Basis of Charge

If Chapter I is the dictionary of the Act, Chapter II is its engine room. It answers the four foundational questions on which the entire edifice of income-tax rests:

Question 1: What is the unit of time for taxation? Section 3 defines the ‘tax year’ as the financial year commencing 1st April. The old dual regime of ‘previous year’ (for earning) and ‘assessment year’ (for assessing) is abolished. This is a welcome simplification that eliminates a source of perpetual confusion for taxpayers, students, and even some professionals.

Question 2: What is the constitutional authority for taxing income? Section 4 provides the charging provision. Without this section, no income-tax can be levied. It is the legal anchor from which the entire Act derives its force.

Question 3: Whose income is taxable in India? Section 5 creates a residence-based system with three concentric circles: residents (worldwide income), RNOR (Indian income + India-controlled business), and non-residents (Indian income only). Section 6 prescribes the day-counting rules for determining residential status.

Question 4: What income is deemed to arise in India? Section 9 extends India’s taxing reach to income that may not physically arise within the borders but has a sufficient nexus with India — through business connections, property, interest, royalty, fees for technical services, and, most controversially, significant economic presence.

The intellectual architecture: Think of these provisions as a funnel. Section 4 casts the widest possible net (‘every person’, ‘total income’). Section 5 narrows the net based on who the person is (resident, RNOR, or non-resident). Sections 6-9 provide the technical machinery for classification and deeming. Sections 7-8 create legal fictions for timing (when income is ‘received’), and Section 10 handles a niche historical provision for Goa’s Portuguese Civil Code marriages.

The most important change is conceptual: the abolition of the dual terminology. Under the old Act, income was earned in the ‘previous year’ and assessed in the ‘assessment year’. This meant that income of April 2024 to March 2025 was the ‘previous year 2024-25’ but the ‘assessment year 2025-26.’ This caused no end of confusion in notices, returns, and court proceedings. The 2025 Act replaces both concepts with the single term ‘tax year.’ Income is earned and assessed for the same year. The revenue department’s systems may take time to fully transition (you will still see AY references on the portal), but the legal position is clear.

Substantive changes are minimal: The charging provision (old S.4 = new S.4), scope of income (old S.5 = new S.5), residence rules (old S.6 = new S.6), and deemed accrual (old S.9 = new S.9) are substantively identical. The section numbers are remarkably similar, which is helpful for practitioners transitioning.

Section 8 is genuinely new: It specifically addresses the taxation of capital assets or stock-in-trade received by a partner from a firm on dissolution or reconstitution. Under the old law, this was handled through judicial interpretation and a 2020 amendment. The 2025 Act codifies it as a standalone provision with clear rules.

2.4.1 A Common Misconception

CRITICAL WARNING: Section 3 of the 2025 Act defines ‘tax year.’ It is NOT the charging section. The charging section is Section 4. Under the 1961 Act, Section 3 defined ‘previous year’ and Section 4 was the charging section. The numbering is deceptively similar, but Section 3’s content has changed entirely. Numerous early commentaries on the new Act have incorrectly described Section 3 as part of Chapter II (Basis of Charge). In fact, Section 3 appears at the tail end of Chapter I in the Act text, although its subject matter is so closely connected to Chapter II that it is best studied here.

2.4.2 Statutory Text with Commentary

Commentary: The ‘tax year’ is simply the financial year: 1st April to 31st March. Tax Year 2026-27 runs from 1st April 2026 to 31st March 2027. There is no separate ‘assessment year’ — the tax year is the period for both earning and assessing. When you file your return for TY 2026-27, you are reporting income of TY 2026-27 and computing tax for TY 2026-27. The words ‘for the purposes of this Act’ make this definition applicable throughout the entire statute. Every reference to ‘tax year’ anywhere in the Act draws its meaning from this provision.

Commentary: This sub-section creates a ‘short tax year’ for new businesses. If you start a business on 15th December 2026, your first tax year is not a full twelve months — it is the period from 15th December 2026 to 31st March 2027 (approximately 3.5 months). The second tax year will be the full year from 1st April 2027 to 31st March 2028. This has practical implications:

(a) Depreciation in the short year: If an asset is used for less than 180 days in the year of acquisition, only 50% of the normal depreciation rate is allowed. In a short first year, this threshold is almost always triggered.

(b) Presumptive taxation turnover limits are not pro-rated for the short year.

(c) Advance tax obligations begin from the quarter in which the business is set up.

The distinction between ‘setting up’ and ‘commencement’: Courts have consistently held that a business is ‘set up’ when it is ready to commence operations, not when it actually begins operations. If you rent premises, hire staff, and install equipment by 1st November but your first patient walks in on 15th November, the business is ‘set up’ on 1st November. This distinction matters because preliminary expenses incurred after ‘setting up’ but before ‘commencement’ are deductible as business expenditure.

