What are the Heads of Income Under the Income Tax Act?

Under the Income Tax Act, there are five heads which are known as the heads of income. At the end of each year, you or your accountant is expected to classify your yearly earnings under these heads of income as per the Income Tax Act. This is to calculate the amount of tax payable by you as a citizen of a country abiding by the laws of the Government. These heads of income are here to ensure that there is proper maintenance of monetary power within the social and governing system. 

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Having these rules allow better cash flow in the economy. It helps elevate the functioning of the Government to provide the citizens and the common people with a better standard of living.

Before going into details about the different heads of income, it is essential to know about the Income Tax Act under which these heads prevail. The Income Tax Act is the founding and the basic structure on which the heads of income stand.

Income Tax Act

The Income Tax Act was enacted in the year 1961. It is the statute under which all issues regarding taxation are listed and stated. The Act includes all forms of levy, administration, collection & income tax recovery. The fundamental aim of the Act is to consolidate and amend the rules of taxation in the country to ensure economic stability and proper circulation of wealth throughout all sectors. The Act consists of long lists of varied sections, with each section having different aspects relating to the taxation of the country.

Section 14 of the Income Tax Act – Heads of Income 

As per Section 14 of the Income Tax Act of 1961, an individual can earn income from several means. The computation of income tax is important and must be calculated according to a person's income. For a hassle-free income tax computation, the Act classifies the income into different categories of heads. The provisions and rules are mentioned in the Income Tax Act. At the end of each financial year, the taxpayer must classify their earnings under these heads of income for accurate tax calculation. Thus, it is essential to know which falls under what category or head. The 5 heads of income stated in this section as explained in detail in the below article.

It is not necessary that every earning individual will have income from all these 5 heads of income. However, classifying one's income on the basis of these heads of income would make ITR filing easier to calculate how much income tax will accrue on them.

Heads of Income Tax

The 5 heads of income are:

  • Income from salary

  • Income from house property

  • Income from profits and gain of business or profession

  • Income from capital gains

  • Income from other sources

These above-mentioned heads of income inform when the tax is to be charged and the requirement to be fulfilled for taxation liabilities. Each of these heads of income has its separate conditions that are needed to be fulfilled to make the income generated from these sources taxable. These conditions are mentioned in different Sections of the Income Tax Act.

Income from Salary

The first head of income is income from salary. If there exists a relationship between payer and payee in a firm or agreement, and the relationship is between employer and employee where the employee is being paid a certain amount of remuneration for their services, then the income can be charged under this head of income. A salary could be any sort of monetary compensation. This could be any basic and normal wage, annuity, pension, gratuity, leave encashment, etc.

After making a total aggregate of the total amount of income excluding the exemptions if, at all present, the total amount of gross salary is then charged under this head of income.

All basic salaries along with commissions and bonuses are completely liable to taxation.

Under this head of income, some allowances are exempt from tax under some conditions. Allowances are: As per the Act, a fixed amount of money paid to an employee concerning the labor and service are made by him. The allowance is generally included with the salary unless specific exemptions are mentioned. Every employer must deduct TDS from the salaries of their employees. 

An important point to note while calculating taxable salary, the salary is taxable on the 'due basis' or 'receipt basis,' whichever is earlier. For example, if a person receives a salary for March 2022 in April 2022, this salary is taxable in the previous year 2021-2022 as this salary was due in March 2022. Likewise, if the employers give an advance salary of April and May 2022 in March 2022, this salary too is taxable in March 2022.

  • Leave travel allowance: Leave allowance trade, or LTA denotes the expenditure incurred for travel when you go on a trip for vacation purposes alone or with a group of friends or family. As this is paid, it is free of tax twice in 4 years.

  • Medical allowance: Up to a limit of rupees 15,000 per annum, medical allowance is tax-free, and you can bear the bill and your family.

  • Conveyance allowance: You can get a monthly tax exemption of up to Rs.800.

These are some of the many types of allowances and their clauses for tax deductions. Other monetary payments made to employees by an employer also have their methods of taxation.

