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Two persons with same income can have different tax liabilties
For Income-Tax, Income is required to be categorized in any one of the following heads:
- Income from Salary
- Income from House property
- Income from Business/Profession
- Income from Capital Gain
- Income from Other source.
Though there are specific as well as generalized rules for classification of income under different heads of income as referred above, still there is a scope of tax planning in the hands of taxpayer for few incomes. Taxpayer must know that two person with same income could have different tax liability. It may sound strange to readers who are not well acquainted with the provisions of Income Tax Act-1961. Categorization & classification of income under different heads could play a decisive role in determining the tax impact.
Let me try to elaborate with an example.
Mr. X is a salaried taxpayer who along with his employment buys shares in stock exchange as an investment. Mr. Y is a businessman engaged in trading of garments & also frequently transacts in shares on daily & hourly basis. Both, X & Y, have purchased 1500 shares of Reliance Industries Ltd (RIL) through Bombay stock exchange for Rs. 850/- on the same day in 2015 and both have sold the shares on the same day in August-2018 for Rs. 1150/-. Ignoring purchase & sale expense for the sake of simplifications, both have earned a profit of Rs. 300/- per share on 1500 shares totaling Rs. 4.50 Lakh. Let us further assume that expected taxable salary income of Mr. X for FY 2018-19 is Rs. 5 Lakh whereas expected business income from Garment business of Mr. Y for the FY 2018-19 is also Rs. 5 Lakh.
For Mr. X, income from transfer of shares of Reliance would be considered under the head “Income from Capital Gain” whereas it would be considered as “Income from Business” for Mr. Y. Reason is obvious. Mr. X is an investor in share market & don’t regularly transact in shares. His purchase of share of RIL will be considered as “Capital Assets” & resultantly, Income from capital assets will be taxable under the head “Income from Capital Gain”. Mr. Y is a regular trader in share market & shares purchased in RIL will be reckoned as stock in trade. The resultant profit in the case of Mr. Y will be categorized as “Income from Business”
The tax treatment of the transactions would be as under:
For Mr. X:
- Since the shares are held as Investment for a period of more than 12 months, it will be considered as Long Term Capital Assets and the profit would result in Long Term Capital Gain (LTCG).
- Income from sale of shares held as Long term Capital Assets was exempt from tax u/s 10(38) till FY 2017-18. However, by the Finance Act-2018, LTCG tax on shares is reintroduced and now it is taxable @ 10% if such amount exceeds 1 Lakh p.a. However, there is a grandfathering clause as a result of which appreciation in the value of shares from the date of acquisition till 31.01.2018 will continue to be exempt & only appreciation in value after 31.01.2018 will be taxable. The highest trade price of RIL on 31.01.2018 was Rs. 964.50 and as a result, income of Rs. 1,71,750/- i.e., 114.50 per share (964.50-850) for 1500 shares would be exempt due to grandfathering clause for taxation of LTCG on shares. Balance, Rs. 2,78,250/- i.e., Rs. i.e., 185.50 per share (1150-964.50) for 1500 shares would be taxable LTCG. Assuming that Mr. X don’t have any other such LTCG income during the FY 2018-19, amount above Rs. 1 Lakh i.e., 1,78,250 will only be taxable. It is taxable not on the basis of applicable tax slab or at the rate of 20% but is taxable at a special rate of 10% u/s 112A. Resultantly, his tax liability would be Rs. 18,538/- considering education cess of 4% also. The tax liability on salary income of Rs. 5 Lakh will be Rs. 13,000/- . Total tax liability of X would be Rs. 31,538/-.
- Being a trader in shares, amount invested in the shares will be treated as “Stock in trade” and the amount would be taxable as “Income from Business”. Exemption provided u/s 10(38) towards Shares held for a period of more than 12 months is not available to stock in trade.
- Amount of Rs. 4.50 Lakh from sale of RIL share will be taxable as “Income from Business” and will be taxable like other regular income of Mr. Y i.e., according to applicable tax slab. Neither benefit of Rs. 1 lakh deduction nor benefit of grandfathering clause towards appreciation in the value of shares till 31.01.2018 will be available to him. His calculation of tax liability will be based upon his other income as special rate of taxation is not applicable for him. With his business income of Rs. 5 Lakh from garment business & Rs. 4.50 Lakh from Shares business, his total business income would be Rs. 9.50 Lakh. His tax liability would be Rs. 1,06,600/- [Rs. 2.50 exempt being a basic exemption limit, 5% on next Rs. 2.50 Lakh & 20% on next 4.50 Lakh plus education cess @4%] .
Both, Mr. X & Mr. Y, were having the total income was of Rs. 10 Lakh. But, the tax liability is altogether different. It is Rs. 31,538/- in the hands of Mr. X whereas it is Rs. 1,06,600/- in the hands of Mr. Y. Of course, the calculations are based on certain set of assumptions & presumptions but the fact remains, “Two persons with same income could have different tax liability”.
The hardest thing to understand is Income Tax. However, its Ignorance has its own cost & consequences.
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