2.5.1 The Constitutional Foundation

Section 4 is the most important section in the Act. It is the charging provision — the legal authority under which income-tax is levied. Without this section, no tax can be collected. It draws its constitutional authority from Entry 82 of the Union List (Seventh Schedule), which grants Parliament the exclusive power to legislate on ‘Taxes on income other than agricultural income.’

2.5.2 Sub-section by Sub-section Analysis

S.4(1) — The Annual Enactment Requirement: Tax is charged at rates enacted by ‘any Central Act’ — this means the annual Finance Act. Every year, Parliament must pass the Finance Bill specifying the rates of income-tax. If Parliament fails to do so (a constitutional crisis), no tax can be charged at any rate. This annual requirement is a democratic safeguard: the executive cannot unilaterally impose tax rates. The phrase ‘in accordance with and subject to’ means the rates are applied through the computational machinery of this Act — exemptions, deductions, set-offs, and all other provisions modify the final tax liability.

S.4(2) — Three Key Elements: The charge is on: (a) the ‘total income’ — not gross income, not receipts, not turnover, but the computed total income after all adjustments; (b) of ‘the tax year’ — income must be allocated to the correct year; (c) of ‘every person’ — all seven categories in Section 2(77). A newborn child with investment income, a 100-year-old HUF, a shell company with no employees, a cricket association (AOP), a local panchayat (local authority) — all are ‘persons’ liable to tax if they have ‘total income.’

S.4(3) — Inclusive Definition of Income-tax: Income-tax ‘includes’ any additional income-tax, by whatever name called. This captures surcharge, health and education cess, and any future additional levy. The practical effect: TDS provisions, advance tax provisions, and penalty/interest computations all apply to the aggregate tax (basic + surcharge + cess), not just the basic tax. When Section 234B charges interest for shortfall of advance tax, it charges interest on the total tax liability including surcharge and cess.

S.4(4) — Charging Income of a Different Period: Certain incomes are taxed in a period other than when they accrue. Examples: undisclosed income found during a search is taxable in the year of search even though it may relate to earlier years. Non-resident shipping income may be computed for a voyage spanning two tax years. This sub-section provides the constitutional authority for such departures.

S.4(5) — The Collection Mechanism: Tax can be collected in three ways: TDS (deducted by the payer), TCS (collected by the seller), and advance tax (paid by the assessee). This sub-section is the link between the charging provision and the collection machinery in Chapters XIX-A through XIX-C.

2.6.1 The Residence-Based System

India follows a residence-based system of taxation, not a citizenship-based system. Your passport is irrelevant for Indian tax purposes — what matters is where you reside. This is a critical distinction: the USA taxes its citizens on worldwide income regardless of where they live; India does not. An Indian citizen living permanently in Dubai with no Indian income has no Indian tax liability (subject to the deemed resident rule discussed in Section 6).

2.6.2 The Three Circles of Taxability

Section 5 creates three concentric circles, each casting a wider or narrower net depending on the person’s residential status:

2.7.1 Why This Section Determines Everything

A person’s entire tax liability — potentially crores of rupees — can turn on whether they were present in India for 182 days or 181 days. Section 6 is the most fact-intensive provision in the Act. It prescribes different rules for individuals, HUFs/firms/AOPs, companies, and a special ‘deemed resident’ rule for Indian citizens in zero-tax jurisdictions. Let us examine each in detail.

2.7.2 Individual Residence — The Basic Rule [S.6(2)]

Analysis of Limb (a): This is straightforward. If you are physically present in India for 182 out of 365 days, you are resident. The day of arrival and the day of departure both count as days of presence in India (per CBDT Circular No. 13/2017). So even a partial day (arriving at 11:55 PM) counts as a full day.

Analysis of Limb (b): This is the ‘look-back’ test. It catches individuals who spend fewer than 182 days in a single year but are frequent visitors. A person who spends 65 days per year in India for five consecutive years will satisfy limb (b) in the fifth year (65 > 60, and 65 x 4 = 260... wait, that’s not enough). Let me provide a precise example:

2.7.3 Relaxations for Specific Categories

The 60-day threshold in limb (b) is relaxed for three categories of individuals:

Category 1 — Indian citizens leaving for employment [S.6(3)]: If an Indian citizen leaves India during the tax year for employment outside India, limb (b) does not apply at all. Such a person becomes resident ONLY under limb (a) — i.e., only if present for 182+ days. This protects Indians who go abroad for work from being taxed on worldwide income merely because they spent a few months in India during the transition.

