Indian taxation System

India is a federal republic comprising the Central Government, twenty-nine self-governing States and six Union Territories. Tax legislation is enacted at both the Central level and State level. The Central Government is empowered to levy almost all direct and some indirect taxes. The State Governments are empowered to levy agricultural income tax and some indirect taxes like sales taxes, property taxes, stamp duty, etc.

The Taxation Laws (Amendment) Ordinance, 2003

Income is taxed in India in accordance with the provisions of the Income-tax Act, 1961 (the Act). The Ministry of Finance (Department of Revenue) through the Central Board of Direct Taxes (CBDT), an apex tax authority, implements and administers direct tax laws. Issues involving interpretation of tax laws are decided by the judiciary, which is independent of the legislature. Circulars, Notifications and Clarifications issued by the CBDT supplement the Act.

The "tax year" runs from 1 April to 31 March of the following calendar year for all taxpayers. Taxable income has to be ascertained separately for different classes of income and is then aggregated to determine total taxable income. The "previous year" basis of assessment is used i.e any income pertaining to the "tax year" is offered to tax in the following year (known as assessment year).

Income tax is levied on "taxable income", comprising the following categories, referred to as "Heads of Income"

• salaries
• income from house property
• profits and gains of business or profession
• capital gains
• income from other sources

Generally, domestic companies, partnerships and local authorities are subject to tax at flat rates, whereas individuals and specified taxpayers are subject to progressive tax rates. Foreign companies and non-resident individuals are subject to tax at rates, which depend upon the type of income. Agricultural income is exempt from income tax at the Central level but is taken into account for rate purposes. Income earned by specified organisations e.g., trusts, hospitals, universities, mutual funds etc., is exempt from tax, subject to the fulfillment of certain conditions.

India adopts the self-assessment tax system. Taxpayers are required to file their tax returns and pay the tax. The Tax Officer may choose to make a scrutiny assessment to assess the correct amount of tax by calling for further details.

Generally, taxpayers are liable to make income tax payments as advance tax, in three or four installment, depending on the category they belong to, during the year in which the income is earned. Employed individuals are subject to tax withholding by the employer on pay-as-you-earn basis.

Taxable Income

Tax is payable on total income after deducting allowable deductions. Income includes profits and gains from business, capital gains, interest, rent, royalties, dividends, service fees, commission, etc.

Dividends

Dividends distributed by domestic companies on or after 1 April 2003 are subject to a dividend distribution tax of 12.8125% (inclusive of surcharge of 2.5%). Dividends so distributed are, however, not subject to tax in the hands of the shareholders (irrespective of their residential status).

Exempt Income

Certain types of income are excluded from the ambit of taxation, some of them being

• agricultural income earned from carrying out direct agricultural operations
• income of approved mutual funds
• income by way of dividends or long-term capital gains of an infrastructure capital fund or an infrastructure capital company from investments by way of shares or long-term finance in any enterprise wholly engaged in the business of developing, maintaining and operating any infrastructure facility, subject to certain prescribed conditions.

Generally, all expenses incurred for business purposes are deductible from taxable income. The requisite for deductibility of expenses is that the expenses must be wholly and exclusively incurred for business purposes; that the expenses must be incurred or paid during the previous year and supported by relevant papers and records. Expenses of a personal or a capital nature are not deductible. Income tax paid is not allowable as a deduction.

Expenditure incurred on taxes (excluding income tax) and duties, bonus or commission to employees, fees under any law, interest on loans or borrowings from public financial institutions and interest on term loans from scheduled banks is deductible only if it is paid during the previous year, or on or before the due date for furnishing the return of income, and the return is accompanied by evidence of such payment. However, interest on capital borrowed for acquisition of assets acquired for extension of existing business is not allowed as a deduction until the time such assets are actually put to use.

Employee’s contributions to specified staff welfare funds – that is, provident funds, gratuity funds, etc. – are allowed only if actually paid during the previous year on or before the applicable due date. However, employer’s contributions to these funds are deductible even if paid before the due date of filing of the return of income.

