Direct and Indirect Taxes

Taxes are classified as direct tax and indirect tax. But the meaning of these two types of taxes is not clear. For a long time economists interpreted these two types in different ways. For instance, one group of economists considered taxes on production as direct taxes and those on consumption as indirect taxes. J.S. Mill distinguished these two types of taxes in terms of the ability to shift the tax. Any person on whom the tax is imposed, if he himself pays the tax, it is called direct tax and if he is able to shift the tax to somebody who ultimately pays it then it is called indirect tax. For example, income tax is paid by a person as it is levied on the income earned by him, so it is a direct tax. On the other hand the sales tax imposed on the seller is shifted to the buyer. Now-a-days the distinction between direct and indirect taxes is explained with reference to the basis of assessments and not on the point of assessment. Hence, taxes assessed on the basis of income are called direct taxes and those assessed on the basis of expenditure are called indirect taxes. However, even this classification is not free from difficulties. For instance, when one man’s income is treated as another man’s expenditure, tax on one man’s income may become the tax on another man’s expenditure. Hence, till date there has been no satisfactory distinction between direct and indirect taxes. However, in practice this distinction is retained more for the purpose of grouping the different taxes.… Read the rest

Principles of a Sound Tax System

According to Mrs. Hicks, a sound tax system should have the following characteristics:

  1. It should facilitate financing of public services.
  2. Tax, should be levied according to the ability of the people, the index of ability being income and family circumstances and
  3. Similarly placed persons should pay similar taxes to avoid any discrimination.

From the discussion above, we may lay down the following four broad characteristics as the principles of a sound tax system.

  1. Equality in Tax Burdens: This principle suggests that when the taxes are levied they ensure equality in tax burdens. In other words, through taxes the government can ensure that the tax burden is spread in such a way that persons who are placed in similar positions are made to bear the same burden of taxes. This implies that people who are better-off should bear more tax burden than those who are worse-off. Though this principle is universal, yet in the implementation of this principle problem like indicators of equality, effectiveness in practice, the method of achieving this equality, etc., will all be faced.
  2. Productivity: With the ever increasing responsibility of modern welfare state, the need for financial resources is always felt. As the modern governments spend huge amounts of money on public projects to maintain high level of public welfare, they have to raise enormous funds through taxation. Unless taxes are productive, the governments will find it difficult to implement public projects. Especially in a developing country, taxes are to be highly productive so that country can achieve growth with stability.
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Adam Smith’s Canons of Taxation

Canons of taxation are sets of criteria by which to judge taxes. These canons are still widely accepted as providing a good basis by which to judge taxes. Adam Smith laid down four canons of taxation. They are:

  1. Canon of Ability: According to this principle of taxation, the people in a country should contribute towards the government expenditure. Their contribution should be according to the ability to pay of each individual. A rich man should contribute more and the poor either should contribute less  or can be exempted. This principle of taxation will ensure that the cost of public expenditure is shared by the people in accordance with their individual ability.
  2. Canon of Certainty: Adam Smith insisted that the government should know in advance the amount of revenue that it could raise and the time when it could mobilize the revenue. On the part of individual tax payers, they must know clearly the amount of tax that they have to pay, the time when they should pay and the method of paying the tax. Adam smith felt that it is necessary that the people should be certain about their tax commitment, so that there cannot be any exploitation of the tax payers either by the government or by the tax collectors.  This implies, once the people are clear about the amount of lax, they will plan their expenditure accordingly so that tax payment will not be felt a penalty.
  3. Canon of Convenience: According to this canon, the tax should be such that it is levied at the time when it is convenient for the people to pay.
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Income Tax Assessment Procedure

Ascertaining total income is one major task of the procedure involved in levying tax on an assessee.  The task of assessing the income returned and determination of tax liability is called ‘assessment’.  The term ’assessment’ has been used in the Income-tax Act meaning differently contexts.  In certain situations, it refers to computation of income, sometimes to the determination of tax payable and in some cases to the whole procedure laid down in the Act of imposing tax liability on assessee.

Assessment of income relating to one Financial Year (FY) starts in the succeeding financial year, which is called Assesment Year (AY). Income tax assessment procedure begins when an assessee files his return of income to the income tax department.

Filing of return [Sec 139 (1)]

A person has to file return of income in the prescribed form within the specified time limit if his total income exceeds the maximum non-taxable limit. A person other than a company though income is less than the nontaxable limit, who satisfies any one of six economic criteria and residing in a specified area.

  1. Ownership of a motor vehicle other than a two wheeler
  2. Occupation of any category of immovable property as may be notified by the CBDT
  3. Incurred expenditure on foreign travel by himself or in respect of any other person. Travel to Bangladesh, Pakistan, Bhutan, Nepal, Maldives, Sri Lanka and Saudi Arabia for hajj or china on pilgrimage to Manasarover are excluded.
  4. Holder of a credit card other than an add on card
  5. Member of a club where entrance fees charged is Rs.25000 or more
  6. Expenditure of Rs.50000 or more during the PY towards consumption of electricity.
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Clubbing of Income Under Income Tax

An assessee may reduce his tax liability by transferring his assets in favor of a person who is related to him. As per [Sec 60] to [Sec 64], income belonging to some other person will be taxed in the hands of the assessee in certain situation for the purpose of avoiding tax evasion. This is called  clubbing of income.

  1. Transfer of income without the transfer of assets: Income arising to nay person by virtue of any transfer of any income, without transferring the assets is deemed to be the income of the transferor and is taxable in his hands. The transfer may be revocable or not. There is no exception to this rule.
  1. Revocable transfer of assets: Any income arising to any person from an asset as a result of revocable transfer of asset shall be deemed to be the income of transferor. As per [Sec62] the income revocable transfer of assets shall not be clubbed with income of transferor when it is effected through the medium of trust is not revocable in the life time of the beneficiary or transferee.
  1. Remuneration of spouse: any remuneration received by the spouse of the individual from a concern in which the individual has substantial interest will be clubbed with the income of the individual. However if the remuneration is solely attributable to the application of technical or professional knowledge and experience of the spouse, then the income will not be clubbed. Where both husband and wife have a substantial interest in the concern and both are in receipt of the remuneration , it will be included in the total income of husband or wife whose total income excluding such remuneration is greater.
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Income from Other Sources

Income from other source is a residuary head of income. Any item of income which does not fall under any other four specific heads of income is to be charged under this head.
According to sec 56(2) following incomes are chargeable under this head.

  • Dividend declared by a foreign company
  • Family pension
  • Winnings from lottery, crossword puzzles, horse race etc
  • Income from plant, machinery or furniture let out on hire where it is not the actual business of the assessee.
  • Interest from securities, bank deposits
  • Income from sub letting
  • Any other receipts which doesn’t fall under any other heads of income.
  • Income from agricultural land situated outside India
  • Examiner ship fees received by college teachers
  • Income from undisclosed source
  • Ground rent etc
  • Receipts without consideration in certain cases

It means any amount paid by a company, out of divisible profits, whether taxable or not taxable, to its share holders in proportion to his share holding in the company. Dividend also includes deemed dividend. The following payments are deemed as dividend.
a)      any distribution entailing the release of company’s assets
b)     any distribution of debentures, debenture stock, deposit certificates
c)      distribution on liquidation of company
d)     distribution on reduction of capital
e)      any payment by way of loan or advance by a closely held company
Dividend distributed or paid by a domestic company after 31-3-2003 is not taxable in the hands of the shareholder under sec10 (34). On such dividend, the dividend declaring company has to pay tax. But deemed dividend under sec2 (22) is taxable in the hand of the share holders.… Read the rest