Indian Tax Structure
This guide provides an overview of the tax structure and current tax rates in India. The tax regime in India has undergone elaborate reforms over the last couple of decades in order to enhance rationality, ensure simplicity and improve compliance. The tax authorities constantly review the system in order to remain relevant. India has a federal system of Government with clear demarcation of powers between the Central Government and the State Governments. Like governance, the tax administration is also based on principle of separation therefore well defined and demarcated between Central and State Governments and local bodies.
The tax on incomes, customs duties, central excise and service tax are levied by the Central Government. The state Government levies agricultural income tax (income from plantations only), Value Added Tax (VAT)/ Sales Tax, Stamp Duty, State Excise, Land Revenue, Luxury Tax and Tax On Professions. The local bodies have the authority to levy tax on properties, octroi/entry tax and tax for utilities like water supply, drainage etc.
Individual Income Tax & Corporate Tax
The provisions relating to income tax are contained in the Income Tax Act 1961 and the Income Tax Rules 1962. The Income Tax Department is governed by the Central Board for Direct Taxes (CBDT) which is part of the Department of Revenue under the Ministry of Finance. In terms of the Income Tax Act, 1961, a tax on income is levied on individuals, corporations and body of persons. Tax rates are prescribed by the government in the Finance Act, popularly known as Budget, every year.
The Government of India has recently taken initiatives to reform and simplify the language and structure of the direct tax laws into a single legislation – the Direct Taxes Code (DTC). After public consultation the Direct Taxes Code 2010 was placed before the Indian Parliament on 30 August 2010, when passed DTC will replace the Income Tax Act of 1961. The DTC consolidates the provisions for Direct Tax namely the income tax and wealth tax. When it comes into effect, probably April 2012, it is likely to have significant impact on the tax payers especially the business community.
In the case of Individuals, incomes from salary, house and property, business & profession, capital gains and other sources are subject to tax. Women and Senior citizens are extended some special privileges. Individuals’ incomes are subjected to a progressive rate system. Tax treatment differs depending on the residence status.
Income of the company is computed and assessed separately in the hands of the company. Income of company is subjected to a flat rate plus a surcharge. In addition to these, an education cess is also charged on the tax amount. Dividends distributed are subjected to special tax and the distributed income is not treated as expenditure but as appropriation of profits by the company. Tax treatment differs depending on the residence status.
A company is liable to pay tax on the income computed in accordance with the provisions of the Income Tax Act. Although many companies have huge profits, and declare substantial dividends, they are relieved from tax liabilities because their income when computed as per provisions of the Income Tax Act is either nil or negative or insignificant. Therefore a provision called Minimum Alternative Tax (MAT) was introduced by an amendment in 1997. As per the MAT provision such companies are required to pay a fixed percentage (presently 18% for 2011-2012) of book profit as minimum alternate tax.
Additionally, by an amendment in 2005 companies are required to pay Fringe Benefit Tax (FBT) on value of fringe benefits provided or deemed to have been provided to the employees.
In addition to income tax chargeable in respect of total income, any amount declared, distributed or paid by a domestic company by way of dividend shall be subjected to dividend tax. Only a domestic company is liable for the tax.
Wealth tax, in India, is levied under Wealth-tax Act, 1957. Wealth tax is a tax on the benefits derived from property ownership. The tax is to be paid year after year on the same property on its market value, whether or not such property yields any income. Similar to income tax the liability to pay wealth tax also depends upon the residential status of the assessee. The assets chargeable to wealth tax are Guest house, residential house, commercial building, Motor car, Jewelry, bullion, utensils of gold, silver, Yachts, boats and aircrafts, urban land, cash in hand (in excess of INR 50,000 for Individual & HUF only),etc. But in reality majority of the potential tax payers do not pay this tax as most of the movable items such as jewelry, bullion etc are stashed away from accounting. Invariably they just pay tax for the immovable wealth such as real estate.
Capital Gains Tax
The central government also charges tax on the capital gains that is derived from the sale of the assets. The capital gain is the difference between the money received from selling the asset and the price paid for it. To restrict the misuse of this provision, the definition of capital asset is being widened to include personal effects such as archaeological collections, drawings, paintings, sculptures or any work of art.
Capital gain also includes gain that arises on “transfer” (includes sale, exchange) of a capital asset and is categorized into short-term gains and long-term gains. The Long-term Capital Gains Tax is charged if the capital assets are kept for more than three years or 12 months in the case of securities and shares that are listed under any recognized Indian stock exchange or mutual fund. Short-term Capital Gains Tax is applicable if the assets are held for less than the aforesaid period.
In case of the long term capital gains, they are taxed at a concession rate. Normal corporate income tax rates are applicable for short term capital gains. In case of the short term and long term capital losses, they are allowed to be carried forward for 8 consecutive years.