Salaries, interest, royalties, technical service fees, commissions or any other amount payable outside India or in India to a non-resident (other than a foreign company), on which the applicable withholding tax has not been withheld or paid are not deductible. Such amounts are deductible in the year in which the withholding tax is paid. Where in respect of these payments, tax has been deducted in the relevant year but paid in the subsequent year within the prescribed time limit, the payments made are deductible in the relevant year. But if the tax so paid in the subsequent year is not paid within the prescribed time limit, the deduction is allowed only in the subsequent year.

Head-office Expenditure

Foreign companies operating in India through a branch are allowed to deduct executive and general administrative expenditure incurred by the head office outside India. However, such expenditure is restricted to the lower of:

• 5% of adjusted total income (as defined)
• expenditure attributable to the Indian business

In cases where the adjusted total income for a year is a loss, the expenditure is restricted to 5% of the average adjusted total income (as defined)

Bad Debts

Bad debts written off are tax-deductible. Provision for doubtful debts is not tax-deductible. Banking companies and public financial institutions are allowed a deduction for provisions for doubtful debts up to 5% of income, as specifically defined for this purpose. Bad debts actually written off by banks and public financial institutions, in excess of the accumulated provision for doubtful debts, are deductible.

Export Profits and other earnings in foreign exchange

Certain incentives are available for certain types of earnings in foreign exchange. Currently, 50% of the profits from the export of select goods and software (calculated as per prescribed formulae) are deductible while computing taxable income. Deductions are also available in respect of select other items of income earned in foreign exchange.

These incentives are, however, being withdrawn in a phased manner and will not be allowed for the year ended on 31 March 2005 and subsequent years.

Losses

Unabsorbed business losses can be carried forward and set off against the business profits of any business for a maximum of eight years. Business loss can be carried forward and set off against the profits of any other business. Losses from a speculation business (as defined) can be set off only against gains from speculation business. Losses are not allowed to be carried forward unless the return of income is filed in time. Unlisted companies could lose the right to carry forward the business loss if there is a substantial change in the shareholding. In the case of mergers and demergers, a transferee company is entitled to carry-forward of select losses of the transferor company, subject to satisfaction of certain conditions by both the transferee as well as the transferor company Carry-back of losses is not permitted.

Grouping / Consolidation

No provisions currently exist for the grouping / consolidation of losses of entities within the same group.
Tax Depreciation / Capital Allowances

Depreciation is calculated on the declining-balance method. Depreciation is computed at varying rates as prescribed. All assets of the same type eligible for the same rate of tax depreciation are treated as a common block for the calculation of depreciation. In the year of purchase of an asset, depreciation is allowed at half the normal rates, unless the asset is used for more than 180 days. The sale value of an asset(s) is deducted from the written down value of the “block” of assets.

In the case of the assets of an undertaking engaged in power generation /distribution, depreciation is permitted on certain specified categories of assets on a straight-line basis. However this is only optional and the assessee can claim depreciation on the declining balance method. Where capital expenditure incurred on scientific research results in the creation / acquisition of depreciable assets, no depreciation is allowed, but the expenditure is fully deductible in the year in which it is incurred.

Depreciation is now allowable on intangible assets at the rate of 25% on the declining balance method except for computer software, which is depreciated at 60% on the declining balance method. For this purpose, intangible assets have been defined as “know-how, patents, copyrights, trade marks, licences, franchises, or any other business or commercial rights of a similar nature”.

In the absence of adequate profits, unabsorbed depreciation on both tangibles and intangibles can be set off against income from any other head and can be carried forward indefinitely.
Amortisation of Expenditure

Preliminary Expenses

Specified preliminary expenses incurred prior to the commencement of business are deductible in equal installment over five years beginning with the tax year in which the business commences.

Scientific Research Expenditure

Certain scientific expenditure incurred prior to setting up of business is deductible in computing business income. Any capital expenditure (other than for acquiring land) incurred on scientific research related to the taxpayer’s business and any sum paid to specified institutions for scientific research is fully deductible in the tax year in which it is incurred. Weighted deduction is available in respect of certain scientific research expenditure.