Category 2 — Indian citizens / PIOs visiting India [S.6(4)]: If an Indian citizen or Person of Indian Origin (PIO) who is outside India comes to visit India, limb (b) does not apply (subject to S.6(5) below). They become resident only if present for 182+ days.

Category 3 — High-income visiting NRIs [S.6(5)]: The above relaxation for visiting NRIs is WITHDRAWN if the person’s Indian income (excluding foreign-source income) exceeds Rs.15 lakh. In that case, the 60-day threshold is replaced by 120 days (not 182 days). This is a targeted provision aimed at high-net-worth NRIs who spend significant time in India and earn substantial Indian income.

2.7.4 The Ship Crew Rule [S.6(6) + Rule 8]

For Indian citizens who are crew members of foreign-bound ships, the calculation of days in India excludes the period of the voyage. Rule 8 operationalises this:

2.7.5 The Deemed Resident Rule [S.6(7)] — The Zero-Tax Jurisdiction Provision

This is perhaps the most controversial provision in Chapter II. Introduced in the 2020 Budget, it creates a legal fiction:

The target: This provision aims at Indian citizens living in zero-tax jurisdictions like the UAE, Bahamas, or Cayman Islands, who may have deliberately arranged their affairs to be tax-resident nowhere. Before this amendment, such individuals fell through the cracks — India couldn’t tax them (they were non-resident) and no other country taxed them either.

2.7.6 Residence of Non-Individual Entities

HUF, Firm, AOP [S.6(9)]: Resident unless the control and management of affairs is situated ‘wholly outside India.’ The word ‘wholly’ is critical — even partial control exercised from India makes the entity resident. A firm where one partner sits in India and another in London is resident in India (because control is not ‘wholly’ outside India).

Company [S.6(10)]: An Indian company is always resident. For other companies: resident if the Place of Effective Management (POEM) is in India. POEM means the place where ‘key management and commercial decisions necessary for the conduct of business of the company as a whole are, in substance, made.’ The CBDT has issued detailed POEM guidelines covering board meeting locations, decision-making authority, where senior management operates, and substance-over-form analysis. A foreign company with its board in Singapore but whose key decisions are actually made by the Indian promoter sitting in Mumbai may have its POEM in India.

Every other person [S.6(11)]: Resident unless control and management is ‘wholly outside India.’ This covers entities like statutory bodies, trusts, and any other ‘person’ under S.2(77).

2.7.7 Not Ordinarily Resident (RNOR) — S.6(13)

RNOR is the intermediate status between resident and non-resident. It offers a cushion: you are treated as resident for procedural purposes, but your foreign-source income is generally not taxable (unless from India-controlled business). Three routes to RNOR status:

Route 1 [S.6(13)(a)]: Individual/HUF manager who has been non-resident in 9 out of the preceding 10 years, OR has been in India for 729 days or less in the preceding 7 years. This protects returning NRIs who have spent most of their lives abroad.

Route 2 [S.6(13)(b)]: Indian citizen/PIO whose Indian income exceeds Rs.15 lakh and who is in India for 120-181 days. These are the high-income visitors caught by S.6(5).

Route 3 [S.6(13)(c)]: Indian citizen deemed resident under S.6(7) (the zero-tax jurisdiction rule).

Section 7 creates timing fictions — it deems certain amounts to be ‘received’ in the tax year even though the assessee may not have actually received them in cash. This ensures that these amounts are included in income on a timely basis:

The practical effect: If a company declares a final dividend on 15th June 2027 for TY 2026-27 but actually pays it in July 2027, the dividend is the income of TY 2026-27 (because it was declared in that year’s AGM, which typically takes place before 30th September). But an interim dividend declared and made available on 20th March 2027 is income of TY 2026-27 itself.

This is a genuinely new standalone provision. Under the old law, the taxation of assets received by partners from firms on dissolution or reconstitution was handled through amendments to various sections and judicial interpretation. The 2025 Act gives it its own section.

2.10.1 The Most Litigated Provision

Section 9 is arguably the most complex and most litigated provision in Indian tax law. It creates legal fictions: even if income has not actually accrued in India, it is ‘deemed’ to accrue here if it has sufficient nexus with India. The section has thirteen sub-sections and operates through eight distinct categories of deemed income. Understanding Section 9 is indispensable for anyone dealing with cross-border transactions.

2.10.2 The Eight Categories of Deemed Income

Category 1 — Business Connection / Assets in India [S.9(2)]: Income from any asset or source of income in India, any property in India, any business connection in India, or the transfer of a capital asset situated in India. The concept of ‘business connection’ is expansively defined in S.9(9) and includes agents with authority to conclude contracts, stock maintenance, order solicitation, and the new digital-era concept of ‘significant economic presence.’

