Advance Tax: A Comprehensive Taxpayer’s Guide

Contents Covered

• Understanding Advance Tax under the Income Tax Act, 1961
• Importance of Paying Advance Tax
• Implications of Not Paying Advance Tax
• Example of Implications of not Paying Advance Tax
• Advance Tax Calculation Method: Key Steps and Tips
• Example Calculation of Advance Tax
• Conclusion

Understanding Advance Tax under the Income Tax Act, 1961

Advance tax is a mechanism under the Income Tax Act, 1961, which allows taxpayers to pay their estimated taxes in installments throughout the financial year, rather than settling the entire tax amount when filing their tax return. This system applies to individuals, Hindu Undivided Families (HUF), firms, companies, and other entities whose estimated tax liability for the financial year exceeds Rs. 10,000. Advance tax helps the Government maintain a steady flow of revenue, while also easing the financial burden on taxpayers by spreading the payment throughout the year.

Importance of Paying Advance Tax

• Prevents Burden at Year-End:
  Paying taxes in installments throughout the year helps taxpayers avoid a large payment at the end of the financial year. This can significantly ease the cash flow burden, especially for individuals or businesses that may have cash-flow constraints.
• Avoids Interest:
  Timely payment of advance tax ensures that taxpayers avoid unnecessary interest. If the tax is not paid on time, the Income Tax Department imposes interest under sections 234A, 234B, and 234C, which can increase the total tax liability.
• Boosts Government Revenue Collection:
  For the Government, advance tax ensures a steady stream of income throughout the financial year, helping in timely allocation of resources and better planning of public expenditure. It eliminates the need for the Government to wait for large sums of tax payments at the end of the year, improving fiscal management.

Implications of Not Paying Advance Tax

If an individual fails to pay advance tax as per the due dates, they will face penalties and interest charges under sections 234A, 234B, and 234C of the Income Tax Act.

• Section 234A (Interest for Default in Filing Return):
  This section imposes interest for delay in filing the income tax return. If the advance tax is not paid in time and the taxpayer does not file the return of income within the due date, interest will be charged at 1% per month on the outstanding tax amount.
• Section 234B (Interest for Default in Payment of Advance Tax):
  If a taxpayer does not pay the advance tax or pays less than 90% of the tax payable, they will be charged interest under this section at 1% per month on the tax due, starting from April 1 of the assessment year.
• Section 234C (Interest for Deferral of Advance Tax):
  If the taxpayer fails to pay the required installment of advance tax or delays the payment, this section applies. Interest of 1% per month will be charged on the amount of shortfall.

These interest charges can accumulate over time and significantly increase the total tax liability, leading to a financial burden for the taxpayer.

Example of Implications of Not Paying Advance Tax

Let’s take the example of an individual whose total income for the financial year is ₹40,00,000. Based on the current tax slabs, the tax payable will be approximately ₹9,00,000.

Now, assume the individual does not pay the advance tax on time. The implications would be as follows:

• Total Tax Liability: ₹9,00,000
• Interest under Section 234A: If the individual delays filing the return, interest will be charged at 1% per month on the outstanding tax. For instance, if the return is filed three months late from the end of the financial year, interest of ₹27,000 (₹9,00,000 * 1% * 3 months) will be levied.
• Interest under Section 234B: If the taxpayer has not paid 90% of the tax liability by the due date (15th March of the assessment year), interest will be levied on the outstanding tax from April 1st. Assuming that no advance tax was paid during the year, the interest will be calculated at 1% per month. In this case, the interest for one year could amount to approximately ₹1,08,000 (₹9,00,000 * 1% * 12 months).
• Interest under Section 234C: If the taxpayer misses the deadlines for installment payments (15th June, 15th September, 15th December), they will face interest on the shortfall. If no installments were paid, the total interest under Section 234C may amount to ₹25,000 (this varies depending on how much was due and how long it was overdue).

Thus, the total interest liability under sections 234A, 234B, and 234C could amount to ₹1,25,000, bringing the total amount payable (tax + interest) to approximately ₹10,25,000.

Advance Tax Calculation Method: Key Steps and Tips

To determine the amount of advance tax, a taxpayer must first estimate their total income for the financial year. This includes income from various sources such as salary, business, capital gains, interest, rent, etc. Once the total estimated income is computed, the taxpayer calculates their tax liability and pays the tax in installments.

Here is a step-by-step process for calculating advance tax:

Estimation of Gross Income from Various Sources

Understanding the different types of income is crucial in calculating advance tax, let us understand some through case examples:

• Case A: Income from Salary
  If an individual receives income solely from salary, it is likely that the employer is already deducting Tax Deducted at Source (TDS) and remitting it to the Government on behalf of the employee. In such cases, there is no requirement for the taxpayer to pay advance tax, as the tax is being paid on their behalf through TDS.
• Case B: Income from Salary and Interest
  If an individual earns income from both salary and interest (e.g., savings accounts, fixed deposits), advance tax must be calculated on the interest income. Since TDS is already deducted on the salary income, the taxpayer only needs to estimate and pay tax on the interest income.
• Case C: Income from Rent, Interest, and Dividends
  If a taxpayer has rental income in addition to interest and dividend income, they need to estimate the total income from these sources for the year. The taxpayer will calculate the tax liability based on the total income derived from rent, interest, and dividends, and pay advance tax accordingly.
• Case D: Income from Business
  In the case of business income, it is more challenging to determine the exact tax liability as it depends on various factors, including business expenses and profits. Therefore, business owners usually estimate their income based on their financial performance in the previous year and apply this estimate to calculate their advance tax.
• Case E: Custom Approach {Smart Tax Estimation: Leveraging Last Year’s Liability}
  A more practical approach to estimate advance tax is to consider the taxpayer’s tax paid in the previous financial year and using it as a starting point. Then, if the income is expected to increase (for example, by 10%), the taxpayer can roughly estimate how much tax they will owe this year. This method works well when the person’s income and tax situation are expected to be similar to the previous year. Although it’s just an estimate, it helps the taxpayer figure out how much to pay in advance without having to wait for the exact tax calculation, especially if there aren’t big changes in their finances or tax rules.
  • Calculation of Net Taxable Income
    (Once the gross income has been estimated from various sources, the next step is to apply the eligible deductions under sections like 80C, 80D, 80G, etc. These deductions will reduce the gross income, giving the taxpayer the net taxable income.)
  • Computation of Tax Liability
    (The net taxable income is then subject to the applicable income tax slabs. The taxpayer must compute their total tax liability based on these slabs and rates.)
  • Apply Rebate
    (Certain rebates, such as the rebate under Section 87A, may apply to reduce the tax liability. Any eligible rebate should be subtracted from the calculated tax liability to arrive at the final tax payable.)
  • Consider TDS
    The taxpayer should also take into account any TDS that has been deducted on their income during the year. The amount of TDS already paid is subtracted from the total tax liability.
  • Pay in Installments
    (Once the advance tax liability has been determined, it must be paid in installments as per the schedule provided in the Income Tax Act. The due dates for advance tax payments are as follows:
    • 15th June: 15% of the total estimated tax liability.
    • 5th September: 45% of the total estimated tax liability, minus the amount already paid in the first installment.
    • 15th December: 75% of the total estimated tax liability, minus the amounts already paid in the first and second installments.
    • 15th March: 100% of the total estimated tax liability, minus the amounts already paid in earlier installments.)

Example Calculation of Advance Tax

Estimate of Advance Tax Liability for Q3 FY 2024-25

Conclusion

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