5 Heads of Income Tax

Income from Salary

Salary income refers to compensation received by an individual for services rendered as an employee under an employment contract. The employer-employee relationship must exist for income to be taxed under this head. This category includes:

• Basic salary
• Allowances (House Rent Allowance, Dearness Allowance, Travel Allowance, etc.)
• Bonuses and incentives
• Commissions
• Pension received from a former employer
• Gratuity and leave encashment
• Perquisites such as rent-free accommodation, employer-provided car, or stock options

Deductions and Exemptions

Several exemptions and deductions are available to salaried individuals:

• House Rent Allowance (HRA): Exempt under Section 10(13A) if the individual resides in rented accommodation. The exemption amount depends on rent paid, salary, and city of residence.
• Leave Travel Allowance (LTA): Exempt under Section 10(5) for travel within India, but conditions apply regarding the frequency of travel and the number of family members covered.
• Standard Deduction: A flat deduction of ₹50,000 is allowed from taxable salary income.
• Professional Tax: If paid by the employee, it is deductible under Section 16.

Employers deduct Tax at Source (TDS) from salary income and provide Form 16 as proof of income and tax deductions.

Income from House Property

Income from house property arises when an individual earns income through renting or owning property. Even if the property is not rented out, notional income is considered taxable under certain circumstances. This head applies to:

• Self-occupied properties (SOP): If an individual owns a house and resides in it, there is no taxable income, but they can claim deductions on interest paid on home loans.
• Let-out properties: Rental income from such properties is taxable.
• Deemed let-out properties: If a person owns more than two self-occupied properties, the additional ones are considered rented and taxed accordingly.

Tax Calculation and Deductions

Income from house property is calculated based on its Annual Value, which is the expected rental income minus applicable deductions:

Standard Deduction: 30% of the net annual value is allowed for maintenance expenses, regardless of actual costs.
Interest on Home Loan: Under Section 24(b), interest paid on a housing loan is deductible:

• Up to ₹2 lakh per year for self-occupied property.
• No limit for rented properties.

If rental income is earned, the total amount received from tenants is taxed after deducting standard deductions and home loan interest. If the interest paid exceeds the rental income, the loss from house property can be adjusted against other income sources up to ₹2 lakh per year.
 

Income from Profits and Gains of Business or Profession

This head applies to income earned from business activities, freelancing, consulting, or any professional services. It includes:

• Income from trading, manufacturing, or service-based businesses
• Earnings from freelancing and self-employment
• Commissions, consultancy fees, and professional charges
• Income from legal, medical, or engineering professions
• Profits from the sale of goods or services
• Bonus or salary received as a partner in a partnership firm

Businesses and professionals can deduct expenses incurred for business operations before calculating taxable income.

Allowable Deductions and Expenses

• Rent paid for business premises
• Salaries and wages paid to employees
• Electricity, internet, and office expenses
• Depreciation on business assets like machinery or vehicles
• Travel and conveyance expenses for business purposes
• Advertising and marketing costs

Professionals and business owners are required to maintain proper records, file income tax returns, and pay advance tax if their estimated tax liability exceeds ₹10,000 in a financial year. If turnover exceeds certain limits, tax audits may be mandatory.
 

Income from Capital Gains

Capital gains refer to profits earned from the sale of a capital asset, such as property, stocks, bonds, or mutual funds. The taxability of capital gains depends on the holding period of the asset, which determines whether it is classified as short-term or long-term.

Types of Capital Gains

Short-Term Capital Gains (STCG): Assets sold within a short period are subject to higher tax rates. Examples include:

• Stocks and mutual funds held for less than 12 months.
• Real estate held for less than 24 months.
• Other capital assets held for less than 36 months.
• Tax rate: 20% on listed securities and taxed at slab rates for other assets.

Long-Term Capital Gains (LTCG): Assets held beyond the short-term period qualify for lower tax rates and tax benefits.

• LTCG tax on listed securities is 12.5% beyond ₹1.25 lakhs (without indexation).
• Real estate and other assets are taxed at 20% with indexation benefits.

Deductions and Exemptions

Certain sections provide relief on capital gains tax:

• Section 54: Exemption on long-term capital gains from selling residential property if another house is purchased.
• Section 54EC: Tax exemption on LTCG if gains are invested in government-specified bonds within six months.

Gains from capital assets must be reported in ITR forms, and proper documentation must be maintained to claim exemptions.
 

Income from Other Sources

This is a residual category covering all earnings that do not fall under the first four heads. Common sources of income under this category include:

• Interest income from savings accounts, fixed deposits, and bonds
• Dividends from shares or mutual funds
• Lottery winnings, gambling, and betting income
• Gifts exceeding ₹50,000 from non-relatives
• Family pension received after the death of a pensioner

Tax Treatment and Deductions

• Interest Income: Taxable under slab rates. A deduction of ₹10,000 under Section 80TTA is allowed for savings account interest. For senior citizens, interest on fixed deposits up to ₹50,000 is exempt under Section 80TTB.
• Dividends: Taxable at slab rates if received from domestic companies.
• Winnings from Lotteries and Betting: Taxed at 30% (plus cess and surcharge) with no deductions allowed.
• Gifts: If received from non-relatives and exceeding ₹50,000 in a financial year, they are taxable. Gifts from close relatives (parents, siblings, spouse) are exempt.
   

Conclusion

The Income Tax Act, 1961, categorizes earnings into five heads of income, each with its own rules for taxation, deductions, and exemptions. Salary income is taxed after considering exemptions like HRA and standard deduction. House property income includes rental income, with tax benefits on home loans. Business and professional income allows expense deductions before taxation. Capital gains taxation depends on the asset type and holding period. Other income sources, such as interest and winnings, are taxed based on specific provisions.

Classifying income correctly ensures compliance with tax laws and maximizes available tax benefits. Proper documentation, timely filing of returns, and awareness of exemptions help in optimizing tax liability.