Surcharge Vs. Cess

 

Surcharge Vs. Cess – Understanding them and their Differences

Why do we pay taxes? What really happens to the tax money? Well, most of us know the answer to these questions. The tax we pay is the income of our government. The money that the government earns is spent on a number of things like infrastructure development, defense, transport, agriculture etc. So, taxes are important because, without taxes, the government’s treasury will remain empty and our country’s development will be neglected.

Surcharge Vs. Cess

But…

When you pay taxes, you see that there are several elements which are pretty direct and evident. One such tax is income tax. Another such tax is corporation tax. Apart from direct taxes, you also pay a host of indirect taxes like VAT or Value Added Tax, Service Tax, Sales Tax etc. However, you may have come across elements like Cess and Surcharge. Basically, you don’t have any idea of what they are and why you pay those things but you still pay. You generally tend to overlook them because the amount you pay for those (sometimes) unsuspecting elements (and sometimes overlooked elements) is actually very less.

The problem is that we end up paying for those elements even when we are paying restaurant bills. These elements come in addition to customary tax. Funny part, though the amount is less in some scenarios, they can lead to large amounts in some other case.

How?

Here is how…

The government decided to raise the Infrastructure Cess by 1 – 4%. This came down on the manufacturers of motor vehicles and hence, in order to avoid that tax, the motor vehicle manufacturers decided to hike their prices. This led to increase in price for the vehicles that we purchase. In case of something dear such as a motor vehicle, price hikes can be lofty. That Infrastructure Cess is supposed to go out of the pockets of the motor vehicle manufactures but they did not want to take that price burden. Hence, they decided to pass the burden on to the consumers. Thus essentially, we as the end users, carry the burden.

Similarly, the government also decided to double the Cess for Clean Environment. Previously, the cess stood at INR 200. Now the cess is at INR 400. Because of this doubling, the price of electricity went up by 4 paise to 6 pasie for every single unit of electricity we consume. Electricity usage may not be high for everyone but over the long run, we pay quite a lot because of the increased cess.

So, what are these cess and surcharges?

Some people may say that they are basically indirect taxes. But they aren’t really so. They are always predefined taxes and come at a specified rate only. It is mandatory to pay such cess and surcharges and we just cannot say no to that. In this article, we will learn about the cess and surcharges in details.

But before we do so, there is one question that we need to answer…

What are direct and indirect taxes?

Nice question and we are glad that you asked. Let us answer this question in two parts:

What are direct taxes?

Direct taxes are taxes that we pay directly to the government. For example, Income Tax is a direct tax that we pay to the government directly. The government applies this tax on individuals and corporations / companies (in case of companies, it is Corporation Tax and not Income Tax). Though the rates differ for individuals and companies, the tax has to be paid if income is earned by someone or by some company.

There is no intermediary in between the government and the taxpayer(s).

What are indirect taxes?

Indirect taxes are paid still paid to the government but the only difference is that some intermediary sits in between.

This is how it works:

  1. The government first taxes the intermediary.
  2. The intermediary then recovers the tax it pays to the government from the end user.

But when and on what are these indirect taxes paid?

They are basically applied on sale of services and products. The manufacturer or the service provider will pay the indirect taxes to the government first. Then the manufacturer or the service provider will add the amount of money it pays as tax to the government to the price of the services or products. The tax plus the price (tax + price) is what comes up as the final price for the end users.

So, what are some examples of indirect taxes? There are several types of indirect taxes such as service tax, VAT, excise duty, sales tax etc.

List of all direct and indirect taxes at Central and State Levels

CENTRAL GOVERNMENT – DIRECT AND INDIRECT TAXES
Direct Taxes Indirect Taxes
Tax applied on Income:

·         Corporation tax as well as MAT applied on companies and corporations.

·         Income tax applied on individuals who earn.

Custom duty:

·         Applied on Imports.

·         Applied on Exports.

Taxes applied on Assets:

·         Capital Gains tax.

·         Security Transaction tax.

Excise duty (This falls under the CENVAT or Central Value Added Tax system)
  Service tax
  Central Sales tax or CST

 

STATE GOVERNMENT – DIRECT AND INDIRECT TAXES
Direct Taxes Indirect Taxes
Tax applied on Income:

·         Professional tax.

·         Agricultural Income tax.

Value Added Tax (VAT) / Sales tax.
Taxes applied on Assets:

·         Registration and Stamp Duty.

·         Land Revenue.

·         (Urban Areas Only) Property tax.

