TAX

TAXATION India has a well developed tax structure. The power to levy taxes and duties is distributed among the three tie...

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TAXATION India has a well developed tax structure. The power to levy taxes and duties is distributed among the three tiers of Government, in accordance with the provisions of the Indian Constitution. The main taxes/duties that the Union Government is empowered to levy are:- Income Tax (except tax on agricultural income, which the State Governments can levy), Customs duties, Central Excise and Sales Tax and Service Tax. The principal taxes levied by the State Governments are:- Sales Tax (tax on intraState sale of goods), Stamp Duty (duty on transfer of property), State Excise (duty on manufacture of alcohol), Land Revenue (levy on land used for agricultural/non-agricultural purposes), Duty on Entertainment and Tax on Professions & Callings. The Local Bodies are empowered to levy tax on properties (buildings, etc.), Octroi (tax on entry of goods for use/consumption within areas of the Local Bodies), Tax on Markets and Tax/User Charges for utilities like water supply, drainage, etc. In the wake of economic reforms, the tax system in India has under gone a radical change, in line with the liberal policy. Some of the changes include:- rationalization of tax structure; progressive reduction in peak rates of customs duty ; reduction in corporate tax rate; customs duties to be aligned with ASEAN levels; introduction of value added tax ; widening of the tax base; tax laws have been simplified to ensure better compliance. Tax policy in India provides tax holidays in the form of concessions for various types of investments. These include incentives to priority sectors and to industries located in special area/ regions. Tax incentives are available also for those engaged in development of infrastructure. Taxation of Individuals Individuals are subject to income tax. Income tax is a direct tax levied on the income earned by individuals, corporations or on other forms of business entities. The Indian constitution has empowered only the Central Government to levy and collect income tax. The Income Tax department set up by the Government, is governed by the Central Board for Direct Taxes (CBDT). The CBDT is a part of Department of Revenue in the Ministry of Finance. It has been charged with all the matters relating to various direct taxes in India. It provides essential inputs for policy and planning of direct taxes in India and is also responsible for administration of direct tax laws through the Income Tax Department. For all the matters relating to Income tax, the Income Tax Act, 1961 is the umbrella Act which empowers the Central Board of Direct Taxes to formulate rules (The Income Tax Rules, 1962) for implementing the provisions of the Act. The Income Tax Act provides that in respect of the total income of the previous year of every person, income tax shall be charged for the corresponding assessment year at the rates laid down by the Finance Act for that assessment year. In other words, the income earned in a year is taxable in the next year and the income-tax rates prescribed for an assessment Year are applicable in respect of income earned during the previous Year. Note that :- The financial year in which the income is earned is known as the previous year. The financial year following a previous year is known as the assessment year. The assessment year is the year in

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which the salary earned in the previous year is taxable. Any financial year begins from 1st of April of every year and ends on 31st of March of the subsequent year.

In case of a business or profession which is newly started, the previous year commences from the date of commencement of the new business or profession up to the next 31st March, unless the person is an existing assessee. The Income Tax Act is subjected to annual amendments by the Union Budget every year. The Finance Bill in the budget contains various amendments which are sought to be made in direct and indirect taxes levied by the Central Government. The bill also mentions the rates of income tax and other taxes. The bill once approved becomes a Finance Act and provisions in it are incorporated in the Income Tax Act. Who is liable to pay income tax? Under the Income Tax Act, income tax is payable by every assessee at the rates fixed by the Finance Act every year. An "Assessee" means a person by whom any tax or any other sum of money (i.e. penalty or interest) is payable under the Act. It includes :-

Every person in respect of whom any proceeding under this Act has been taken for the assessment of his income or of the income of any other person in respect of whom he is assessable, or of the loss sustained by him or by such other person, or of the amount of refund due to him or to such other person; Every person who is deemed to be an assessee under any provision of this Act; every person who is deemed to be an assessee in default under any provision of this Act. The term "person" under the Act includes:- An Individual      

A Hindu Undivided Family(HUF) A Company A Firm An Association of Persons (AOP) or a Body of Individuals (BOI), whether incorporated or not. A Local Authority Artificial juridical persons

