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Friday, November 08, 2013

Incidence of tax and Tools to save tax

Q. “The incidence of tax depends upon the residential status of an assessee.” Discuss. Distinguish Tax Evasion, Tax Avoidance, Tax Mitigation and tax planning.

Ans:  As per Section 5 of the Income Tax Act 1961, incidence of tax on a taxpayer depends on his residential status and also on the place and time of accrual or receipt of income.
 In order to understand the relationship between residential status and tax liability, one must understand the meaning of “Indian income” and “Foreign income”. An Indian income is one which satisfies any of the following conditions:

a.       If income is received (or deemed to be received) in India during the previous year and at the same time it accrues (or arises or is deemed to accrue or arise) in India during the previous year, or
b.      if income is received (or deemed to be received) in India during the previous year but it accrues (or arises) outside India during the previous year, or

c.       if income is received outside India during the previous year but it accrues (or arises or is deemed to accrue or arise) in India during the previous year.

Similarly, Foreign income is one which satisfies both the following conditions:
a.       Income is not received (or not deemed to be received) in India; and
b.      income does not accrue or arise (or does not deemed to accrue or arise) in India.

Indian income is always taxable in India irrespective of the residential status of the taxpayer. Foreign income of an individual and HUF from a business controlled or profession setup in India will be taxable in the hands of resident and ordinarily resident and resident but not ordinarily resident but not in the hands of a non-resident. However, Foreign income from a business controlled or profession setup outside India will be taxable only in the hands of resident and ordinarily resident and not in the hands of a resident but not ordinarily resident or a non-resident person.

Foreign income of any other taxpayer (Company, Firm, AOP, BOI etc.) will be taxable if the taxpayer is resident in India and will not be taxable in case the taxpayer is non-resident in India. 

Tax incidence of different taxpayers is as follows—
Particulars
ROR
RNOR
NR
Income received in India
Income deemed to be received in India
Income accruing or arising in India
Income deemed to accrue or arise in India
Income received/ accrued outside India from a business in India
Income received/ accrued outside India from a business controlled outside India
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes
Yes
Yes
No
No

Tax Evasions, Tax Avoidance, Tax mitigation and Tax Planning
The methods adopted to reduce the tax liability can be broadly put into four categories: "Tax Evasion";”Tax Avoidance”, "Tax Mitigation", "Tax Planning".  The difference between these four methods sometimes become blurred owing to the perception of the tax authorities and / or tax payer.

Tax Evasion : Tax Evasion term is usually used to mean 'illegal arrangements where liability to tax is hidden or ignored i.e. the tax payer pays less than he is legally obligated to pay or by hiding income or information from tax authority.   Thus, here the tax liability is reduced by "illegal and fraudulent"  means. For example: understatement of income.

Tax Avoidance : Tax Avoidance refers to the legal means so as to avoid or reduce tax liability, which would be otherwise incurred, by taking advantage of some provision or lack of provision in the law.   Thus, in this case tax payer tries to reduce his tax liability but here the arrangement will be legal, but may not be as per intent of the law.   Thus, in this case, tax payer does not hide the key facts but is still able to avoid or reduce tax liability on account of some loopholes or otherwise. For example: misinterpreting the provisions of the IT Act.

Tax Mitigation : "Tax Mitigation" is a situation where the taxpayer takes advantage of a fiscal incentive afforded to him by the tax legislation by actually submitting to the conditions and economic consequences that the particular tax legislation entails.  A good example of tax mitigation is the setting up of a business undertaking by a tax payer in a specified area such as Special Economic Zone (SEZ).

Tax Planning : Tax Planning is defined as "arrangement of a person's business and / or private affairs in order to minimize tax liability". For example: availing deduction.