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Direct Tax Interview Questions: Your Guide to Crack Interview!

Direct taxation plays a pivotal role in shaping a nation’s economy and ensuring equitable revenue collection. A strong command over direct tax concepts is essential for professionals aspiring to excel in finance, taxation, or accounting careers. Whether you’re preparing for interviews in top CA firms, corporate tax departments, or government positions, understanding key questions and how to approach them can set you apart from the competition. 

In this blog, we’ll cover the most important Direct Tax interview questions, along with insightful approaches and sample answers to help you confidently navigate any tax-related discussion. Let’s dive into the world of Direct Tax and equip you with the knowledge to succeed!

January 17, 2025

1. Explain the difference between direct and indirect taxes.

Approach:

  • Define direct and indirect taxes.
  • Highlight key differences with examples.
  • Mention the impact on individuals and businesses.
Sample Answer:
Direct taxes are taxes levied directly on the income or wealth of individuals or entities, such as Income Tax or Corporate Tax. The liability cannot be shifted to another person.
Indirect taxes, like GST or Customs Duty, are levied on goods and services, and the burden can be passed on to the end consumer. For example, Income Tax is paid directly by the individual earning income, while GST is collected by the seller but paid by the consumer.


2. Case: Responding to Income Tax Notice Scenario:

A taxpayer received a notice under Section 143(1) for discrepancies in their ITR. The notice highlights a mismatch between income reported in the return and TDS details in Form 26AS. The taxpayer reported ₹12 lakhs as income but Form 26AS shows ₹15 lakhs.

Question: How would you respond to this notice? Explain the process of verifying discrepancies, rectifying errors, and responding to the tax authorities.

Approach:

  1. Understand the Notice Type:
    • Identify that the notice under Section 143(1) is an intimation for discrepancies between the ITR filed and the data available with the tax department (e.g., Form 26AS).
    • Recognize that this is not a demand notice but requires reconciliation.
  2. Verify Discrepancies:
    • Cross-check the income reported in the ITR with details from Form 26AS, AIS (Annual Information Statement), or TDS certificates.
    • Identify the source of mismatch (e.g., omitted income, incorrect TDS credit, or reporting errors).
  3. Rectify Errors:
    • If the discrepancy is valid (e.g., missed reporting ₹3 lakhs of income), prepare a revised return under Section 139(5).
    • If there’s no error on your part, gather supporting documents (e.g., TDS certificates, salary slips) to justify your reporting.
  4. Respond to the Notice:
    • Log in to the Income Tax e-Filing portal.
    • Navigate to e-Proceedings > Compliance > Select the notice.
    • File a response under Response to Notice section, attaching supporting documents if necessary.
  5. Monitor the Outcome:
    • After submission, track the status of the response.
    • If unresolved, be prepared for further scrutiny or hearings under Section 143(2).
Sample Answer:

If I were responding to this notice, I would first verify the income reported in my return with the Form 26AS. In this case, there is a mismatch of ₹3 lakhs. Upon investigation, I would check if:

  • I omitted income from a source (e.g., interest or freelance earnings).
  • There was an error in TDS credit mapping or incorrect PAN usage by the deductor.
If the error is valid, I would revise my return under Section 139(5) to include the missed income and pay any additional tax liability along with interest. I would then respond to the notice by:
  1. Logging into the Income Tax e-Filing portal.
  2. Navigating to the notice under Compliance and selecting Response to Notice.
  3. Explaining the reason for the discrepancy and attaching the revised return acknowledgment (if applicable).
If the error was on the tax deduction's part, I would attach my TDS certificates and explain the situation, requesting rectification. This ensures compliance and avoids penalties, resolving the issue promptly.


3. Case: TDS Compliance Scenario:

A company paid professional fees of ₹5,00,000 to a consultant but failed to deduct TDS. The tax officer disallowed the expense during assessment.

Question:

Discuss the implications of non-deduction of TDS and explain how the company can rectify the issue to avoid disallowance under Section 40(a)(ia).

Approach:

Explain the Provision: Mention the requirement to deduct TDS under Section 194J (or professional fees above ₹30,000 in a financial year).

Highlight the consequence of non-deduction under Section 40(a)(ia), leading to disallowance of the expense.

