Tax Law and income tax act 1961

5 Heads of Incomes under tax law

Introduction

Section 14 of the income tax lays down that there can be various modes of income for a person. These modes are classified into 5 broadheads for the purposes of computation and determination of total income and tax rates apply thereafter.

The 5 main heads of incomes are-

Income from salary
Income from house property
Capital gains
Profit and gains from business and profession
Income from other sources

Income from salary

Section 15 of the Act explains when income is considered “salaries.”

Any payment owed to a former employee by the employer for work done in the previous year counts, whether it has been paid or not.
Salary paid to an employee by the employer or former employer in the previous year counts, even if it was not due at that time.
Salary paid to an employee by the employer or former employer in the previous year that was not taxed in any other year also counts.

The main point is that there must be an employer-employee relationship. If this relationship does not exist, the income cannot be classified as salary.

Section 17 of the Act has mentioned the term ‘salary’, which included-

Wages;
Any annuity or pension;
Any gratuity;
Any charges, commissions, perquisites or benefits in lieu of or notwithstanding any compensation or wages;
any advance of salary;
Any payment received by a worker in regard to any time of leave not benefited by him;
The yearly accumulation to the balance at the employee partaking in a perceived Provident Fund, to the degree to which it is chargeable to assess under Rule 6 of Part A of the fourth schedule;
The total of all wholes that are included in the transferred parity as alluded to in sub-rule 2 of Rule 11 of PartA of the Fourth schedule of an employee partaking in a perceived Provident Fund, to the degree to which it is chargeable to assess under sub-rule 4 thereof; and
The contribution made by the Central Government or any other employer in the previous year, to the account of an employee under a pension scheme, referred to in Section 80CCD

Allowances

The employer pays allowances to his employees in order to fulfill his personal expenses. Allowances can be fully taxable or partly taxable. Partly taxable allowances include house rent allowance and special allowances under section 10(14) (i)&(ii).

Fully taxable allowances are:

Dearness Allowance
Overtime allowance
Fixed Medical Allowance
Tiffin Allowance
Servant Allowance

Perquisites

Perquisites are additional benefits employees receive beyond their salary, such as rent-free accommodation and cars. Reimbursements do not count as perquisites, and these benefits are provided only during employment.

Taxable perquisites include:

– Rent-free accommodation

– Interest-free loans

– Movable assets

– Educational expenses

– Insurance premiums paid by the employer

Profits in Lieu of Salary

Section 17(3) gives a comprehensive meaning of profits in lieu of salary. Any payment due or accrued to be paid to the employee by the employer. Payment to be valid under section 17(3), there are two essential features-

There must be compensation received by an assessee from his employer or former employer;
It is received at or in connection with the termination of his employment or adjustment of terms and conditions.

‘Profit in lieu of Salary’ is taxable on ‘due’ or ‘receipt’ basis. Payment from unrecognized provident or superannuation fund is taxable as “profit in lieu of salary” if that balance consists employer’s contribution or interest on an employer’s contribution.

Income from house property

When assessing property for tax purposes, include all your buildings, lands, and flats, but exclude any properties you use for business. This falls under income from house property (Section 22).

Income from house property includes both leased and deemed ownership. You will pay taxes on this income after applying deductions from Section 24. For repairs and maintenance, you can deduct thirty percent of the Net Annual Value, but you cannot do this for properties you live in yourself.

You can categorize your house properties in three ways for tax purposes:

Properties that you rented out for the entire year.
Properties that were half vacant and half rented out.
Properties that you rented out for a time and then used as your home.

Deemed ownership-

Section 27 provides that certain persons are not legal owners of a property but are still considered to be deemed owners under certain conditions.

Condition 1 – Transfer of property to a child or spouse, without consideration.

Condition 2 – Holder of an impartible estate is deemed to be the owner of the entire estate.

Condition 3 – Members of a co-operative society or company or association of person

Condition 4 – Person in possession of a property on lease for more than 12 years as per Section 269UA(f).

Co-owners of a Property – Section 26

When two or more people own a property with defined shares, the income is considered as coming from one source and is shared among them. They can get relief under Section 23.

Unrealized Rent

Unrealized rent, or unpaid rent, is not included in the net annual value. If paid later, it will be added to that year’s income from house property.

Set-off and Carry Forward of Losses

Under Section 70, losses from house property can offset income from other properties. Section 71 allows these losses to be set off against other income types, but not against casual income.

Unadjusted losses can be carried forward for up to 8 years and can only offset income from house property. The maximum set-off against other income is Rs 2 lakh, whether the property is self-occupied or rented out.

Income from capital gains

Profit or gain from selling capital assets held as investments is taxed as capital gains. Gains can be short-term or long-term, depending on how long you held the asset. A capital gain happens when you transfer a capital asset. If the asset is not a capital asset, it won’t be taxed as capital gains. Any profit or loss made in the year you sold the asset is considered taxable income for that year, and you may use indexation if applicable.