Licence Fees for Telecommunication Services

Capital outlay for acquiring any right to operate telecom services is amortisable over the licence period.

Minimum Alternate Tax

A Minimum Alternate Tax (MAT) is levied on all companies whose income tax payable on the taxable income computed according to the provisions of the IncomeTax Act 1961 is less than 7.5 % of the book profits, as defined.

The effect of this provision is that all companies covered by MAT would be taxed at 7.6875% (income tax 7.5% plus surcharge of 2.5% thereon) of their Book Profits irrespective of whether they have taxable income.

However, MAT is not applicable to

• Income from the business of developing, maintaining, and operating certain infrastructure facilities
• Income from units in specified zones or specified backward districts
• Income of certain loss-making companies
• Export profits
  

Income Tax Returns and Payment of Corporate Tax

Currently, corporate taxpayers are required to file tax returns with the tax authorities on or before 31 October of the year following the end of the tax year. There are no provisions for the extension of time to file the tax return. Failure to file a tax return on or before the due date attracts interest at the rate of 1.25% per month on the final tax due.

Companies are required to pay advance tax in four installment spread over the financial year, by the due dates as shown below
 

India adopts the self-assessment tax system. All taxpayers are required to compute their taxable income, pay tax thereon and file the tax return with the tax authorities on or before the due date for filing the same. The Assessing Officer may choose to make a scrutiny assessment to assess the correct amount of tax by calling for further details.

Permanent Account Number (PAN)

All taxpayers must obtain a registration number known as the Permanent Account Number (PAN) from the tax authorities. This number must be indicated on all returns, documents and correspondence filed with the tax authorities.

Tax Deduction Account Number (TAN)

All persons required to deduct tax at source from any kind of payments must obtain a Tax Deduction Account Number (TAN) from the tax authorities. This number has to be indicated on all tax deduction certificates, challans, returns and other specified documents.
Tax Incentives / Special Provisions

Incentives for Indian Companies

The tax laws provide various incentives for industrial growth and development in specified areas subject to the fulfillment of specified conditions. Some of these incentives are:

• Subject to the fulfillment of specified conditions, 100% tax deduction for the first 5 years and 30% for the subsequent five years for new industrial undertakings / establishments in backward areas. This deduction is in addition to the deduction of expenses incurred for business purposes.
  
  
• Subject to the fulfillment of certain conditions, companies engaged in provision of infrastructure facility and the generation of power or the generation and distribution of power are eligible for a tax deduction of 100% of the profit for a period of 10 years. Companies engaged in telecommunication service are eligible for a tax deduction of 100% of the profits for first 5 years and 30% of the profits for next 5 years. This deduction is in addition to the deduction of expenses incurred for business purposes.
  
  The 10-year time limit may be chosen by the assessee at his option, within a period of fifteen years beginning from the year in which the undertaking commences the activity.
  
  
• Subject to the fulfillment of specified conditions, 100% of the profits and gains derived by an undertaking located in any Free Trade Zone or Export Processing Zone or 100% Export Oriented Unit from the export of articles or things or computer software are tax deductible for ten consecutive years. No deduction is allowable in respect of any year commencing after 1 April 2010 and thereafter.
  
  
• Subject to the fulfillment of specified conditions, 100% tax deduction for the first 5 years and 50% for the next two years is allowed in respect of the profits and gains derived by an undertaking located in any Special Economic Zone from the export of articles or things or computer software. Thereafter, for the next three years deduction would be restricted to 50% of the amounts credited to a special reserve created for this purpose.
  
  
• Subject to the fulfillment of specified conditions, the profits and gains derived by an undertaking located in any Export Processing Zone or Industrial Area/ Estate or Industrial Growth Centre or Industrial Park or Integrated Infrastructure Development Centre or Backward areas are tax deductible. The tax deduction is either 100% for ten consecutive years or 100% for first five years and 30% thereafter, depending upon the time of starting the manufacturing activities in these locations.
  
  
• Subject to the fulfillment of specified conditions, the profits and gains derived by a multiplex theatre, or a convention centre are tax deductible. The tax deduction is 50% for a period of five consecutive years.

