The Indian Income Tax Act is so complex that sometimes a tax payer is lost in an indefinite loop. There is an endless cycle of sections, provisos, clauses, and conflicting cases. So on and so on it continues. Amidst all this tangle, the average tax payer cannot help but feel confused and helpless.
A person can have income from various sources. For calculating tax on income, first, it is necessary to ascertain the source from where the income arises. This is because different income is taxed at different rates. While computing taxable income, the first step is to identify the head of income to which the income belongs. Therefore, it is important to understand various heads of income, before we deal with any income tax compliance.
What do you mean by ‘Heads of Income’?
Under Income Tax Act, income is classified into various categories known as Heads of Income. First, calculation of income of a person takes place under each such head separately. After this, computation of total income takes place.
Tax is payable on such total income at applicable rates.
Why are heads of income necessary, when the tax is ultimately payable on Total income?
There are various reasons why heads of incomes are necessary.
First, income classification takes place according to its nature. So specific provisions of the law cater to the nature of income, instead of a source of income.
Secondly, it enables the Government to identify a particular class of individuals, to grant specific exemptions tax liability.
Thirdly, it is possible to lay down different procedures, compliance, income tax return forms, and calculation methods for each class of people.
Fourthly, after filing returns, the IT department can set different procedures and extent of assessments.
Lastly, the data generated through a compilation of income tax returns serves as a useful basis for planning tax amendments.
Thus, there are numerous reasons why Heads of Income are such an important base of the entire Income Tax Act.
What are the various heads of income under Income Tax Law?
The Income Tax Act identifies five heads of income.
- Income from House Property
- Profits and Gains from Business or Profession
- Capital Gains
- Income from other sources
We shall discuss each head independently. However, it is important to understand the following two points.
- Same income cannot be classified under two heads.
- In case a person has multiple sources of income, each such income will fall into a different head according to its nature. Thus, it is possible for one person’s income to fall into multiple heads.
1. Income from Salaries
This head covers all kinds of emoluments that a person earns working as an employee. The basis of categorizing income under this head is the employer – employee relationship.
If the employer – employee relationship does not exist, then income cannot be classified under this head. For example, in the case of Internship, employer – employee relationship does not exist. Hence, a stipend will not form part of income from salary. Salaries, Pensions, Allowances, Perquisites, etc. are examples of income forming part of this head.
Thus, if you are working as an employee, your earnings from such employment will form part of your salary.
2. Income from House Property
This head covers rental income arising from letting out a house property. If the property is not let out, then it is taxed on the basis of expected rent.
However, if you are using such property for your residence it is called Self-occupied property. Such property is not liable to tax. However, there is one condition. The exemption applies to only one self-occupied property.
This head covers only buildings, whether rented or self-occupied. It does not include renting of machinery, equipment, vehicle, etc.
Thus, if you own one or more house properties, your earnings from such property will form part of this head.
3. Profits and Gains from Business or Profession
This head covers two broad categories of income.
Firstly, the profits from the business of any kind whether manufacturing, trading, etc.
Secondly, the income from independent professionals who provide various services.
The calculation takes place according to the Statement of Profit and Loss. Thereon, adjustment of certain items takes place to arrive at Taxable Profits.
Income in the nature of brokerage or commission is also considered as Business Income. However, the sale of assets and investments are not taken into account under this head. They are covered under Capital Gains.
Thus, if you are a businessperson or a professional, your earnings from such business or professional services will form part of this head.
4. Capital Gains
This head covers the gains from the sale of capital assets.
The income is taxable in the financial year in which the sale of assets takes place. These gains further fall into two categories. The first category is Long Term Capital Gains (LTCG). If the sale takes place 36 months after purchasing the asset, then it is LTCG. Else, it is a Short Term Capital Gain (STCG).
This head covers the sale of fixed assets and investments as well. The cost of purchasing first undergoes adjustment for inflation. It will then be reduced from the consideration received from Sale.
Thus, any income on the sale of a capital asset will fall under this head.
5. Income from other sources
This is the residual head. Any income, unless it is exempt, which does not come under any of the above heads falls under this head. For example, Gifts, Interest income, stipend from the internship, etc.
Under this head, no deduction of expenses is allowed, except in certain cases.
Thus, if you earn bank interest or receive gifts etc. such income will fall under this residual head of income.
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