Discuss Implications:

Explain the tax officer's disallowance of ₹5,00,000 as a deduction, increasing taxable profits.

Clarify potential penalties and interest under Sections 201 and 201(1A) for non-compliance.

Rectification Process:

Outline how the company can deduct TDS later and deposit it with interest.

Mention that once TDS is deposited and reported in the subsequent financial year, the disallowed expense can be claimed in the year of deposit.

Sample Answer:

Under Section 194J of the Income Tax Act, TDS is required to be deducted at 10% on professional fees exceeding ₹30,000 in a financial year. In this case, the company failed to deduct ₹50,000 as TDS on ₹5,00,000 paid to the consultant.

As a result, under Section 40(a)(ia), the entire ₹5,00,000 is disallowed as a deductible expense during assessment, leading to an increase in taxable income. Additionally, the company may face:

  1. Penalty under Section 201 for non-deduction.
  2. Interest under Section 201(1A) at 1% per month for the period of non-deduction and 1.5% per month for the delay in deposit after deduction.

To rectify the issue:

  1. The company should immediately deduct TDS of ₹50,000 and deposit it with the government, along with interest under Section 201(1A).
  2. File the TDS return for the relevant quarter and provide the consultant with Form 16A.
  3. Once this is done, the disallowed amount of ₹5,00,000 can be claimed as an expense in the subsequent financial year when TDS is deposited.

For example, if TDS is deducted and deposited in FY 2024-25, the ₹5,00,000 disallowed in FY 2023-24 will be allowed as an expense in FY 2024-25.

This ensures compliance and minimizes penalties while addressing the disallowance under Section 40(a)(ia).


4. What are the various heads of income under the Income Tax Act?

Approach:

  • List all five heads.
  • Provide a brief explanation of each.
Sample Answer:
The Income Tax Act classifies income into five heads:
  1. Income from Salary - Includes wages, pensions, and perquisites.
  2. Income from House Property - Rental income minus deductions like standard deduction and interest on loans.
  3. Profits and Gains of Business or Profession - Income from business operations or professional services.
  4. Income from Capital Gains - Profits from the sale of capital assets.
  5. Income from Other Sources - Residual income, such as dividends, lottery winnings, or interest income.

5. How is residential status determined under the Income Tax Act?

Approach:

  • Define residential status categories.
  • Explain the criteria for determining status.
Sample Answer:
Residential status is determined based on an individual’s physical presence in India during a financial year:
  1. Resident - If the individual is in India for 182 days or more, or for 60 days in the current year and 365 days in the preceding 4 years.
  2. Non-Resident (NR) - If neither condition is met.
  3. Resident but Not Ordinarily Resident (RNOR) - Special status for returning NRIs or expatriates meeting specific criteria.
Residential status affects taxability—residents are taxed on global income, while non-residents are taxed only on Indian income.


6. What are the deductions available under Section 80C?

Approach:

  • List popular deductions with limits.
  • Explain their relevance for tax planning.
Sample Answer:
Under Section 80C, an individual can claim deductions up to ₹1.5 lakh for investments and expenses like:
  1. Life Insurance Premiums
  2. Employee Provident Fund (EPF)
  3. Public Provident Fund (PPF)
  4. National Savings Certificate (NSC)
  5. ELSS (Equity Linked Savings Scheme)
  6. Principal repayment on home loan
  7. Tuition fees for children (up to 2 children).
These deductions incentivize savings and investments while reducing taxable income.


5. How are capital gains taxed, and what are the exemptions available?

Approach:

  • Differentiate between short-term and long-term capital gains.
  • Highlight common exemptions under Sections 54, 54EC, etc.
Sample Answer:
Capital gains are classified as:
  1. Short-term Capital Gains (STCG): Taxed at 15% (for listed securities) or as per slab rates for others.
  2. Long-term Capital Gains (LTCG): Taxed at 10% (above ₹1 lakh for equities) or 20% with indexation for others.
Exemptions include:
  • Section 54: LTCG on sale of a residential property reinvested in another residential property.
  • Section 54EC: LTCG reinvested in specified bonds (e.g., REC, NHAI).
  • Section 54F: Sale of any capital asset (except house property) and reinvestment in a residential house.