Sources of Income The term 'Income ' in the Income Tax Act connotes a periodical monetary return ‘coming in' with some sort of regularity, or expected regularity, from definite sources. The Income Tax Act provides that for the purpose of charge of income tax and for computation of total income all income shall be classified under five sources of income. Income of a person from each of these sources is calculated to find out the gross total income of the person. The total income from all the above heads of income is calculated in

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accordance with the provisions of the Act as they stand on the first day of April of any assessment year. Permissible deductions are reduced and then income-tax payable is calculated at the prescribed rates. If income of a person is derived from various heads, the person is entitled to claim deduction permissible under respective head whether or not computation under each head results in taxable income. The definition of income under the Income Tax Act is inclusive in nature i.e. apart from the items listed in the definition, any receipt which satisfies the basic condition of being income is also to be treated as income and charged to income tax accordingly. o o o o o

Income from Salaries Income from Capital Gains Income from House property Income from Profits & gains of business or profession Income from other sources

Income from Salaries Salary is the remuneration received by or accruing to an individual periodically for service rendered as a result of an express or implied contract. The existence of employer-employee relationship is the sinequa-non for taxing a particular receipt under the head "salaries." No, payment can be taxed under this section unless the relationship of employer and employee exists between the payer and payee. Thus, There should be contractual employer-employee relationship. The contract may be express, oral or implied. For instance, the salary received by a partner from his partnership firm carrying on a business is not chargeable as "Salaries" but as "Profits & Gains from Business & Profession". Similarly, salary received by a person as MP or MLA is taxable as " Income from other sources"., but if a person receives salary as Minister of State/Central Government, the same shall be charged to tax under the head"Salaries". Pension received by an assessee from his former employer is taxable as "Salaries" whereas pension received on his death by members of his family(Family Pension) is taxed as " Income from other sources". Under the Income-tax Act "Salary" includes :         

Wages Annuity or pension Gratuity Fees,commission,perquisites or profits in lieu of salary Advance of Salary Receipt from Provident Fund Contribution of employer to a Recognised Provident Fund in excess of the prescribed limit Leave Encashment Compensation as a result of variation in Service contract etc. The deductions from salary income admissible under the Income-tax Act are :-

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 

Standard Deduction Professional/Employment tax levied by the State Govt.

Entertainment Allowance  

Perquisites Allowances

Perquisites "Perquisite" may be defined as any casual emolument or benefit attached to an office or position in addition to salary or wages. Perquisite as defined in the Income tax Act includes:Value of rent-free/concessional rent accommodation provided by the employer. Any sum paid by employer in respect of an obligation which was actually payable by the assessee. Value of any benefit/amenity granted free or at concessional rate to specified employees etc. The following perquisites are not taxable either under the executive instructions of the Central Board of Direct Taxes or by virtue of specific provision in the Act/Rules:Rent-Free House Rent-free official residence provided to a judge of a High Court or of the Supreme Court. Rent-free furnished residence (including maintenance thereof) provided to an official of Parliament, a Union Minister or a Leader of Opposition in Parliament Accommodation provided in a 'remote area' to an employee working at a mining site or an onshore oil exploration site, or a project execution site or an accommodation provided in an offshore site of similar nature. Accommodation provided on transfer of an employee in a hotel for not exceeding 15 days in aggregate. Car Reimbursement of expenses in respect of car (which is owned by employee and used for personal and official purpose) (amount not taxable is up to Rs. 1,200 per month for car having engine capacity of not more than 1600cc, Rs. 1,600 per month for car of above 1600cc and Rs. 600 per month for driver). Conveyance facility provided to High Court Judges and Supreme Court Judges. Conveyance facility provided to an employee to cover the journey between office and residence. Interest-Free Loan Interest-free / concessional loan of an amount not exceeding Rs.20,000

