Heads of Income under the Income Tax Act, 1961

F Introduction

The Income Tax Act, 1961 provides a comprehensive framework for the levy and collection of income tax in India. In order to ensure clarity, uniformity, and accuracy in the computation of taxable income, the Act classifies income under different categories known as heads of income. This classification is provided under Section 14 of the Act, which divides total income into five distinct heads based on the nature and source of income. Each head is governed by specific provisions, rules of computation, deductions, and exemptions. The classification of income not only simplifies tax assessment but also prevents overlapping taxation and ensures fairness in the application of tax laws. Understanding these heads of income is essential for proper tax compliance and forms a fundamental aspect of the study of income tax law.

The five heads of income are:

Salary
Income from House Property
Profits and Gains from Business or Profession
Capital Gains
Income from Other Sources

F Income from Salary

Ø Meaning

Under Section 15 of the Income Tax Act, 1961, income is chargeable under the head “Salary” when there exists an employer–employee relationship between the payer and the recipient. Salary is taxable on due basis or receipt basis, whichever is earlier.

Ø Components of Salary

As per Section 17, salary includes the following components:

1. Basic Salary

2. Dearness Allowance

3. Perquisites such as rent-free accommodation, motor car facility, etc. (Section 17(2))

4. Allowances like House Rent Allowance (HRA), conveyance allowance, etc. (Section 17(1))

5. Bonus and commission

6. Pension

Ø Taxability

Salary income is taxable whether paid by:

1. The Government,

2. A private employer, or

3. A foreign employer,
subject to the residential status of the assessee as provided under the Act.

Ø Deductions Allowed

Deductions from salary income are allowed under Section 16, which include:

1. Standard deduction (Section 16(ia))

2. Entertainment allowance (Section 16(ii) -applicable only to government employees)

3. Professional tax (Section 16(iii)).

Ø Example

A company pays an employee basic salary, allowances, and bonus every month. According to Sections 15, 16, and 17, the total amount received is taxable under the head Income from Salary.

F Income from House Property

Ø Meaning

Under Section 22 of the Income Tax Act, 1961, income derived from buildings or land appurtenant thereto, of which the assessee is the owner, is taxable under the head “Income from House Property.” The basis of taxation is ownership and not the actual receipt of rent.

Ø Types of House Property

Self-occupied property
Let-out property
Deemed let-out property

Ø Computation

Income from house property is computed on the basis of Annual Value, as provided under Section 23:

1. Gross Annual Value

2. Less: Municipal taxes actually paid by the owner

3. Equals: Net Annual Value

Ø Deductions under Section 24

The following deductions are allowed from the Net Annual Value:

1. Standard deduction at 30% of the Net Annual Value (Section 24(a))

2. Interest on borrowed capital (Section 24(b))

Ø Example

A person owns a residential house and lets it out on rent. As per Sections 22 to 24, the rental income after deducting municipal taxes, standard deduction, and interest on housing loan is taxable under the head Income from House Property.

F Profits and Gains from Business or Profession

Ø Meaning

Under Section 28 of the Income Tax Act, 1961, income earned from carrying on any business or profession by the assessee during the previous year is chargeable to tax under the head “Profits and Gains from Business or Profession.” Business includes trade, commerce, and manufacture, while profession involves specialized intellectual or technical skill.

Ø Business vs Profession

1. Business: Activities such as trading, manufacturing, and other commercial operations.

2. Profession: Occupations requiring specialized knowledge or skill, such as law, medicine, accountancy, architecture, etc.

Ø Taxable Incomes

The following incomes are taxable under this head:

1. Profits and gains from business operations (Section 28(i))

2. Income from professional services

3. Value of perquisites arising from business or profession (Section 28(iv))

4. Compensation or receipts for termination or modification of business contracts (Section 28(ii))

Ø Allowable Deductions

Deductions are allowed under Sections 30 to 37, which include:

1. Rent, wages, and salaries

2. Repairs and maintenance

3. Depreciation on assets (Section 32)

4. Interest on business loans (Section 36(1)(iii))

5. Bad debts (Section 36(1)(vii))

Ø Example

An advocate earns professional fees from clients. After deducting office rent, staff salaries, depreciation on furniture, and other allowable expenses as per Sections 30–37, the net income is taxable under the head Profits and Gains from Business or Profession.