6. What is Transfer Pricing, and why is it significant?

Approach:

  • Define transfer pricing.
  • Emphasize its importance for cross-border transactions.
Sample Answer:
Transfer Pricing refers to the pricing of goods, services, or intangibles transferred between related entities within a multinational enterprise. It ensures that transactions are conducted at arm’s length price to prevent profit shifting and tax base erosion.
The Income Tax Act mandates maintaining documentation and disclosures under Sections 92 to 92F, and penalties apply for non-compliance.


7. Explain the concept of MAT (Minimum Alternate Tax).

Approach:

  • Define MAT and its rationale.
  • Mention the relevant section and rate.
Sample Answer:
MAT ensures that companies with significant book profits but negligible taxable income due to exemptions or deductions pay a minimum tax.
It is levied under Section 115JB at 15% of the book profit (plus surcharge and cess). However, MAT credits can be carried forward for 15 assessment years and offset against future tax liabilities.


8. What is TDS (Tax Deducted at Source)? Mention key provisions.

Approach:

  • Define TDS.
  • Highlight the payer’s responsibilities and examples.
Sample Answer:
TDS is a mechanism where tax is deducted at the source of income by the payer and deposited with the government. It applies to salaries, interest, rent, professional fees, etc., under various sections like 192, 194A, 194H, etc.
The payer must deduct TDS when making the payment, issue a TDS certificate (Form 16/16A), and file quarterly TDS returns.


9. How are charitable trusts taxed under the Income Tax Act?

Approach:

  • Mention the conditions for tax exemptions.
  • Highlight the importance of registration under Sections 12AB and 80G.
Sample Answer:
Charitable trusts are eligible for tax exemptions on income used for charitable purposes under Section 11, provided they are registered under Section 12AB. Donations received can qualify for deduction under Section 80G for the donor.
However, income from non-charitable activities is taxable at the maximum marginal rate.


10. What is the process for filing an income tax return (ITR)?

Approach:

  • Outline the steps briefly.
  • Mention forms based on taxpayer categories.
Sample Answer:
The ITR filing process involves:
  1. Determining the applicable form (e.g., ITR-1 for salaried individuals, ITR-3 for professionals).
  2. Calculating taxable income by including all heads of income and claiming deductions.
  3. Paying the balance tax due (if any).
  4. Submitting the return online via the Income Tax e-filing portal.
  5. Verifying the return through e-verification or by sending a signed acknowledgment to CPC Bengaluru.

11. What is the ‘Deemed to be Let Out’ property in the context of ‘Income from House Property’?

Approach:

  1. Define the concept: Explain what "Deemed to be Let Out" (DTLO) property means under the Income Tax Act.
  2. Highlight applicability: Mention the specific scenarios when a property is considered as DTLO.
  3. Explain income computation: Briefly describe how the notional rental income is calculated for DTLO properties.
  4. Mention exemptions: Highlight cases where DTLO does not apply.
  5. Provide examples: Add a simple example for clarity.
Sample Answer:

The concept of ‘Deemed to be Let Out’ property arises under the head Income from House Property in the Income Tax Act. If an individual owns more than two residential properties, one property can be treated as self-occupied, and the remaining properties are considered as Deemed to be Let Out, even if they are not rented.For DTLO properties, the owner is taxed on the notional rental income, which is the expected reasonable rent the property could fetch in the open market.Income Computation for DTLO Property:
The income from such a property is computed as follows:

  1. Calculate the Annual Value (higher of fair rent or municipal value, but limited to standard rent if applicable).
  2. Deduct Municipal Taxes paid (if any).
  3. Deduct 30% standard deduction for repairs and maintenance.
  4. Deduct interest on home loan (if applicable).
Exemptions:
  • DTLO does not apply if the second property is located in a different city due to employment or business, and the owner resides in rented accommodation.

Additional Questions to Prepare:
  • How does the Income Tax Act define "agricultural income"?
  • What are the implications of Advance Tax and its calculation?
  • What is the significance of Form 15G and 15H?
  • What is GAAR (General Anti-Avoidance Rule)?
  • Explain the taxation of partnerships and LLPs.
Reference Links:-

Internal Audit Interview Questions- Crack your Interview in First attempt.


Vedika Beriwal
Aspiring Company Secretory | M.COM | Masters in Bharatanatyam | Sharing insights on professional growth and success in the CA CS journey.

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