1.e Incidence of tax¶
Introduction to Incidence of Tax
The concept of tax incidence is a fundamental aspect of tax policy and economics, addressing a key question: who ultimately bears the burden of a tax? While it may seem straightforward that the entity legally obligated to pay a tax should bear its full cost, the reality is more complex. Taxes can be shifted, and their economic burden can fall on different parties than those initially intended.
What is Tax Incidence?¶
Tax incidence refers to the analysis of the distribution of a tax's economic burden among various stakeholders in the economy, including producers, consumers, workers, and owners of resources. It explores both the legal incidence (who is required to pay the tax to the government) and the economic incidence (who actually bears the cost of the tax after market adjustments).
Incidence of Tax and Scope of Total Income (Section 5 of the Income Tax Act, India)¶
Understanding the scope of total income is crucial for determining the tax liability of an individual or entity. This depends largely on the residential status of the assessee (taxpayer) during the relevant financial year. Here’s how it works:
Residential Status Categories¶
Resident in India:¶
- Individual or Hindu Undivided Family (HUF): Further classified into:
- Resident and Ordinarily Resident (ROR): A person who fulfills both the conditions of residency and meets additional criteria to be considered "ordinarily resident."
- Resident but Not Ordinarily Resident (RNOR): A person who fulfills the conditions of residency but does not meet the criteria to be "ordinarily resident."
- Other Entities (Companies, Firms, etc.): Simply categorized as Resident in India.
Non-Resident in India (NRI):¶
An individual or entity that does not meet the conditions to be considered a resident in India.
Scope of Total Income Based on Residential Status¶
(A) Resident and Ordinarily Resident (ROR) in India [Section 5(1)]:¶
A person who is a Resident and Ordinarily Resident in India is taxed on their global income, meaning:
- Income Received or Deemed to be Received in India: Any income that is actually received in India or is deemed to be received in India during the financial year.
- Income that Accrues or Arises in India: Any income that accrues (is earned) or arises in India, regardless of where it is received.
- Income that Accrues or Arises Outside India: Any income that accrues or arises outside India, even if it is not related to any business or profession in India.
(B) Resident but Not Ordinarily Resident (RNOR) in India [Section 5(1) Proviso]:¶
A Resident but Not Ordinarily Resident in India is taxed on:
- Income Received or Deemed to be Received in India: Same as the ROR category.
- Income that Accrues or Arises in India: Same as the ROR category.
- Income that Accrues or Arises Outside India: Taxable only if it is derived from a business controlled or a profession set up in India. Income from any other sources outside India is not included in the total income.
(C) Non-Resident (NRI) in India [Section 5(2)]:¶
A Non-Resident in India is taxed only on income that:
- Income Received or Deemed to be Received in India: Any income received in India or deemed to be received in India during the financial year.
- Income that Accrues or Arises in India: Any income that accrues or arises in India, regardless of where it is received.
Key Differences and Impact on Tax Incidence:¶
- Global Income Taxation: Only Resident and Ordinarily Resident (ROR) individuals or entities are subject to tax on their global income.
- Foreign Income:
- For RNOR individuals, only income that is linked to a business or profession in India is taxable if it arises outside India.
- For NRIs, foreign income is entirely excluded from the scope of total income.
- Tax Incidence:
- Highest for ROR, as they are taxed on all global income.
- Moderate for RNOR, as they are only partially taxed on foreign income.
- Lowest for NRIs, as they are only taxed on Indian income.
The residential status of an assessee is a key determinant of their tax liability in India. The broader the scope of total income (as in the case of ROR), the higher the tax incidence. For RNOR and NRI, the tax burden is reduced as foreign income is either partially or entirely excluded from their total income, respectively. This classification ensures that the tax system accounts for the varying levels of connection and economic presence that individuals and entities have with India.
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