Excise Duty applied on Narcotics and DESI liquor.
  Taxes applied on animals and boats.
  Motor vehicle tax.
  Electricity tax.
  Toll tax.
  Luxury tax applied on spas, restaurants etc.
  Tax applied on gambling, betting.
  Advertisement tax apart of adverts put on newspaper, TV and radio.

That’s pretty much a comprehensive list of direct and indirect taxes that are applied on people and businesses by central and state governments.

Now, let us try and understand cess and surcharge…

Remember that Cess and Surcharge do not fall in direct or indirect tax categories.

So, what really is Cess?

There are certain pre-decided purposes that the government wants to achieve. The tax that is collected by the government for those purposes is known as Cess. For example, no matter what the government does, it will always work towards funding both secondary education and higher education. This purpose is predefined and is never altered irrespective of the agenda (political or economic) of the ruling government. So, government collects tax for this predefined purpose through cess. There are two types of cess applied here:

  1. Education Cess
  2. Secondary and Higher Education Cess.

Similarly, development of agriculture is yet another predefined purpose. This cannot be removed from government’s agenda. Even if the budget is stating something towards development of agriculture in India or it isn’t, this cess will be there and the money collected through that cess will go towards the development of agriculture in India. Krishi Kalyan Cess is tax we pay for this predefined purpose.

Here are some interesting features of cess:

  • A cess may actually be removed any moment. It is completed the decision of the government. When the government feels that enough fund has been collected for the given purpose, the cess may be removed.
  • There are some services which are listed on the tax exemption list. Those services will never attract cess.
  • Cess can be introduced any time. It can also be abolished any time or the government may simply decide to alter it any time. It does not involve the elaborate process of passing bill through parliament and then amending Income Tax Act. Just a simple notification is to be raised and voila! That’s all is needed – a notification. So, cess actually works as an easy income source for the government but limited with the fact that the money collected by a cess needs to go into that particular purpose only.

Where does the cess collection go?

Every single rupee that the government earns as revenue goes in the Consolidated Fund of India, usually known by the abbreviated name – CFI. Everything from income tax to corporation tax to sales tax to VAT – everything goes into CFI and so does the cess! There is however one thing that happens in case of cess fund. Every penny that is collected out of cess will be used only and only for the purpose for which it has been collected. Remaining tax collections can be used in any XYZ purpose that the government deems necessary.

For example, the government collects what is known as Fuel Cess. This money that is collected actually goes into development of roads. For that, there is a separate fund known as the Central Road Fund. The Fuel Cess that is collected from people, first goes to the CFI. Then, an appropriation bill is passed in the parliament and the money collected from Fuel Cess is transferred to the Central Road Fund.

What are the different types of cess that we pay from time to time?

Cess is gradually becoming one of the most favorite forms or channels of revenue generation for the government. Basically, cess application allows government to fund all the schemes that the government comes up with from time to time. For instance, after the Swachh Bharat Abhiyan was launched, the government introduced Swachh Bharat cess. Later, the government introduced Krishi Kalyan cess. Then came the Infrastructure cess. The government also doubled Clean Environment cess.

In order to avoid any criticism, the government also decided to do away with 13 different types of cess which were not very profitable for the government and only garnered 50 crore rupees or less in a year.

Now, let us take a look at different types of cess that we need to pay and take a look at their rates, purpose and exactly how much we need to pay for each cess (in absolute terms). We will make use of a table for this as it will make our job easy.

Cess Type Cess Purpose Cess Rate Cess Calculation
Swachh Bharat Cess (SBC) This cess is for promotion and financing of Clean India Mission or Swachh Bharat Abhiyan Service value’s 0.5% which doesn’t include any applicable tax as well as service tax Suppose you dine out and your restaurant bill stands at INR 700. The SBC amount will be INR [(700 x 0.5) ÷ 100] = INR 3.5
Education Cess (EC) For promotion of work related to education 2% of income tax payable by a taxpayer OR, 2% of applicable service tax (whichever applies) Assuming that you have to pay income tax of INR 5,000. The EC you need to pay is INR [(5000 x 2) ÷ 100] = INR 100. Thus, the total tax you need to pay is INR 5,100.
Infrastructure Cess (IC) For automobile segments welfare 1% for vehicles which operate on CNG (Compressed Natural Gas), LPG (Liquefied Petroleum Gas) or petrol. The vehicles are no bigger than 4 meters in length and do not have an engine capacity in excess of 1200 cc. Depends on how much fuel you purchase for your vehicle and also on the type of vehicle you have.
2.5% for vehicles which operate on diesel and are no bigger than 4 meters in length. Also, those vehicles should not have a capacity higher than 1500 cc.
4% for all other vehicles which are bigger and have higher capacity engines, irrespective of whether they use petrol, diesel, CNG or LPG.
Higher Education and Secondary Education Cess For improvement of Higher Secondary and Secondary education in India 1% of income tax payable by a taxpayer OR, 1% of applicable service tax (whichever applies) Assuming that you have to pay income tax of INR 5,000. The cess you need to pay is INR [(5000 x 1) ÷ 100] = INR 50. Thus, the total tax you need to pay is INR 5,050.
Krishi Kalyan Cess (KKC) Promotion and financing of initiatives designed for improvement of agrarian sector in this economy Service value’s 0.5% which doesn’t include any applicable tax as well as service tax Suppose you dine out and your restaurant bill stands at INR 700. The KKC amount will be INR [(700 x 0.5) ÷ 100] = INR 3.5
Clean Environment Cess For promotion of clean environment and reduction of carbon footprints on this environment For each 1 ton of coal extracted, a flat amount of INR 400  