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Others Gift-in-kind up to Rs.5,000 in a year. Employer's contribution to staff group insurance scheme Allowances "Allowance" is defined as a fixed quantity of money or other substance given regularly in addition to salary for meeting specific requirements of the employees. Most allowances are taxable like city compensatory allowance, tiffin allowance, fixed medical allowance and servant allowances. Encashment of any concession is also taxable. House Rent Allowance:- Out of house rent allowance received during the year, least of the following three amounts will not be included in income. The amount equal to 50% of annual salary, for persons staying in Mumbai, Chennai, Calcutta or Delhi, but 40%, for others The actual amount of house rent allowance received The amount of rent actually paid in excess of 10% of annual salary ( Here, salary includes basic salary, dearness allowance, and commission on fixed percentage, but not other allowances). Transport allowance :- Transport allowance for travelling from residence to office is exempt up to Rs 800 per month Any allowance granted for encouraging the academic, research and other professional pursuits is exempt, to the extent the allowance is utilised for the purpose specified. Children Education Allowance:- Rs. 100 per month per child up to a maximum of two children. Any allowance granted to an employee to meet the hostel expenditure on his child:- Rs. 300 per month per child up to a maximum of two children Salary income is taxable in the hands of individuals only. No other type of person such as a firm, companies can earn salary income. Income from Capital Gains Under the Income Tax Act, any profits or gains arising from the transfer of a capital asset effected in the previous year, shall be chargeable to income tax under the head 'capital gains' and shall deemed to be the income of the previous year in which the transfer took place unless such capital gain is exempted under the prescribed exemptions. 'Capital gains' means any profit or gains arising from transfer of a capital asset. If any Capital Asset is sold or transferred, the profits arising out of such sale are taxable as capital gains in the year in which

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the transfer takes place. Capital gains is the difference between the price at which the capital asset was acquired and the price at which the same asset was sold. In technical terms, capital gain is the difference between the cost of acquisition and the fair market value on the date of sale or transfer of asset. Under the existing provisions of Section 2(14), a 'capital asset' means, property of any kind held for personal use by the assessee, whether or not connected with his business or profession, personal effects held for personal use by the assessee or any number of his family dependent on him are excluded from the ambit of the definition of capital asset. The only asset that is in the nature of personal effects, but is included in the definition of capital asset is jewellery and ornaments. However, with effect from assessment year 2008-09, archeological collections, drawings, paintings, sculptures or any work of art have also been excluded from the meaning of personal effects and transfer of such personal effects will also attract capital gains tax. Capital Assets are of two types i.e., long term and short term. A capital asset held for 36 months or less before it is sold or transferred.is called as a short-term capital asset and if the period exceeds 36 months, the asset is known as a long-term capital asset. In case of shares, debentures and mutual fund units the period of holding required is only 12 months. Transfer of a short term capital asset gives rise to "Short Term Capital Gains" (STCG) and transfer of a long capital asset gives rise to "Long Term Capital Gains" ( LTCG). Different rates of tax apply for gains on transfer of the long term and short-term capital assets. Gains on short-term capital asset are taxed as regular income.  

Computation of Capital Gains Exemptions from Capital Gains

Computation of Capital Gains Capital gains are to be computed by deducting the following three amounts from the consideration money received on transfer of the asset:The actual cost of the asset or its estimated market value as on 1.4.81, if acquired earlier Where the asset was purchased, the actual cost is the price paid. But, where the asset was acquired by way of exchange for another asset, the actual cost is the fair market value of that other asset as on the date of exchange. Any expenditure incurred in connection with such purchase, exchange or other transaction e.g. brokerage paid, registration charges and legal expenses also forms a part of this cost. Sometimes advance is received against agreement to transfer a particular asset. Later on, if the advance is retained by the tax payer or forfeited for other party's failure to complete the transaction, such advance is to be deducted from the actual cost. The cost of improvement, if any, for the asset The cost of improvement means, all expenditure of a capital nature incurred in making additions or alternations to the capital asset. However, any expenditure which is deductible in computing the income under the heads Income from House Property, Profits and Gains from Business or Profession or Income from Other Sources (Interest on Securities) would not be taken as cost of