Income from House Property

Another head of the Income Tax Act is income from house property. This part sheds light and detail about the taxation policy on the house or real estate that you, as a taxpayer, are residing in. Vacant house property is considered as 'self-occupied' in regards to the purpose of income tax. In the situation that a taxpayer owns more than a single self-occupied house, then only one house is treated and considered as a single self-occupancy house property. Rest is considered to be let out.

The second head of the Income Tax Act is dedicated to sections 22 to 27, which correspond to the computation and calculation of the total standard amount of income by a person in the house or property that they rightfully own. The tax amount charged is not acquired from the amount of rent that is received but rather from the property or land as a whole. Nonetheless, if the; and or property is being used for a normal course of business, then the income generated from the rent will also be included to be charged for tax income. All commercially owned residents or properties owned are also subjected to taxes.

For income from house property to be taxable, a few conditions must be satisfied and fulfilled.

  • The house property has to consist of a house, building, or any land appurtenant.

  • The taxpayer should be the owner of the house property.

  • The house property must not be used for any business or professional venture done and carried out by the taxpayer. It can only be used for residential purposes.

Having these conditions met, the income generated by house property thereby becomes chargeable and liable to tax deduction as per the Income Tax Act.

Income from House Property is charged to tax on a notional basis. Tax under this head of income does include income from letting out house property, commercial properties, and any other types of properties. Several deductions like standard deduction, the deduction for interest on home loans (if any), and deduction for municipal taxes paid are also allowed under this head of income.

TDS on rent also needs to be deducted if the value of rent is more than a specified limit.

Income from Profits and Gain of Business or Profession

This is the third head of income under the Income Tax Act. A business includes any kind of trade, commerce, manufacturing, or any nature of trade. Profession implies the acquisition of specific or special knowledge in a particular field after a period of education and verified examination. Under this head of income, profits and gains made during the tenure of business are subjected to complete and total taxation. Profits incurred on the sale of imports, incentives, any interest or form of salary or bonus, and a commission from a firm are all taxable under this head of income in the Income Tax Act. For an income to be charged under the head of income from profits and gains from business or profession, there are some rules and conditions that must be fulfilled according to Section 28 of the Income Tax Act.

  • For income to be charged, a business or profession must exist in the first place.

  • The business or profession must be carried out by the taxpayer or assessed by themself.

  • The profession or business whose income is to be charged must be operational and be carried on for a greater part of the previous year.

  • The tax charge is based on the profits and gains made by the business during its running and operating time of the previous year.

  • The charge made can be extended to any and all business or profession that is ongoing or being carried on by the assessee.

Only if these conditions are applicable, then the income from profits and gains generated can be taxed under the Income Tax Act. It is important to note that to be charged under this head of income, the business or profession need not be operational throughout the entire previous year. As long as it has been carried on by the assessee for some time during the previous year, it is chargeable.

There are a few types of income that are chargeable under this head of income are:

  • Profits generated from the sale of a certain license

  • Gains earned by the business during an assessment year

  • The profits that an organization makes on its income

  • Cash received on the export of a government scheme

  • The benefits that a business receives

  • Gains, bonuses, or salary that an individual receives due to a partnership with a firm

Income from Capital Gains

Being the fourth head of income under the Income Tax Act, income gained from any capital asset, be it movable or immovable, is deemed taxable. Capital gains are divided into two parts: long-term capital gains and short-term capital gains. These gains are taxed under the head of income – income from capital gains.

When a person sells his capital assets after holding them for 36 months or more, they will fall under long-term capital gain. The applicable tax rate is 20% in the case of LTCG. Alternatively, if he sells capital assets within 36 months, it will be termed as short-term capital gain, and the rate of tax will be 15%. In the case of securities, this is applicable if one sells his holdings within 12 months from the purchase date. 

Capital gain is exempt from tax under sections 54, 54B, 54D, 54EC, 54ED, 54F, 54G, or 54GA.

Income from Other Sources

The fifth and last head of income under the Income Tax Act is income from other sources. Any income derived from sources other than the previously mentioned four heads is considered to be under this category of income. Some examples of income from other sources include interest gained from bank deposits, winning in the lottery, or even any sum of money which is more than Rs. 50,000 received from another individual who does not form a part of the taxpayer relative, spouse or if the money is acquired via inheritance or will. All these sources, even if it is gambling or even card games, are chargeable for tax under Section 56(2) of the Act.

