1.d Kinds of income

Introduction to Kinds of Income

Income can be derived from various sources, and the nature of this income can vary significantly. For tax purposes, it is crucial to identify the different kinds of income that a taxpayer may earn. These can include salaries, rental income, business profits, capital gains, interest, dividends, and more. Each of these income sources is treated differently under tax law, with specific rules governing their taxability, exemptions, and deductions.

The classification of income into different categories helps in the proper application of tax rules and ensures that all possible types of income are captured for taxation. To systematically apply these rules, income is classified under different heads, as prescribed by the Income Tax Act.

Heads of Income

The Income Tax Act, 1961, in India, categorizes all types of income into five distinct heads. Each head of income has its own charging section that defines the scope of income chargeable under that head. The heads of income are designed to exhaust all possible types of income that can accrue to or be received by a taxpayer. Below are the detailed heads of income:

1. Income from Salary

This head covers all income received by an individual in the form of salary, wages, pensions, and other forms of employment-related earnings. The income under this head is taxed based on the taxpayer's salary structure and other related benefits provided by the employer. Common components include:

• Basic salary
• Allowances (House Rent Allowance, Travel Allowance)
• Pension income
• Perquisites (company car, accommodation)

2. Income from House Property

This head includes rental income earned from property owned by the taxpayer. It also covers income from property that is not let out but is owned by the taxpayer. The computation of income under this head involves deducting municipal taxes and interest on home loans from the rental income.

3. Profits and Gains from Business or Profession

This head covers income derived from carrying on any business or profession. It includes profits and gains from the regular operations of a business or professional practice. The income under this head is computed after considering all allowable business expenses and deductions related to the business or profession.

4. Capital Gains

This head covers profits arising from the transfer of a capital asset, such as land, buildings, stocks, bonds, or any other asset. Capital gains are classified into:

• Long-term capital gains: Arising from assets held for more than a specified period.
• Short-term capital gains: Arising from assets held for a shorter duration.

The tax rates and exemptions differ based on whether the capital gains are short-term or long-term.

5. Income from Other Sources

This is the residuary head of income that includes any income not taxable under the first four heads. Examples include:

• Interest from savings accounts, fixed deposits
• Dividends from shares
• Winning from lotteries or gambling
• Gifts received under certain circumstances

Income under this head is taxable as per the rates specified in the Income Tax Act.

Process of Computation of Total Income

The computation of total income involves several steps, beginning with the classification of income under the appropriate heads and ending with the calculation of the total income, which is the basis for determining the tax liability. Below is a detailed guide to understanding the process:

Step 1 – Classification of Income

The first step in computing total income is to classify the income earned by the taxpayer under the relevant head of income as defined by the Income Tax Act. Each head of income has a corresponding charging section that defines the scope of income chargeable under that head. The heads of income exhaust all possible types of income that can accrue to or be received by the taxpayer. The classifications are as follows:

1. Income from Salary: Includes income from salary, wages, pensions, and other forms of employment-related earnings.
2. Income from House Property: Includes rental income from property owned by the taxpayer.
3. Profits and Gains from Business or Profession: Income derived from carrying on any business or profession.
4. Capital Gains: Profits from the sale of a capital asset, such as land, buildings, or stocks.
5. Income from Other Sources: The residuary head, which includes income not taxable under the first four heads, such as interest, dividends, or gifts.

Step 2 – Computation of Income Under Each Head

Once income is classified under the relevant head, it must be computed according to the provisions governing that particular head of income.

Exemptions

• Wholly Exempt Incomes: Certain incomes are entirely exempt from income tax, such as agricultural income. These incomes do not form part of the Gross Total Income.
• Partially Exempt Incomes: Some incomes, like House Rent Allowance (HRA) or Education Allowance, are partially exempt. The exempt portion is excluded up to the specified limits, and the remaining amount is included in the computation of total income under the relevant head.

Deductions and Allowances

Each head of income has prescribed deductions and allowances that must be considered before arriving at the net income chargeable under that head. For example: - Income from House Property: Deduct municipal taxes and interest on loan. - Profits and Gains from Business or Profession: Deduct allowable business expenses.

Step 3 – Clubbing of Income

To prevent tax avoidance, the Income Tax Act includes provisions for clubbing the income of certain persons (e.g., spouse, minor child) with the income of the taxpayer who has diverted income to these persons. Clubbing ensures that the diverted income is taxed in the hands of the taxpayer, preventing misuse of tax slabs.

Step 4 – Set-off and Carry Forward of Losses

Taxpayers may have multiple sources of income under the same head or across different heads, and they may incur losses in some areas while making profits in others.

Set-off Within the Same Head

Losses from one source can be set off against profits from another source under the same head of income. For example: - Loss from a printing business can be set off against profit from a textile business under the head "Profits and Gains from Business or Profession."

Inter-head Set-off

In certain cases, losses under one head of income can be set off against profits under another head. For example: - Loss from "Income from House Property" can be set off against profits from "Profits and Gains from Business or Profession."

However, there are restrictions, such as business loss not being allowed to be set off against salary income.

Carry Forward of Losses

If losses cannot be fully set off in the current year due to insufficient eligible profits, they can be carried forward for set-off in subsequent years, as per the provisions of the Act.

Step 5 – Computation of Gross Total Income

After computing the income under each head and applying the deductions, allowances, clubbing provisions, and set-off/carry forward of losses, the final figures are aggregated to arrive at the Gross Total Income.

Step 6 – Deductions from Gross Total Income

There are specific deductions available from Gross Total Income under sections such as 80C to 80U. These deductions can be broadly categorized into three types: - Deductions for Certain Payments: E.g., life insurance premiums, contributions to provident fund, etc. - Deductions for Certain Incomes: E.g., income from savings bank interest under section 80TTA. - Deductions for Certain Conditions: E.g., deductions for disabled individuals under section 80U. -

Step 7 – Computation of Total Income

The income arrived at after claiming the above deductions from the Gross Total Income is known as the Total Income. This amount is rounded off to the nearest multiple of `10.

# Computation of Total Income

1. Determination of Residential Status

2. Classification of Income under 5 Heads

3. Salaries
4. Income from house property
5. Profits and gains from business or profession
6. Capital gains

7. Income from other sources

8. Aggregation of Income

9. Application of Clubbing Provisions

10. Set-off/Carry Forward and Set-off of Losses

11. Gross Total Income

12. Deductions from Gross Total Income

13. Total Income

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