surcharge) are payable, yielding effective tax rates of 33.99% for domestic companies and 41.2% for foreign companies.

From 2005-06, electronic filing of company returns is mandatory.^[3]

References

External links

[1] Taxable heads of income

[2] Income Tax Act, Tax rates for foreign companies

[3] Corporate taxpayers must file electronically, point 4 of IT circular.

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