Amount of Cess Collected and Amount That Has Been Utilized

Because you pay Cess, you will want to know how much money has been collected and how much has been used. The table below will give you a proper snapshot till 2015.

Cess Type Data Period Collected Amount Amount Transferred or Utilized (in Crores)
Cess on Tea 2014-2015 57.37 crores NIL
Universal Service Obligation Fund 2002-2015 66,117 crores 26,983 crores
Cess on Feature Films 2014-2015 3.83 crores 1.73 crores
Research and Development Cess 1996-2015 5,784 crores 1,228 crores
Central Road Fund 2010-2015 101,142 crores 99,922 crores
Primary Education Cess 2004-2015 154,818 crores 141,520 crores
Higher Education and Secondary Education Cess 2006-2015 64,228 crores NIL
Data collected from CAG report on Government of India’s Account for 2014-2015

If you notice carefully, you will notice that there is something called “Amount Transferred or Utilized” in the table above. The question is, where is the amount transferred? As we said earlier, the cess collected actually goes to CFI (Consolidated Fund of India). From there, the cess is transferred to a specific fund designed for the purpose for which the cess was collected in the first place. So, we see that in case of Tea Cess and Higher Education and Secondary Education Cess, it is NIL. The truth is that no fund has been created for those cess and even no scheme was announced lately so that the collected fund can be used.

That completes our discussion on Cess. There isn’t enough to discuss. So, we will move forward and learn about Surcharge in our next segment. Ready?

What is Surcharge?

In plain and simple words, ‘IT IS ADDITIONAL TAX’. This means that if you are paying income tax (as per the income slab you fall in), you may be asked to pay additional tax if your income is really high. There was a time when surcharge was applicable only and only on businesses. This changed in 2013 when it was announced by the Union Government of that time that individuals who have income over INR 1 crore will also have to pay surcharge at the rate of 15%. In Budget 2017 (that is the current budget), it was announced by Union Finance Minister, Arun Jaitley that surcharge of 10% will be applicable on those who have a yearly income within the range INR 50 lakhs and INR 1 crore. Those with annual income over INR 1 crore will continue to pay surcharge at 15%.

Here is something you need to know about Surcharge:

  • Not all taxpayers are required to pay surcharge. Surcharge is applicable only to those individuals who:
    • Have income within range: INR 50 lakhs – INR 1 crore: Surcharge rate – 10%.
    • Have income over INR 1 crore: Surcharge rate – 15%
  • People who pay surcharge will have to pay Education Cess (2%) and Higher Education and Secondary Education Cess (1%) over and above (Income Tax + Surcharge).

Surcharge Rates for Various Taxpayers

For this subsection, we will like to start by saying that there are two broadly categorized types of taxpayers – the individual taxpayers and the businesses that pay taxes. Also, you need to know that surcharge is applied on the payable income tax and not on the taxable income itself. Let us take a look at the surcharge rates that are currently applicable for different types of taxpayers.

For HUFs and Individuals:

The weirdest part of surcharge is that for HUFs and Individuals is way higher. In fact, it is the highest.