Category 2 — Salary Earned in India [S.9(3)]: Salary is deemed to accrue in India if it is earned in India. Services rendered in India — including rest periods between Indian assignments that form part of the employment contract — constitute ‘earning in India.’ A non-resident consultant who works 15 days in India and takes 2 days off between Indian stints has salary for all 17 days deemed Indian-source. Government salary paid to Indian citizens for service abroad is always Indian-source.

Category 3 — Dividends from Indian Companies [S.9(4)]: Always deemed to accrue in India, regardless of where the dividend is declared, distributed, or paid. If an Indian company’s board meets in London and declares a dividend to its Mauritius shareholders, the dividend is still Indian-source income.

Category 4 — Interest [S.9(5)]: Interest payable by: (a) the Government; (b) a resident (except for foreign business/income); (c) a non-resident if the borrowed money is used for Indian business. The PE (permanent establishment) deeming provision is particularly important for banks: interest payable by an Indian PE of a foreign bank to its head office is deemed Indian-source, and the PE is treated as a separate, independent entity for this purpose.

Category 5 — Royalty [S.9(6)]: The broadest definition in the Act. ‘Royalty’ covers patents, inventions, models, designs, secret formulae, trademarks, copyright, software licences, satellite transmission, and even customised electronic data. The definition of ‘process’ was deliberately expanded to include ‘transmission by satellite (including up-linking, amplification, conversion for down-linking)’ — a legislative override of court rulings that had narrowed the definition. ‘Computer software’ includes any programme recorded on any medium, including customised electronic data.

Category 6 — Fees for Technical Services (FTS) [S.9(7)]: Consideration for managerial, technical, or consultancy services. Excludes: (a) construction, assembly, mining projects; (b) amounts chargeable as salary. The boundary between FTS and business income is a perennial dispute under DTAAs. India’s treaties with the US and UK, for example, do not have an FTS article — services income is taxable only if the non-resident has a PE in India.

Category 7 — Gifts to Non-Residents [S.9(8)]: Sums of the nature referred to in S.2(49)(u) (i.e., gifts/deemed income from inadequate consideration) paid by an Indian resident to a non-resident or RNOR are deemed Indian-source. This prevents tax-free extraction of wealth through gift-like mechanisms.

2.10.3 Significant Economic Presence [S.9(9)(d) + Rule 13]

This is the digital economy provision, designed to tax companies like Google, Amazon, and Netflix that earn substantial revenue from India without any physical presence. A non-resident has a ‘business connection’ in India if:

(a) Revenue from Indian transactions exceeds the prescribed threshold; OR

(b) Systematic engagement with Indian users exceeds the prescribed number.

2.10.4 The Indirect Transfer Rule [S.9(10)] + Rules 10-12

Born from the Vodafone controversy (where Vodafone acquired Hutchison’s Indian telecom business through a share transfer in the Cayman Islands, and India sought to tax the transaction), Section 9(10) provides:

The Income Attribution Formula [Rule 12]: When the indirect transfer rule applies, the income taxable in India is proportional to the Indian assets:

Safe harbour exceptions [S.9(10)(g)]: The indirect transfer rule does NOT apply to: (a) transfers by Category I/II FPIs; (b) transferors (individually or with associated enterprises) holding 5% or less voting power/share capital and having no management/control rights; (c) small portfolio investors in multi-layered structures who hold 5% or less indirect interest. These exceptions protect genuine portfolio investors from being caught by rules designed for strategic acquisitions.

2.10.5 The Fund Manager Safe Harbour [S.9(12)]

Without this provision, every offshore fund managed by a fund manager sitting in India would have a ‘business connection’ in India, making the fund’s entire income taxable here. This would destroy India’s fund management industry. Section 9(12) provides:

This is a niche provision applicable only to married couples in Goa and the Union Territories of Dadra & Nagar Haveli and Daman & Diu who are governed by the Portuguese community property system (Communiao dos Bens). Under this system, all property of the husband and wife is jointly owned. Section 10 prevents their combined income from being assessed as an AOP/BOI and instead:

• Divides income under all heads (except salaries) equally between husband and wife.

• Taxes salary in the hands of the spouse who actually earned it.

• Includes the divided income separately in each spouse’s total income.

Practical impact: This is favourable to such couples because splitting income between two persons takes advantage of the progressive slab structure. If combined rental income is Rs.20 lakh, each spouse includes Rs.10 lakh, potentially being taxed at lower marginal rates than a single person with Rs.20 lakh.

Although Section 14 (which disallows expenditure related to exempt income) falls in Chapter IV, Rule 14 prescribes the computation method and is numbered within the Chapter II rule series. It is therefore discussed here.

[End of Chapter II. Chapter III: Incomes Not Forming Part of Total Income — covering Sections 11-12 and Schedules II-VIII — follows.]