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improvement. Cost of improvement for goodwill of a business, right to manufacture, produce or process any article or thing is NIL. Expenses incurred on transfer of the asset. In case of a long-term capital asset, the costs are increased as per a Cost inflation index for the year. Exemptions from Capital Gains There are certain cases where the transfer of capital assets is taking place but the capital gain arising out of such transactions is exempt from income tax. Such exemptions are of two types:Exemption of capital gains under section 10 of the Income Tax Act. It contains exempted capital gain in the hands of various categories of persons. Exemptions of capital gains under the following sections:Profit on sale of property used for residence(Section 54) Capital gain on transfer of land used for agricultural purposes not to be charged in certain cases(Section 54B) Capital gain on compulsory acquisition of lands and buildings not to be charged in certain cases (Section 54D) Capital gain not to be charged on investment in certain bonds(Section 54EC) Capital gain on transfer of certain listed securities or unit, not to be charged in certain cases(Section 54ED) Capital gain on transfer of certain capital assets not to be charged in case of investment in residential house(Section 54F) Exemption of capital gains on transfer of assets in cases of shifting of industrial undertaking from urban area (Section 54G) Income from House property The term 'House property' consists of buildings or land appurtenant to such buildings. Income from letting out of vacant plots of land when there is no adjoining building will not be taxed under this head (but will be taxed as income from other sources). The existence of a building is, therefore, an essential prerequisite for taxation of income from house property. 'Building' will include residential house (whether let out or self-occupied), office building, factory building, godowns, flats etc. But, the purpose for which the building is used by the tenant is also immaterial. It does not make any difference at all if the property is owned by a limited company or a firm. However, if the building or part thereof is used by

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the owner himself for the purpose of his own business then there will be no income from such portion of the house property. Under the Income-tax Act, the basis of calculating income from House property is the 'Annual Value'. This is the inherent capacity of the property to earn income and it has been defined as the sum for which the property might reasonably be expected to let from year to year. Where the actual rent received is more than the reasonable return, it has been specifically provided that the actual rent will be the annual value. Where, however, the actual rent is less than the reasonable rent , the latter will be the annual value. The annual value of property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner shall be subjected to Income Tax under the head 'Income from property' after claiming deductions (under section 24) provided such property, or any portion of such property is not used by the assessee for the purposes of any business or profession, carried on by him, the profits of which are chargeable to income tax.   

Computation of income from Self Occupied property Computation of income from let out property Ownership of property

Computation of income from Self Occupied property Income is computed after giving certain deductions from the annual value of the property. Computation of annual value of self occupied property:- Self occupied property does not generate any rent and its annual value will be determined on a notional basis as if it had been let out. The annual value of Self occupied property is taken as NIL if the property is fully utilized for own residential stay during the year or if the property is not actually occupied as owner and is also not let out. However, if a property is let out for only a part of the year, proportionate annual value will be calculated. Entitled deductions for self occupied property:-The only entitled deduction is interest, if any payable, on loan taken for the purchase or construction of the house property. Computation of income from let out property Income is computed after giving certain deductions from the net annual value of the let out property. Computation of net value of let out property:- For let out properties, the gross annual value will be the greater of the following three amounts.  Municipal value of the property  Actual rent received during the year;  Fair rent i.e. rent of similar properties in the same or similar locality. Out of the gross annual value, municipal taxes actually paid during the year has to be deducted to arrive at the net annual value. The municipal taxes are to be deducted in the following cases:-

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 

The property is let out during the whole or any part of the previous year (There is no such deduction in respect of one self-occupied house property for which 'nil' annual value is adopted). The Municipal taxes must be borne by the landlord (If the Municipal taxes or any part thereof are borne by the tenant, it will not be allowed). The Municipal taxes must be paid during the year (Where the municipal taxes become due but have not been actually paid, it will not be allowed. Similarly, the year to which the taxes relate to, is also immaterial).

Under section 24 the following expenses will be allowed as deductions from the net annual value arrived at after deducting municipal taxes from the gross annual value:Repairs & Collection Charges: 30% of the Annual Value. It is a statutory deduction not dependent on the actual expenditure incurred on repairs or collection by the owner. Interest: When money is borrowed on interest and the property in question is either acquired or constructed or repaired or reconstructed with such borrowed funds, interest payable thereon is deducted from the annual value. The amount of interest payable for the relevant year should be calculated and claimed as deduction. It is immaterial whether the interest has actually been paid during the year or not. Entitled deductions for let out property:- The deductions available for computing House Property Income are the following.  