Income above INR 1 crore (HUFs and individuals who fall in Super Rich category)

The current surcharge rate for HUFs and individuals who earn in excess of INR 1 crore in a year, the surcharge is 15% of the total payable income tax. The surcharge was introduced for the first time in year 2013 and the rate at introduction was 10%. However, the rate has been revised upwards several times. The table below shows the revisions made for various fiscal years:

Fiscal year Surcharge rate
2013-2014 10 %
2014-2015 10 %
2015-2016 12 %
2016-2017 15 %
2017-2018 15 %

Income between INR 50 lakhs and INR 1 crore (HUFs and individuals who fall in Rich Category)

The surcharge for the rich category of people was introduced in budget 2017. This means that the surcharge will be applicable from fiscal year 2017-2018. There was no surcharge for the rich category of people prior to this. The table below shows the surcharge for the rich category of people.

Fiscal year Surcharge rate
2013-2014 0 %
2014-2015 0 %
2015-2016 0 %
2016-2017 0 %
2017-2018 10 %

For Businesses:

Surcharge of 15% is applicable on income if the businesses fall in the following categories:

  • LLP
  • Partnership Firm
  • Cooperative Society
  • Local Authority

For Domestic Companies:

For Domestic companies, the surcharge rate is 7% on the payable tax.

For Foreign Companies:

Foreign companies enjoy the lowest surcharge as per Income Tax Act. Some people may not like this but there is a reason for low surcharge applicable on foreign companies. Of the many reasons, the two primary reasons are:

  • Ease of doing business.
  • Cost reduction to invite Foreign Investment, which eventually leads to higher employment within India.

The surcharge rates for the foreign companies is given in the table below:

Income Slab Surcharge Rate
Income below or equal to INR 1 crore 0 %
Income between INR 1 crore and INR 10 crores 2 %
Income above INR 10 crores 5 %

Calculation of Surcharge and Concept of Marginal Relief

Calculation of surcharge is difficult and a bit complicated because there is a concept of Marginal Relief in between. Before we move forward and give an example of how surcharge is calculated with marginal restriction, we need to first explain the concept of marginal relief.

So, what is marginal relief?

We will skip the complicated definition and straightaway take an illustration for explanation.

Scenario 1:Let us assume that the annual income is INR 1 crore. This is the net taxable salary. So, the table below will show the tax calculation:

PLEASE NOTE THAT WE ARE CONSIDERING THE SCENARIO OF 2014-2015 WHERE SURCHARGE WAS APPLICABLE AT THE RATE OF 10% AND ONLY ON THOSE WHO HAVE INCOME ABOVE INR 1 CRORE
Elements Element Denoted by Letters Figures and calculation
Net taxable income INR 1,00,00,000
Payable income tax A INR 28,25,000
Surcharge payable on payable income tax B INR 0 (it is zero because surcharge will be applicable only if the income exceeds INR 1 crore)
Total education cess (2% + 1%)* C INR 84,750
Total payable tax D = A+B+C INR 29,09,750
* Please note that the cess is applied for Primary Education Cess and Higher Education and Secondary Education Cess

Scenario 2:Now, let us consider a situation where the income increases above INR 1 crore by just Rs. 10. So, the total taxable income will stand at INR 1,00,00,010. What will happen in this case?

Let us check the table below:

PLEASE NOTE THAT WE ARE CONSIDERING THE SCENARIO OF 2014-2015 WHERE SURCHARGE WAS APPLICABLE AT THE RATE OF 10% AND ONLY ON THOSE WHO HAVE INCOME ABOVE INR 1 CRORE
Elements Element Denoted by Letters Figures and calculation
Net taxable income INR 1,00,00,010
Payable income tax A INR 28,25,003
Surcharge payable on payable income tax B INR 2,82,500
Total education cess (2% + 1%)* C INR 93,225
Total payable tax D = A+B+C INR 32,00,728
* Please note that the cess is applied for Primary Education Cess and Higher Education and Secondary Education Cess

Now compare the two scenarios side by side in the table below:

PLEASE NOTE THAT WE ARE NOT CONSIDERING CESS CHARGES. WE WILL ONLY FOCUS ON INCOME TAX AND SURCHARGE
Elements Scenario 1 Scenario 2
Taxable income INR 1,00,00,000 INR 1,00,00,010
Payable income tax INR 28,25,000 INR 28,25,003
Payable surcharge INR 0 INR 2,82,500
Extra that is to be paid in Scenario 2 INR 2,82,503

In the table above, you will notice that just for Rs 10 increase in salary, the extra tax that one needs to pay is INR 2,82,503. This is completely disproportionate. So, the taxpayer will actually prefer to stick with income of INR 1 crore instead of getting a hike of Rs 10.

