Indian Income Tax Demystified
Any government would need money to run the country strategically. The money it extracts from an individual or a corporation is called tax. Taxation also helps in reducing inequalities of income, social development activities, for encouraging exports and restricting imports and finally, to control inflation. What if I have a low income? Will my money go away in taxes? - Good News. People with low income do not have to pay taxes. People with more income pay more tax. And that is why I mentioned reducing inequalities of income. Say for example you need pure water in your house. You decided to set it up yourself. Think about the total cost - it would be too much, isn't it? So, if you are getting pure water in your house, that is only because you paid tax to avail the service - and that amount is way less than what you would pay, if you set it up alone. Not only you, your whole society is benefited. Interesting, isn't it?
Type of Taxes
Yes, you read it right. There are two type of taxes and surprisingly, you pay both. I am referring to Direct Tax and Indirect Tax. Its is pretty easy to understand. If the government takes away a part of your salary directly, it is called a direct tax. If you head on to a restaurant, and order a pizza, which you thought costs Rs. 200/- but end up paying Rs. 250/- : that is Indirect Tax. Didn't the pizza guy say "including taxes" ? Even if you buy a product from the market, the price tag would read for example - MRP. 100/- inclusive of all taxes. So Indirect Taxes are taxes that are levied upon the services and goods that you avail. Easy, isn't it?
Now I do not wish to scare you, but these are divided into 26 sub-types. Lets see one by one in short.
- Income tax - This is when your salary exceeds taxable limit. When you invest your money, you save tax. ( Read my previous article on investments). Tax limit? What is that? Check out the image to know what limit you fall in.
- Capital Tax - When you earn profit by selling stocks, bonds, precious items.
- Prerequisite Tax - When your company provides you non monetary benefits for example, car, these are taxable under prerequisite tax.
- Security Transaction Tax - Some people skip paying capital tax. But our government is smart enough. Your money will be deducted as and when you do the transaction on selling stocks, bonds etc.
- Corporate Tax - Two types of corporate companies exist in India i.e. Domestic and Foreign. Depending on their income, they need to pay corporate tax. There are four types to this, but lets not get into that right now.
- Sales Tax - There can be goods that transfer within states (ever heard of VAT?), among states and during import-export. Such goods are liable for sales tax.
- Service Tax - For all the services that you avail, like car washing, dining in restaurants etc, you pay service tax.
- Value Added Tax - If you check the news, the term GST (Goods Service Tax) is trending these days. VAT is nothing but tax levied by Central Government on sale of goods. The tax varies from item to
- Custom Duty and Octroi - Did you not order a TV from your relative from Dubai? if you did, I am sure you paid the custom duty at the airport. So goods imported from foreign have to pay custom duty.
- Excise Duty - Opposite of custom duty. Tax charged on goods manufactured within the country.
- Anti Dumping Duty - Goods exported by one country to another at a lower price than normal value - is a malpractice carried out by some. Hence, the central government has imposed this tax, to keep the international trade charges under scrutiny.
- Professional Tax - Employees working in private organizations need to pay professional tax.
- Dividend distribution Tax - If you own a company, and are paying off dividends to your investors, you need to pay this tax.
- Property Tax or Municipal Tax - If you own a property, you pay this tax.
- Entertainment Tax - Did you not check the price breakup of your movie ticket the last time you watched a movie ? - Please do next time. You paid entertainment tax along with the movie ticket charge. This tax is for everything that entertains you.
- Stamp Duty, Registration Fees, Transfer Tax - When you got the property transferred from the seller to your name, you would have paid all the three. So when the property ownership gets transferred from one person to another - you are liable to pay all the three.
- Education Cess, Surcharge - Good news, you pay for poor people's education in India, through education cess. Surcharge is extra tax that you pay. Check your salary slip (if you work in private organization).
- Gift Tax - On your next birthday, if you receive a gift worth more than 50k, the giver would have to pay gift tax. (I know its surprising ;-))
- Expenditure Tax - Tax imposed if you avail services from a hotel or restaurant.
- Wealth Tax - Tax levied on personal capital.
- Toll and Road Tax - Never wondered what this is during your inter state trip - did you? - Government takes little money from you to maintain its infrastructure and maintenance.
- Krishi Kalyan Tax - As the name suggests, you are paying for the farmer's welfare.
