BASIC CONCEPTS OF INCOME TAX(PART 3)

income tax, calculation, calculate

A QUICK RECAP

In the last session, we come to a step closer to the completion of basic nuances of taxation. We have talked about the payment of the taxation of the previous year’s income during the same year.

In this case, the previous year is the same as that of the assessment year

Under this head, we have basically discussed sec 172,174,174A,175,176. Furthermore, we have discussed the sections [sec68,69,69A,69B,69C &69D] related to the relevant previous years for undisclosed sources of income.

Then we have brief discussion on how to compute “taxable income” & “tax” thereon.

RATES OF INCOME TAX

              NORMAL TAX RATES                        SPECIAL TAX RATES
Normal rates of income tax (these are specified by the relevant Finance Act):

·       These are the rates that may vary from person to person. Normal income is always taxed by using normal rates of tax.

Special rates of income tax (these are specified by the Income Tax Act):

·       These are the rates that do not vary from person to person but are chargeable at the same rate irrespective of the type of person. Special incomes (e.g., capital gains, lotteries, etc.) are taxed by using special rates of tax.

 

Capital v/s revenue receipts:

A receipt is taxable if it is of the nature of income. But receipts which are of capital nature are generally not taxable. The basic scheme of income-tax is to tax income not capital, and similarly to allow revenue expenditure. But this general rule is subject to certain exceptions. An amount referable to fixed capital is a capital receipt whereas a receipt referable to circulating capital would be a revenue receipt. While the latter is chargeable to tax, the former is not subject to income-tax unless otherwise expressly provided.

 

 

 

Distinction between Capital Receipt and Revenue Receipt:

                 REVENUE RECEIPT                   CAPITAL RECEIPT
It has a short-term effect. The benefit is enjoyed within one accounting period. It has a long-term effect. The benefit is enjoyed for many years in the future.
It occurs repeatedly. It is recurring and regular. It does not occur again and again. It is nonrecurring and irregular.
It is shown in profit and loss account on the credit side. It is shown in the Balance Sheet on the liability side.
It does not produce capital receipt. Capital receipt, when invested, produces revenue receipt e.g., when capital is invested by the owner, business gets revenue receipt (i.e., sale proceeds of goods etc.).
This does not increase or decrease the value of assets or liabilities. The capital receipt decreases the value of an asset or increases the value of liability e.g., sale of a fixed asset, loan from bank etc.
Sometimes, expenses of capital nature are to be incurred for revenue receipt, e.g., purchase of shares of a company is capital expenditure but dividend received on shares is a revenue receipt. Sometimes expenses of revenue nature are to be incurred for such receipt e.g., on obtaining loan (a capital receipt) interest is paid until its repayment.
It is always taxable unless an exemption is provided. It is not taxable unless it is specifically included in the definition of ‘income’.

 

                     FIXED CAPITAL                 CIRCULATING CAPITAL
Fixed capital is that which is not involved directly in the process of business but remains unaffected by the process. Circulating capital is that part of the capital which is turned over in the business and which    ultimately results in prot or loss. For instance, proceeds of sale of stock-in-trade is a revenue receipt while the sale proceeds of building, machinery or plant will be a capital receipt

 

The Income-tax Act does not define the term “Capital receipt” & “Revenue receipt”. Also, it has not laid down the criterion for differentiating the capital and revenue receipt. Yet, it has exempted certain capital receipts from taxation while certain capital receipts have been taken into ambit of capital receipts chargeable as capital gains. Whether a particular receipt is of the nature of income or capital is explained below by the following examples. The following test can be applied to determine the nature of a particular receipt.

 

                 BASE          EXPLAINATION              EXAMPLE
Type of capital will depend upon the nature of business. The very same thing may be fixed capital in the hands of one business but circulating capital in the hands of another. An amount received on account of sale of trading goods or receipts in respect of circulating capital or of owing capital is revenue receipt, for example sale of a motor car by a dealer. On the other hand, a receipt on account of sale of fixed assets is a capital receipt, for example, amount received on sale of a motor car by a person who is not a car dealer.
Nature of receipt also depends upon the reference to the recipient Whether a particular receipt is capital or revenue in nature must be determined with reference to the recipient who is sought to be taxed as the assessee. For tax purposes the capital or revenue character of the receipt must be determined on the basis of the nature of the trade in the course of which or in connection with which it arises. •                    The reimbursement of capital outlay is a capital receipt even if the total amount received exceeds the cost of the outlay itself.

•                    Compensation received for the loss of a capital asset is a receipt of a capital nature whereas the compensation received for damage to or loss of a trading asset is a revenue receipt.

•                    A capital asset is converted into income and the price realized on its sale takes form of the periodic payments of a revenue nature;

•                    Where a person sells his properties and the sale price is

payable to him by the purchaser in the form of annuities of a fixed sum so long as the seller is alive or until he attains a particular age.

Capital & revenue receipts in relation to business activities. Profits & gains arising from the various transactions which are entered into the ordinary course of business of the tax payers or those which are incidental to or closely associated with his business would be revenue receipts chargeable to tax.

But even in these cases, the receipts may be of a capital nature in certain circumstances.

·       Profits on purchase & sales of shares by a share broker on his own account;

·       Profits arising from dealings in foreign exchange by a banker or other financial institutions, income from letting out buildings owned by a company to its employees etc.

 

For a moment, profit on sale of shares & securities held by a bank as investments would be of a capital nature. Where profits arise from transactions that are outside the normal dealing of the assessee, although connected with his business, the taxable nature or otherwise of the profits would depend upon the fact whether or not the transactions in question constitute trading activity.

 

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