The central government levies excise duty under the Central Excise act of 1944 and the Central Excise Tariff Act of 1985. Central Excise duty is an indirect tax levied on goods manufactured in India and meant for domestic consumption. The Central Board of Excise and Customs under the Ministry of Finance, administers the excise duty. Central Excise Duty arises as soon as the goods are manufactured. It is paid by a manufacturer, who passes on its incidence to the customers. Excisable goods have been defined as those, which have been specified in the Central Excise Tariff Act as being subjected to the duty of excise.
There are three main types of excise duty –
- Basic Excise Duty is charged on all excisable goods other than salt at the rates mentioned in the said schedule
- Additional Duties of Excise is charged on goods of special importance, in lieu of sales Tax and shared between Central and State Governments
- Special Excise Duty is charged on all excisable goods on which there is a levy of Basic excise Duty. Every year the annual Budget specifies if Special Excise Duty shall be or shall not be levied and collected during the relevant financial year.
Note: Under the Cenvat (Central Value Added Tax) Scheme, introduced under The Cenvat Credit Rules, 2004, a manufacturer of product or provider of taxable service shall be allowed to take credit of duty of excise as well as of service tax paid on any input received in the factory or any input service received by manufacturer of final product. Such credits can be used to setoff any excise duty tax payable.
In the recent budget, a number of tax exemptions have been initiated. Specific goods enjoy concessional duty rates. Exemptions are allowed to tax payers engaged in the manufacture of certain goods such as, water treatment, bio-diesel, processed food etc and certain types of establishments such as small scale industries, cottage industries that create jobs are also exempted.
Customs duty in India falls under the Customs Act 1962 and Customs Tariff Act of 1975. Customs duty is the tax levied on goods imported into India as well as on goods exported from India. Taxable event is import into or export from India. Additionally educational cess is also charged. The customs duty is evaluated on the value of the transaction of the goods. The Central Board of Excise and Customs under the Ministry of Finance manages the customs duty process in the country. The rate at which customs duty is applicable on the goods depends on the classification of the goods determined under the Customs Tariff. The Customs Tariff is generally aligned with the Harmonized System of Nomenclature (HSL). It should be noted that preferential/concessional rates of duty are also available under the various Trade Agreements.
Service tax was introduced in India way back in 1994 and started with mere 3 basic services viz. general insurance, stock broking and telephone. Subsequent Budgets have expanded the scope of the service tax as well as the rate of service tax. More than 100 services are subjected to tax under this provision. An education cess is also charged on the tax amount. The Central Board of Excise and Customs under the Ministry of Finance manages the administration of service tax.
Every service provider of a taxable service is required to register with the Central Excise Office in the concerned jurisdiction. Exemptions are available for services that are exported, small service providers whose revenue fall below the prescribed level, services provided to UN and International Agencies and supplies to SEZ(Special Economic Zones). Subject to conditions, service tax is not payable on value of goods and material supplied while providing services.
Securities Transaction Tax (STT)
Transactions in equity shares, derivatives and units of equity-oriented funds entered in a recognized stock exchange attract Securities Transaction Tax. Service Tax, Surcharge and Education Cess are not applicable on STT. Taxation of profit or loss from securities transactions depends on whether the activity of purchasing and selling of shares / derivatives is classified as investment activity or business activity. Treatment of STT also depends upon whether the income from these securities transactions are included under the head “Income from Capital Gains” or under the head ‘Profits and Gains of Business or Profession’.
NOTE: The Indian Government is keen on merging all taxes like Service Tax, Excise and VAT into a common Goods and Service Tax (GST). GST system has been proposed in order to simplify current indirect tax system which is very tedious and complicated. All goods and services will be brought into the GST base. There will be no distinction between goods and services. Alcohol, tobacco, petroleum products are likely to be out of the GST regime. The state and central combined tax rate is speculated to be between 16%-20% in line with the global trend. Originally slated for implementation by the year 2010 it has been postponed twice and now scheduled for the year 2012. The central and state tax authorities which had locked horns earlier are seemingly nearing a consensus. If implemented this will be the most outstanding reform ever to the Indian tax system.
Apart from the central taxes, the states also levy taxes on various good and services. Main state taxes consist of:
Value Added Tax (VAT)
Sales tax charged on the sales of movable goods has been replaced with VAT in most of the Indian states since 2005. This was introduced to counter the rampant double taxation issues and resultant cascading tax burden that occurred due to the flaws inherent in the previous sales tax system.
VAT, chargeable only on goods and does not include services, is a multi-stage system of taxation, whereby tax is levied on value addition at each stage of transaction in the supply chain. The term ‘value addition’ implies the increase in value of goods and services at each stage of production or transfer of goods and services. VAT is a tax on the final consumption of goods or services and is ultimately borne by the consumer. VAT comes under the state list. Tax payers can claim credit for the taxes paid at earlier stages and purchases known as Input Tax Credit, by producing relevant tax invoices. The credit can be used to setoff any VAT tax liability.