To qualify as capital gains, there are four criteria:

There must be a capital asset.
The asset must be sold by you.
The sale must happen in the relevant financial year.
You must have a gain or loss from the sale.

Capital assets can be tangible or intangible, movable or immovable, and can be owned by you for personal or business reasons.

However, some items do not count as capital assets. These include stock for resale, personal belongings, and agricultural land.

Capital gains are of two types

Short term capital assets– those assets held by an assessee for at most 36 months, immediately prior to its date of transfer.

In ITO v. Narayana K Shah, the court ruled that shares conferring occupancy rights are not treated as regular shares under section 2(42A). Therefore, gains from selling these shares within 36 months are considered short-term capital gains.

Long term capital assets– those assets held by an assessee for more than 36 months. Long-term capital gains are generally taxable at a lower rate.

Exemptions under section 54 :

Exemptions for long-term capital assets apply to individuals and Hindu Undivided Families (HUFs). A capital gain arises from transferring residential property, and the assessee can claim an exemption if they buy another house within one year before or two years after the transfer, or if the transfer occurs within three years of construction. The exemption amount is the lesser of the capital gains or the cost of the new house.

Income from Profit and Gain from business and profession

Business and Profession has been defined under Section 2(13) and Section 2(36) respectively.

Business. It includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce, or manufacture.

Profession. “Profession” includes vocation.

Section 28 of the Income Tax Act deals with the “Profits and Gains of Business or Profession.” It lists different types of income that are taxable under this section:

Business or professional profits – This includes any earnings from running a business or practicing a profession.
Management compensation – If someone receives payments when ending their management role in an Indian or foreign company, that income is taxable.
Payments from associations – Money received from a trade or professional association for services provided to its members is also taxable.
Benefits from licenses and incentives – Profits from selling import entitlement licenses, cash compensations, and duty drawbacks are included.
Duty Entitlement Pass Book Scheme – Any profit from exchanging licenses under this scheme is taxable.
Duty-Free Replenishment Certificate – Benefits from trading these certificates are also taxable.
Business-related perks – Any benefits or perks from business activities, whether they can be converted into cash or not, are included.
Income for partners – This includes interest, salary, or commission earned by a partner from their firm.
Keyman insurance policy payments– Any money received from a Keyman insurance policy, including bonuses, is taxable.
Income from speculative transactions – This refers to profits gained from speculative trades.
Capital asset loss payments – Any money received when a capital asset is lost, destroyed, or transferred is taxable if the expenses on that asset were claimed as a tax deduction under Section 35AD.

Sections 30 to 37 mention deductions under the heading “Profits and Gains from Business or Profession.”

Section 30: Deductions allowed for lease payments, rates, taxes, and insurance related to business property.

Section 31: Deductions for repairs and insurance of apparatus, plants, or furniture, excluding capital expenditures.

Section 32: Deductions for deterioration of tangible and intangible assets used for business.

Section 32AC: Deductions for investments in new plants or machinery if assembled after March 31, 2013, with specific sale conditions.

Section 33AB: Record-keeping for tea, coffee, or rubber businesses allows for deduction claims.

Section 33AC: Shipping businesses can deduct up to 50% of their income.

Section 35: Expenditure on scientific research related to business can be deducted with proper accounting.

Section 35AC: Deductions are allowed for expenditures to public sector companies on approved projects.

Section 35AD: Capital expenditure for specified businesses is deductible.

Section 36: Deductions include insurance premiums, bonuses, interest on borrowed capital, and write-offs for bad debts.

Section 37(2B): Promotional expenditures for political parties are not deductible.

Income from other sources

All types of income not addressed in the previously mentioned categories fall under the heading “Income from Other Sources” as outlined in Section 56 of the Income Tax Act. Some examples of income included in this category are:

– Dividends as defined under Section 2(22);

– Winnings from lotteries, horse races, crossword puzzles, and other games;

– Contributions received by the employer from the employee’s work towards the Staff Welfare Scheme;

– Interest earned on debentures, government securities, or bonds;

– Income derived from leasing out machinery, plants, or furniture, which is taxable as income from other sources if it does not fall under “Profits and Gains of Business or Profession”;

– Payments received under Keyman insurance policies, including any rewards;

– Salary earned from operating hardware, plants, or furniture owned by the assessee.

Certain gifts are excluded from taxation:

– Gifts received from relatives;

– Gifts received on the occasion of marriage;

– Gifts provided by local authorities;

– Gifts received through inheritance;

– Gifts from funds, institutions, hospitals, etc.

This framework allows for a wide range of income types to be considered for taxation under the category of income from other sources.

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Tax Law and income tax act 1961 Tax Law and income tax act 1961 Tax Law and income tax act 1961 Tax Law and income tax act 1961

Tax Law and income tax act 1961