Assessing Your Taxable Income And Taxes

Updated: Nov 16 2003, 05:30am hrs
As is the common adage In this world, nothing is certain but death and taxes, thus it is very important to assess ones income and thereafter, the amount thereof which is taxable to arrive at the tax that would be payable during the year.

The Role Of Method Of Accounting
Under section 209(3)(b) of the Companies Act, 1956, companies are mandatorily required to use the accrual (mercantile) system and double entry system of accounting. However, others are free to choose the method of accounting i.e. cash or mercantile. The method of accounting followed by a person would primarily determine the income earned during the year. For instance, under section 145 of the Income Tax Act, 1961 (the Act), income falling under the heads Profits and gains of business or profession or Income from other sources is determined based on whether cash or mercantile system of accounting is followed. In the case of other heads of income like Salaries, Income from house property and Capital gains, the income would be determined based on the provisions of the Act irrespective of the method of accounting followed i.e. cash or mercantile.

Thus, it is very important to correctly choose the method of accounting. Where there is uncertainty or large timing differences in receipt of income, it would be advisable to follow the cash basis of accounting otherwise, there may be cases where one shows income earned during the year of say Rs 1,00,000 without its actual receipt, whereon tax would be payable at say 35 per cent of Rs 35,000. But, wheres the cash Therefore, in the case of professionals and consultants, the cash basis of accounting is commonly followed.

Likewise, in the case of manufacturers and traders, the mercantile system is more suitable as it would reflect the true financial position. For example, a trader buys goods worth Rs 5,00,000 of which, during the year, half the quantity is sold for Rs 300,000, which is received in the subsequent accounting year, and the balance quantity lies in stock.

Now, if this trader follows the cash basis of accounting, the income statement would not reflect any profit (i.e. purchase of Rs 5,00,000 less closing stock of Rs 2,50,000). In contrast, if the trader follows the mercantile system of accounting, the income statement would reflect the true profit of Rs 50,000 (i.e. Rs 3,00,000 less Rs 2,50,000).

Tax On Net Income
Then comes the issue of taxation of the net income. Under the Act, certain incomes are tax-free and others taxable. Similarly, certain expenses are allowable and others disallowable. As a result, one needs to arrive at the taxable net income earned during the year to determine the tax liability. Furthermore, under the provisions of the Act, one has to pay the income tax on the estimated taxable income for the assessment year in advance in different installments during the previous year (See In Advance, Please!).

Under the Act, previous year refers to the period from the 1st day of April to 31st of March and assessment year is the financial year immediately following the previous year. In other words, previous year from April 1, 2003 to March 31, 2004 would correspond to assessment year 2004-2005.

In relation to the above, in certain cases one may receive income whereon tax has already been deducted at source, commonly known as TDS, under the Act. In such cases, one would be liable to pay advance tax only to the extent of the tax payable on taxable income net of TDS and rebates under section 88 (investments like public provident fund, national savings certificates, life insurance premium et al), section 88B (rebate for senior citizens) and section 88C (rebate for women below the age of 65 years) subject to fulfillment of the conditions stated therein.

Failure To Pay Advance Income Tax
Under section 208 of the Act, one is liable to pay advance tax in every case where the amount of tax payable during the particular assessment year is not less than Rs.5,000. Moreover, failure to pay advance tax or delays in payment thereof or shortage in payment thereof attracts interest (See The Interest Burden).

Furthermore, payment of interest under sections 234A, 234B or 234C are regarded as an accretion to income tax, and hence arent allowed to be deducted as an expense for computing taxable income - Assam Forest Products (P) Ltd vs CIT [1989] 180 ITR 478 (Gauhati).

Conversely, in cases where one has paid advance tax cum TDS exceeding the amount of income tax payable on the income for the year, then this excess is liable to be refunded under the Act by the Income Tax Department to the assessee along with interest under section 244A of the Act at the rate of 0.50 per cent (with effect from September 8, 2003) for every month or part thereof from April 1 of the assessment year or actual date of filing the Return of Income, whichever is later, to the date of granting the refund, provided however that the refund is not less than 10 per cent of the income tax. But, the interest received under section 244A of the Act is taxable.

Thus, it is crucial for one to judicially estimate the taxable income that would be earned during the previous year so that tax thereon can be paid within the specified deadline to avoid payment of interest.

The author is a Chartered Accountant