Different rates of VAT are charged depending on the category to which the goods belong. Rates vary for essential commodities, bullion and valuable stones, industrial inputs and capital goods of mass consumption, and others. Petroleum tobacco, liquor and so on are subjected to higher rate and differ from state to state.
Notably, there is no VAT on imports and export sales are not subjected to VAT. Therefore VAT charged on inputs purchased and used in the manufacture of export goods or goods purchased for export, is available as a refund.
Note: The Central Sales Tax which is levied on inter-State sales would be eliminated gradually.
It is a tax that is levied on the transaction performed by means of a document or instrument as per the regulations of Indian Stamp Act, 1899. It is collected by the government of the state where the transaction is carried out. Stamp duty rates vary between the states.
Stamp duty is paid on instruments, which are essentially a document to create, transfer, limit, extend, extinguish or record a right or liability. Document acquires legality once it is stamped properly after the payment of the requisite stamp duty charges. Stamp duty is payable for transfer of shares, share certificate, partnership deed, bill of exchange, shares, share transfer, leave and license agreement, debentures, gift deed, bank guarantee, bonds, demat shares, development agreement, demerger, power of attorney, home loans, houses & house purchase, lease deed, loan agreement and lease agreement.
Power to impose excise on alcoholic liquors, opium and narcotics is granted to States under the Constitution and it is called ‘State Excise’. The Act, Rules and rates for excise on liquor are different for each State.
In addition to the above taxes by the Central and State Governments the local bodies have the authority to levy tax on properties, octroi/entry tax and tax onutilities
OTHER KEY NOTES
Filing of VAT, CENVAT, Service Tax returns
Periodic returns must be submitted by companies registered for CENVAT or VAT/CST or Service Tax in India.
- CENVAT filings are monthly, on the 10th day following the period end.
- VAT reporting is either monthly or quarterly, depending on the particular State’s rules.
- Service Tax filings are bi-annual.
Permanent Account Number (PAN)
PAN is an all India, unique ten-digit alphanumeric number, issued in the form of a laminated card by the Income Tax Department.
Who Must Have a PAN
- if his total income or the total income of any other person in respect of which he is assessable, during any previous year, exceeded the maximum amount which is not chargeable to income-tax; or
- carrying on any business or profession whose total sales, turnover or gross receipts are or is likely to exceed INR 500,000 in any previous year; or
- who is required to furnish a return of income or
- being an employer, who is required to furnish a return of fringe benefits
PAN is increasingly being recognized as a valid Identity Proof across India and a mandatory document for important transactions such as purchase of property, motor vehicles, share transactions, opening of bank accounts, obtaining loans, maintaining deposits etc., therefore any person not fulfilling the above conditions may also apply for allotment of PAN.
Tax Deduction at Source (TDS)
The Income-tax Act enjoins on the payer of specific types of income, to deduct a stipulated percentage of such income by way of Income-tax and pay only the balance amount to the recipient of such income. Some of such incomes subjected to T.D.S. are salary, interest, dividend, interest on securities, winnings from lottery, horse races, commission and brokerage, rent, fees for professional and technical services, payments to non-residents etc.
Tax Collection at Source (TCS)
Tax is collected at the point of sale. It is to be collected at source from the buyer, by the seller at the point of sale. Such tax collection is to be made by the seller, at the time of debiting the amount payable to the account of the buyer or at the time of receipt of such amount from the buyer, whichever is earlier. The goods to be subjected to TCS are clearly specified and the type of buyers, sellers and purpose are clearly defined in the Act. Tax rates vary depending on the goods.
Note: All those persons who are required to deduct tax at source or collect tax at source on behalf of Income Tax Department are required to apply for and obtain Tax Deduction and Collection Account Number (TAN), a 10 digit alpha numeric number, which is required to be quoted in all documents involving TDS/TCS transactions. Failure to apply for TAN or not quoting the same in the specified documents attracts a penalty.
Double Taxation Relief
India has entered into Avoidance of Double Taxation Agreement (DTAA) with 65 countries including countries like U.S.A., U.K., Japan, France, Germany, etc. The agreement provides relief from the double taxation in respect of incomes by providing exemption and also by providing credits for taxes paid in one of the countries. These treaties are based on the general principles laid down in the model draft of the Organisation for Economic Cooperation and Development (OECD) with suitable modifications as agreed to by the other contracting countries. In case of countries with which India has double taxation avoidance agreements, the tax rates are determined by such agreements and vary between countries.
The Indian government provides relief from double taxation irrespective of whether there is a DTAA between India and the other country concerned, if
- The person or company has been a resident of India in the previous year.
- The same income must be accrued to and received by the tax payer outside India in the previous year.
- The income should have been taxed in India and in another country with which there is no tax treaty.
- The person or company has paid tax under the laws of the foreign country concerned.