This is where the concept of marginal relief comes in. It simply means that “UNDER NO CIRCUMSTANCES, THE INCREASE IN PAYABLE TAX (WHICH IS INCLUSIVE OF THE SURCHARGE) CAN EXCEED THE AMOUNT BY WHICH THE INCOME INCREASES ABOVE THE MARK OF INR 1 CRORE.”

This bleakly translates into the following:

The extra income tax that one needs to pay (which is inclusive of the surcharge) should be restricted to salary increase above INR 1 crore. However, Cess will be extra and that will be calculated over and above (income tax + surcharge (restricted if necessary))

Calculation of Marginal Relief, Surcharge and Total Payable Income Tax (excluding Cess)

Now that we know the concept of marginal relief, let us take a numerical example to calculate the surcharge and total income tax payable.

There will be multiple steps. We will pick one at a time. But before we start, we make the following assumptions:

  • We are in Fiscal Year 2014-2015 where surcharge rate is 10% of payable income tax.
  • The taxpayer is an individual of age below 60 years.
  • The taxpayer has an annual income of INR 1 crore and 74 thousand (INR 1,00,74,000).

Step 1: Calculation of surcharge and total tax to be paid

Element Actual Figure (Amount)
Income that can be taxed INR 1,00,74,000
Income tax payable INR 28,47,200
Surcharge payable (10% on payable tax) INR 2,84,720
Total tax to be paid INR 31,31,920

Step 2: Is salary increment higher that tax increment? Finding out…

Increment in the yearly income or salary = INR 1,00,74,000 – INR 1,00,00,000 = INR 74,000

Increment in tax to be paid = (Tax to be paid on INR 1,00,74,000 – Tax to be paid on INR 1,00,00,000) = INR 31,31,920 – INR 28,25,000 = INR 3,06,920

In this case

Increment in yearly income is LESS THAN increment in tax to be paid. In this case, the marginal relief kicks in and says that the increment in tax to be paid (inclusive of the surcharge payable) should get restricted to INR 74,000.

Step 3: Surcharge calculation with marginal relief in place

Income Slab Element Element Representation in Letter Absolute Numbers
Above 1 crore Income that will be taxed A INR 1,00,74,000
Income tax payable NOT including surcharge B INR 28,47,200
Exactly 1 crore Income that will be taxed C INR 1,00,00,000
Income tax payable (surcharge is not applicable at all) D INR 28,25,000
Incremental Tax E = B – C INR 22,200

Now, as per the data so far, the increase in income is INR 74,000 and the incremental tax (inclusive of surcharge) cannot exceed INR 74,000 because of Marginal Relief. But, the tax without surcharge element stands at INR 22,200. So, the surcharge that will be charged here will be:

INR 74,000 – INR 22,00 = INR 51,800

So, the surcharge that will be applicable subject to marginal relief will be INR 51,800.

Now that we know the surcharge, let us calculate the final tax that is to be paid.

Step 4: Calculation of final tax to be paid

Now, the final tax that will be paid will include:

  • Income tax without surcharge
  • Surcharge
  • Education cess (3% of payable tax)

The table below will show the calculation

Element Element Representation in Letters Absolute Numbers
Taxable Income INR 1,00,74,000
Tax A INR 28,47,200
Surcharge B INR 51,800
Cess C (3% of A+B) INR 86,970
Total payable tax D = A+B+C INR 29,85,970

KINDLY NOTE: In case:

Incremental income > Incremental tax,

Marginal Relief will no longer be applicable and surcharge will be applied with the usual rate.

That’s pretty much everything about surcharge. There is nothing more to explain. However, we are still left with one more segment – Different Between Surcharge and Cess. Let us cover that section and finish the article.

Difference Between Surcharge and Cess

  • Cess is a fund which has been earmarked for a specific purpose. Surcharge is not earmarked. It can be used for any purpose.
  • If cess implementation purpose gets fulfilled, the government removes the cess. This is not the case with surcharge. Surcharge has no such restriction and can be continued.
  • Surcharge is applied on payable tax or total service value. Cess is payable only on total payable tax (which may or may not include surcharge). However, there may be some cess (such as Krishi Kalyan Cess) where the cess is applicable on total service value (similar to that of surcharge).

Now that we have learned about differences, we can take a quick look at some similarities between surcharge and cess.

Similarities between Surcharge and Cess

  • Both surcharge and cess collected by central government will go into CFI or Consolidated Fund of India.
  • Central government is not obligated to share surcharge and cess collection with state governments.

That’s pretty much everything that you need to know about Surcharge and Cess. In case you have any question, feel free to send a comment or two. We will try to reply as fast as possible.

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