30% of the net annual value for repair and maintenance and rent collection expenses for the property Interest on money borrowed to build, buy or repair the property;

Ownership of property The assessee for taxation of income from house property must be the owner. An 'owner' of the property is one who can exercise the rights of the owner. The word 'owner' refers to the owner of the property and not to the owner of its annual value. The definition of the term 'owner of house property' has been extended beyond mere legal ownership to also cover the cases of deemed ownership. A person is deemed as owner in following cases:  

As transferor of the property to spouse or minor child for inadequate or no consideration As holder of an impartible estate or a property in part performance of a contract under the Transfer of Property Act As share holder of a co-operative society or a company, which entitles to hold any property, etc.

In case of joint ownership of any property, when the share of each co-owner is definite and ascertainable, it has been provided that each of the owners will be assessed individually in respect of share of income from the property. In other words, income from the property will be determined and

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allocated to each co-owner according to his share. When each of the co-owners of a property uses it for his residence, each of them will also get the concessional treatment in respect of one self-occupied property.

Income from Profits & gains of business or profession Under the Income Tax Act, 'Profits and Gains of Business or Profession' are also subjected to taxation. The term "business" includes any (a) trade, (b)commerce, (c)manufacture, or (d) any adventure or concern in the nature of trade, commerce or manufacture. The term "profession" implies professed attainments in special knowledge as distinguished from mere skill; "special knowledge" which is "to be acquired only after patient study and application". The words 'profits and gains' are defined as the surplus by which the receipts from the business or profession exceeds the expenditure necessary for the purpose of earning those receipts. These words should be understood to include losses also, so that in one sense 'profit and gains' represent plus income while 'losses' represent minus income. The following types of income are chargeable to tax under the heads profits and gains of business or profession:      

 

Profits and gains of any business or profession Any compensation or other payments due to or received by any person specified in section 28 of the Act Income derived by a trade, profession or similar association from specific services performed for its members Profit on sale of import entitlement licences, incentives by way of cash compensatory support and drawback of duty The value of any benefit or perquisite, whether converted into money or not, arising from business Any interest, salary, bonus, commission, or remuneration received by a partner of a firm, from such a firm Any sum whether received or receivable in cash or kind, under an agreement for not carrying out any activity in relation to any business or not to share any know-how, patent, copyright, franchise, or any other business or commercial right of similar nature or technique likely to assist in the manufacture or processing of good Any sum received under a keyman insurance policy Income from speculative transactions.

In the following cases, income from trading or business is not taxable under the head "profits and gains of business or profession":

Rent of house property is taxable under the head " Income from house property". Even if the property constitutes stock in trade of recipient of rent or the recipient of rent is engaged in the business of letting properties on rent.

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 

Deemed dividends on shares are taxable under the head "Income from other sources". Winnings from lotteries, races etc. are taxable under the head "Income from other sources".

Profits and gains of any other business are taxable, unless such profits are subjected to exemption. General principals governing the computation of taxable income under the head "profits and gains of business or profession:





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 

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Business or profession should be carried on by the assessee. It is not the ownership of business which is important , but it is the person carrying on a business or profession, who is chargeable to tax. Income from business or profession is chargeable to tax under this head only if the business or profession is carried on by the assessee at any time during the previous year. This income is taxable during the following assessment year. Profits and gains of different business or profession carried on by the assessee are not separately chargeable to tax i.e. tax incidence arises on aggregate income from all businesses or professions carried on by the assessee. But, profits and loss of a speculative business are kept separately. It is not only the legal ownership but also the beneficial ownership that has to be considered. Profits made by an assessee in winding up of a business or profession are not taxable, as no business is carried on in that case. However, such profits may be taxable as capital gains or as business income, if the process of winding up is such as to involve the carrying on of a trade. Taxable profit is the profit accrued or arising in the accounting year. Anticipated or potential profits or losses, which may occur in future, are not considered for arriving at taxable income. Also, the profits, which are taxable, are the real profits and not notional profits. Real profits from the commercial point of view, mean a gain to the person carrying on the business and not profits from narrow, technical or legalistic point of view. The yield of income by a commercial asset is the profit of the business irrespective of the manner in which that asset is exploited by the owner of the business. Any sum recovered by the assessee during the previous year, in respect of an amount or expenditure which was earlier allowed as deduction, is taxable as business income of the year in which it is recovered. Modes of book entries are generally not determinative of the question whether the assessee has earned any profit or loss. The Income tax act is not concerned with the legality or illegality of business or profession. Hence, income of illegal business or profession is not exempt from tax. Income from other sources