- Dividend Tax - tax imposed on dividends received by shareholders.
- Infrastructure Cess - tax levied on production of vehicles.
- Entry tax - Tax imposed on movement of goods from one state to another.
- Swachh Bharat Tax - You pay tax to keep the country clean.
I know what you are thinking. Indian tax system is funny. If there is something that is exempted on getting taxed, then it is death. Are you thinking What Will happen If I don't pay tax? - Hold on, I will tell you.
Income Tax Return - Definition and Types
They call it ITR - Income Tax Returns. It is a form where you show your income, and tax imposed there on, to the income tax department. There are 7 forms available ITR 1 through ITR 7. There is form 2 and 2A, 4 and 4S. That makes 9 ITR forms - I will keep the definitions simple:
- ITR-1 - Used for individual tax payer.
- ITR-2A - Used by Hindu Undivided Family (persons lineally descended from a common ancestor, including wives and unmarried daughters) or an individual tax payer.
- ITR-2 - For people who stay out of India, people who have earned by sale of assets, Individuals or HUF.
- ITR-3 - Used by HUF or an Individual who operates strictly as a partner.
- ITR-4 - Used by people who earn income through a profession.
- ITR-4S - Used by Individual or HUF.
- ITR-5 - Used by firms, co-operative societies, local authorities etc.
- ITR-6 - Forms used by companies except companies exempted from Section 11 of India Law (whose income is used for property used for charity).
- ITR-7 - Form used by organizations involved in charity, news agency, medical institution etc.
So many forms! How can I decide which form should I fill in?
If you are earning a decent salary, and if its your turn to file income tax, ITR-1 is for you. If you are unsure which form to fill in, there are numerous websites that will assist you to decide.
Take a look at the systematic classification that our website https://incometaxindiaefiling.gov.in/e-Filing/Services/DownloadItrLink.html has represented.
What happens if you DO NOT file Income Tax?
I know you've been waiting for this. Income tax is something that is difficult for most to comprehend. Failure to pay tax is a crime. First and foremost, you get a notice from Income Tax Department asking you to file tax at the earliest.You could be jailed for three to seven years with fine. In some cases, you might end up paying fine three times more than your annual income. Plus,1% interest on outstanding tax added from the due date to actual date of filing tax. All this is decided by government officials. Each tax type has its own penalties for not adhering to its timelines. You might land up in unwanted trouble. Why invite all these when the income tax filing process is pretty simple. Now a days, there are companies that fives you the bread on the table. Pay them a little sum, give all the information they need, and they do all the homework for you. For example - https://myitreturn.com/
Three Major Benefits of Filing Tax
Anyone would wish that the tax amount be decreased, by any means.
- One way is to save money in an investment tool. When you invest, amount invested is reduced from the taxable income. This will bring down the tax amount you have to pay. Go ahead, open an LIC account.
- When you want to purchase a home, one of the formalities include showing the bank the proof that you have filed the tax. You can submit this as income proof when applying for a loan.
- You encourage scammers and corrupt people by not paying tax. You don't want to do that, do you?
The FY-AY Difference and Due Date for Filing Tax
I see people getting dwindled between Financial Year and Assessment Year. So here is the difference:
The year in which you have earned is the Financial Year. The year in which your income is assessed is assessment year. People call it FY and AY in short. In India, FY is between April 1 to 31 March. The following year is AY, where you file your tax, based on the income you earned.
Government decides on the dates to file income tax every year. Check out my simple diagram on FY-AY concept.
FY 2016-17(AY 2017-18) :
- 31st July 2017 - For Individuals
- 30th September 2017 for Businesses
FY 2015-16(AY 2016-17) :
- 5th August 2016 for Individuals
- 17th October 2016 for Businesses
Calculation of Income Tax on Salary
My dad used to push me to understand my pay slip clearly. He said that I should know, at least, the meaning of salary components. I never paid heed to it, until one day, my tax deducted was a staggering figure. This disappointed me severely, I raised an incident to my company HR to explain me, how the tax calculation was done. They gave me some tax calculation formula and though it looked a clear and crisp explanation, I failed to understand. The HR did their job perfectly, it was I, who was a dummy. It was at that time, that I decided to take a deep dive, and understand the tax calculation. Before we go ahead, do you know the difference between Net Salary and Gross Salary ? Its very simple:
Net Salary - Money that you take home after all deductions are made.