Section 145 of the Income Tax Act states the details for the computation and income tax calculator generated from other sources. As per the Section, income from other sources shall be computed and calculated by the regular accounting method which is followed by whoever the assessee is. This can be either in cash or in a mercantile accounting system.

Which Types of Income Come Under Income from Other Source?

Section 56(2) of the Income Tax Act enlists certain incomes which are taxable under this head of income, that is, Income from Other Sources. Some of these incomes include:

  • Dividend income

  • Interest income

  • Family pension income

  • Gifts received

  • Royalty income

115JC of the Income Tax Act

The Government had introduced profit-linked deductions and incentives to encourage investment and growth in various industries. Many taxpayers misused this provision and became zero tax by paying marginal tax, although they were capable of paying normal tax. Thus, MAT (Minimum Alternate Tax) was introduced for the companies, and AMT (Alternative Minimum Tax) was introduced for taxpayers other than companies under section 115JC of the Income Tax Act. The rate of Alternative Minimum Tax is 18.5% of the Adjusted Total income. Surcharge and CESS are applicable in addition to 18.5%.

The provisions of Alternative Minimum Tax apply to the following category of taxpayers:

  • Individual, HUF, AOP (Association of Persons), or BOI (Body of Individuals) if the adjusted total income exceeds INR 20 lacs

  • Any other taxpayer (other than the company), irrespective of the total income.

The AMT provisions apply to the above category of taxpayers only if:

  • The taxpayer claims a deduction under Section 80H to Section 80RRB (except Section 80P)

  • Claims a deduction under Section 35AD.

  • Claims a deduction under Section 10AA.

A taxpayer should obtain a report from a chartered accountant if the provisions of AMT apply to him. As per a report under Section 115JC of the Income Tax Act, the CA certifies that the Adjusted Total Income and AMT are calculated as per the provisions of the Income Tax Act.

Conclusion

These are the 5 heads of income under the Income Tax Act of 196. These detail and specify the different incomes and monetary functions that are liable for taxation by the Government. Knowing the details of these 5 heads of income will allow proper management of tax. The taxpayer can be clear as to the nature of the tax they are paying to the Government, and the collection of said tax becomes much smoother and overall convenient. All citizens who are eligible for taxpayers must abide by these heads of income. If any taxpayer is caught not abiding by the clauses mentioned in the Income Tax Act and makes an effort to withhold from paying the due tax amounts, they are punishable by the law's full extent.

FAQ's

  • Q: What are the 5 heads of income tax?

    Ans:

    The 5 heads of income tax are:

    • Income from salary.
    • Income from house property.
    • Income from profits and gains from business or profession.
    • Income from capital gains.
    • Income from other sources.
  • Q: Can I claim a deduction of expenses incurred to earn Income from Other Sources?

    Ans: Yes, you can claim a deduction of such expenses provided they directly relate to such income.
  • Q: Do I have to pay tax on gifts (income from other sources) if received on the occasion of marriage?

    Ans: No, any gifts received (whether in cash or kind) on the occasion of marriage are totally exempt from income tax.
  • Q: What are some of the incomes chargeable under the income from profit and gains from the business head?

    Ans:

    Some of the income chargeable under this head of income are:

    • Profit made from the sale of a license
    • Profit/salary/bonus earned from business partnership
    • Cash received through export
    • Any organizational income
    • Business benefit 
  • Q: What is the deduction available under HRA under the salary heads of income tax?

    Ans:

    Salaried individuals can gain a deduction on the HRA (house rent allowance) received. It is the least of the following amounts:

    • The actual amount received as HRA
    • 50% of salary, including basic salary and DA in metro cities
    • Actual rental expense less 10% of your salary
  • Q: On which income is the tax liability calculated?

    Ans: The Income Tax Act of 1961 states that the tax liability is levied on the net income of an assessee and not their gross income. Thus, the net income can be reached after deducting expenses incidental to their employment.
  • Q: What is the AMT rate under section 115JC of the Income Tax Act?

    Ans: The rate of Alternative Minimum Tax (AMT) is 18.5% of the Adjusted Total income under the section 115JC of the Income Tax Act

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