Under the Income Tax act, income of every kind which is not to be excluded from the total income shall be chargeable to income tax under the head 'Income from other sources', if it is not chargeable to income tax under any of the other heads of income. Thus, income from other sources is a residuary head of income i.e. income not chargeable under any other head is chargeable to tax under this head.

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All income other than income from salary, house property, business and profession or capital gains is covered under 'Income from other sources'. The following incomes are chargeable to tax :

    

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Dividend received from any entity other than domestic company. This is because dividend received from a domestic company has been made exempt in the hands of the receiver. Accordingly dividend received from a cooperative bank or dividend received from a foreign company will be taxable as income form other sources. Any pension received by the legal heirs of an employee. Any winnings from lotteries, crosswords, puzzles, races including horse races, card games or other games of any sort or gambling or betting of any form or nature. Income from any plant, machinery or furniture let out on hire where it is not the business of the assessee to do so. Income from securities by way of interest. Any sum received by the assessee from his employees as contribution to any staff welfare scheme. However when the assessee makes the payment of such contribution within the time limit under the scheme of welfare, then the payment will be allowed as a deduction and only the balance amount will be taxable. Income from subletting. Interest on bank deposits.

Allowable Deductions The following deductions are available to the assessee in obtaining the taxable amount:



In case of taxable dividend income and interest from securities, any reasonable sum paid by way of remuneration or commission for the purpose of realizing such income including interest on borrowed capital if such borrowed capital is used for making investment in shares or securities. In case of income from plant, machinery or furniture given out on hire, the following expenses will be allowed as deduction:  Current repairs to building  Current repairs to machinery, plant or furniture  Insurance premium paid for insuring the plant, machinery, building or furniture.  Depreciation on building, machinery, plant or furniture

In case of any expenditure other than capital expenditure or personal expenditure which has been incurred wholly, necessarily and exclusively for earning income like revenue expenditure, such expenditure will also be allowed as a deduction. In case of family pension received by legal heirs of an employee, a standard deduction of 1/3rd of such amount or Rs 15,000 whichever is less will be allowed by way of deduction. The following amounts are not deductible under Section 58 while computing the taxable amount:-

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 Personal expenses of the assessee.  Any interest which is payable outside India on which income tax has not been paid or deducted at source.  Any sum paid on account of wealth tax in India or abroad.  Any amount not allowable by virtue of it being unreasonable.  Any expenditure in connection with income from winning form lotteries, crosswords, and cross puzzles, races including race horses, car race and other games of races, gambling, betting of any form. However expenses are allowed as a deduction in computing the income of an assessee who earns income from maintaining as well as holding race horses. Compute the taxable income Given the different sources of income, depending upon the nature of income the tax treatment of the income of the individual varies :





In case of the income earned by the tax payer, all incomes shall be subject to taxation except: The incomes subject to exemption and  incomes to be included in the income of others. If individual is a part of a firm, in case of his share in the profits of the firm, his income is exempt (under section 10(2A) of the Act) from taxation. But with respect to his salary and interest from the firm, these are taxable as business income of the individual. If individual is a part of association of persons(AOP) or body of individuals(BOI), if the association or body is taxable at the maximum marginal rate (or at a higher rate), then the individuals share of profit is not taxable under the Act.

Steps to find out the taxable income of individuals:

 

Find out the income under the different 'heads of income', which include: Salaries  Income from House property  Profits and gains of business or profession  Capital Gains  Income from other sources The income is subjected to 'adjustment of losses' of the current years and earlier years. The income after the adjustment of losses is the "gross total income". From the gross total income the prescribed 'deductions' under the Income Tax Act are made.

The balance so obtained is known as "Net Income" or Taxable Income. (Source : www.incometax.gov.in)

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