The tax laws set out a number of circumstances in which non-resident taxpayers are subject to special rules for the calculation of taxable income or to special tax rates.
Tax Liabilities

Shipping

Non-residents engaged in shipping operations are subject to tax on a deemed profit of 7.5% of gross revenue.

Oil and Gas

Income earned by non-residents from specified activities in connection with exploration for and production of oil and natural gas is subject to tax on a deemed profit of 10% of gross revenue. If the actual profits are lower than the deemed profits of 10%, such lower profits can be offered to tax, subject to maintenance of prescribed books of account and furnishing of an audit report.

Aircraft

Non-residents engaged in operating aircraft are subject to tax on a deemed profit of 5% of gross revenue.

Turnkey Power Projects

Foreign companies engaged in specified activities in connection with the execution of turnkey power project contracts approved by the Central Government and financed under an international aid programme are subject to tax on a deemed\profit of 10% of gross revenue. If the actual profits are lower than the deemed profits of 10%, such lower profits can be offered to tax, subject to maintenance of prescribed books of account and furnishing of an audit report.

Royalties and Fees for Technical Services

Royalties and fees for technical services received by a foreign company from an Indian Government or an Indian concern in pursuance of an agreement made after 31 March 1976 and which is approved by the Central Government, or is in accordance with the Industrial Policy, are subject to tax at the rate of 20.5% (20% plus 2.5% surcharge thereon) on gross basis.

However, any royalty or fees for technical services received by a foreign company having a Permanent Establishment (PE) or a fixed place of profession in India shall be considered as 'business profits' under the domestic tax law. Accordingly, such royalty or fees for technical services, to the extent relatable to the PE or a fixed place of profession in India, is chargeable to tax at the rate of 41% (40% plus 2.5% surcharge thereon). While computing the taxable income under the head 'business profits' all expenses incurred for business purposes (other than amounts payable to the head office) would be allowed as a deduction.

Interest Income From Units

Interest on loans given in foreign currency, and income from units of specified mutual funds purchased in foreign currency received by a foreign company or a non-resident, are subject to tax at the rate of 20.5% (20% plus 2.5% surcharge thereon) of gross receipts.

Offshore Funds

Income on units of specified mutual funds purchased in foreign currency and long-term gains on the transfer of such units received by offshore funds are subject to tax at the rate of 10% of gross receipts.

Foreign Institutional Investors (FIIs)

Income received by FIIs in respect of securities (other than units of specified mutual funds) listed on a recognised stock exchange in India is subject to tax at the rate of 20.5% (20% plus 2.5% surcharge thereon). Whereas long-term capital gains on the transfer of such securities are subject to tax at the rate of 10.25% (10% plus 2.5% surcharge thereon), short-term capital gains on the transfer of such securities are subject to tax at the rate of 30.75% (30% plus 2.5% surcharge thereon).

Shares and Bonds Issued in Foreign Currency

Income by way of interest or dividends or long-term capital gains arising on transfer of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) purchased by a non-resident in foreign currency is taxed at the rate of 10.25% (10% plus 2.5% surcharge thereon). However, gains arising on the transfer of such shares or bonds, made outside India by a non-resident to another non-resident, are not subject to tax.
Direct Taxation

An individual who is "resident" in India is liable to tax on his world wide income. A "non-resident" individual is liable to tax in India only in respect of income earned or received in India. An individual who is "not ordinarily resident" in India is liable to tax in India in respect of income earned or received in India and any income that accrues outside India from a business controlled in India or a profession set up in India. more...
Indirect Taxation

Sales Tax is a levy on purchase and sale of goods in India. Sales Tax is levied under authority of both Central Legislation (Central Sales Tax) and State Governments Legislations (Local Sales Tax). Central Sales Tax is governed by the Central Sales Tax Act, 1956 which covers inter-state transactions of sale of goods as well as transactions of import of goods into or export of goods out of India. The Local Sales Tax is governed by the respective State Sales Tax Acts under which tax is levied on intra-state transactions of sales.more...