Gross Salary - Everything. Take home payment + deductions. Basic pay + Dearness allowance + House Rent Allowance + transport allowance + special allowance + other allowance, to be precise.
Let's compute the income tax for a salaried person (most common case):
- From the salary slip, find out the Gross Salary first, referring the above equation. Multiply that by 12, to get the Annual Gross Income. Let's say it came up to Rs. 900000.
- Investments include Provident Fund, Life Insurance Premium, Equity Linked Savings Scheme, Home Loan monthly installment, National Savings Certificate, Infrastructure Bond, Pension Funds, Tuition fees and Unit Linked Insurance Plan. Have you invested in all these? - Then you should get the Annual Investment Figure and subtract it from #1. Let's assume the investment amount to be Rs. 1,25000. So, 900000-125000 = 787500. This figure is called Net Taxable Income.
- By looking at the figure, you can tell where you fit in the tax slab. For our case, it fits in the range of Income between Rs. 500,001 - Rs. 10,00,000. We will go reverse. So, we have to find out 20% of Income exceeding Rs. 5,00,000.
- Lets first find out Income exceeding Rs. 5,00,000 = 787500-50000 = 287500. Now, 20% of 287500 = 57500. Note it down. ------> [A]
- Going one slab above,for Income between Rs. 2,50,001 - Rs. 500,000, its 10% of Income exceeding Rs. 2,50,000.
- Lets find out Income exceeding Rs. 2,50,000. = 500000 - 250000 = 250000. Now, get the 10% of that = 25000. Note it down. ------> [B]
- Going one slab above,for Income upto Rs. 2,50,000, what's the tax rate? - Nil. Good news.
- Total Tax payable is A + B = Rs. 82500 /-
And Finally - 21 Easy Ways To Save Tax
- Savings Account - Interest earned is nontaxable till Rs. 10,000 /-
- Long Term Capital Gains - Hold equity shares for more than a year, and the sum received will be non-taxable - same applies to mutual funds as well.
- Non Resident Rupee - If you are staying outside, take a loan at 4%, invest the money under NRE account, earn tax free money at 9%
- Life Insurance - If the premium paid did not exceed 20% of the sum assured, you will be exempted on tax.
- Scholarship for Education - Irrespective of whether its private or government, it is non-taxable.
- HUF account - This option is only for Hundi, Sikh and Jain families. If you earn anything apart from your salary, deposit that in a secondary HUF account.You will avail benefit under section 80C. Pay tax only on your salary.
- Dividends - Received from #5 are all tax free for the receiver.
- Marriage Gifts - Are all tax free.
- Agricultural Income - Tax free for agricultural land/products.
- Inherited Money - No tax if your ancestors left money for you!Donations - Under section 80G its non-taxable. But do not forget to get the stamped receipts.
- 80C: the real tax saver - You can have a PPF account, LIC, NSC, ELSS, Home loan repaid principal amount, 5 year fixed deposit with either banks or post office, coaching fees for child upto 2 years - all of them to claim for tax exemption under 80C.
- EPF/PF - Money received after 5 years is not liable to tax.
- Education Loan - Is non-taxable under section 80E.
- Medical Insurance - Under section 80D - Rs. 15000/- for self, spouse and children. Rs. 20k for person(s) above 65 years.
- Business persons - The amount used for stay and food, will be represented as business expense. A salaried person can not do that and hence he has to pay more tax!
- Leave travel allowance - Go for a vacation with you and your family, you will not be taxed on the travel expense.Daily Travel Allowance - You can receive tax exempt up to Rs. 1600/- per month. (per annum - Rs. 19200 /- !)
- House Rent Allowance - If you are staying in a rented place, get the rent receipts from your land lord. Submit them along with PAN card. But, the rent should exceed Rs. 100000 /-, annually.
- Gratuity - Sum of money paid to you when you retire. This is tax free for up to Rs. 350000 /-.
- Meal Coupons - I never used these until I learned that they are tax free up to Rs. 2600/- per month.
- Medical Bills - Up to Rs. 15000/- is non-taxable for you and your family.
- Voluntary Retirement Scheme - If you opt to retire, the amount received is nontaxable up to Rs. 500000 /-.
So, do not think tax as an axe that can cut your money down. Be smart, and reduce tax deduction by utilizing any of the above 23 ways. Happy Taxing! :-)