F Capital Gains

Ø Meaning

Under Section 45 of the Income Tax Act, 1961, capital gains arise when there is a transfer of a capital asset during the previous year. Capital assets include property of any kind held by an assessee, whether or not connected with business or profession.

Ø Types of Capital Gains

Capital gains are classified based on the period of holding:

1. Short-Term Capital Gains (STCG): Gains arising from transfer of a capital asset held for a short period (Sections 2(42A))

2. Long-Term Capital Gains (LTCG): Gains arising from transfer of a capital asset held for a long period (Sections 2(29A) and 2(42A))

Ø Capital Assets Include

As defined under Section 2(14), capital assets include:

Immovable property such as land and buildings

2. Shares and securities

Gold and jewellery

Ø Exemptions and Reliefs

The Act provides relief from capital gains tax through:

1. Reinvestment exemptions under Sections 54, 54F, 54EC, etc.

2. Indexation benefit for long-term capital assets under Section 48, which adjusts the cost of acquisition for inflation.

Ø Example

A person sells a residential house after holding it for several years and earns a profit. As per Sections 45 to 55A, the profit is taxable under the head Capital Gains, subject to available exemptions.

F Income from Other Sources

Ø Meaning

Under Section 56 of the Income Tax Act, 1961, Income from Other Sources is a residuary head of income. It includes income which is not chargeable under any of the other four heads of income specified in Section 14.

Ø Common Incomes Covered

The following types of income are commonly taxable under this head:

1. Interest on bank deposits, fixed deposits, and securities

2. Dividend income

3. Winnings from lotteries, gambling, betting, and similar activities

4. Gifts received, subject to conditions prescribed under the Act

5. Family pension

Ø Deductions

As per Section 57, deductions are allowed for:

Expenses laid out wholly and exclusively for the purpose of earning such income

Certain expenses are specifically disallowed under Section 58.

Ø Example

Interest earned on fixed deposits with a bank is taxable under Sections 56 and 57 as Income from Other Sources.

F Importance of Classification of Income

Ø Prevents Double Taxation

The classification of income under the five heads prescribed in Section 14 ensures that the same income is not taxed more than once under different heads. Each income is chargeable only under the most appropriate head, thereby avoiding overlapping assessments.

Ø Ensures Correct Deductions and Exemptions

Different deductions and exemptions are allowed under specific heads of income, such as Section 16 for salary, Section 24 for house property, and Sections 30 to 37 for business or profession. Proper classification ensures that the assessee claims only those deductions which are legally permissible.

Ø Helps in Accurate Computation of Tax Liability

Each head of income has a separate method of computation laid down in the Act, such as Sections 15–17 for salary and Sections 22–27 for house property. Correct classification enables accurate computation of taxable income and determination of the correct tax liability.

Ø Facilitates Uniform Application of Tax Law

The statutory classification under Section 14 provides a uniform framework for assessment, ensuring consistency in tax administration across different assessees and assessment years. This promotes certainty, fairness, and transparency in the application of tax law.

· Prevents double taxation

· Ensures correct deductions and exemptions

· Helps in accurate computation of tax liability

· Facilitates uniform application of tax law

F Conclusion

The classification of income under the five heads—Salary, Income from House Property, Profits and Gains from Business or Profession, Capital Gains, and Income from Other Sources—forms the foundation of the Income Tax Act, 1961. This structured framework, as provided under Section 14, ensures that income is assessed under the appropriate head based on its nature and source. Such classification prevents double taxation, enables the correct application of deductions and exemptions, and ensures the accurate computation of tax liability in accordance with statutory provisions. Further, it facilitates uniform and consistent application of tax law, promoting certainty, fairness, and transparency in taxation. Overall, the systematic classification of income is essential for effective tax administration and compliance, and it plays a crucial role in achieving equity and efficiency in the Indian tax system.