Under the Indian Income Tax Act, income is broadly classified into five heads for the purpose of taxation. These heads of income are used to determine the total income of an individual or entity for a financial year.
It is important to note that each head of income has its own set of rules for calculating taxable income, exemptions, and deductions. Therefore, it is important for taxpayers to understand the nature of their income and which head of income it falls under.
The five heads of income are as follows:
- Income from Salaries: This head of income includes all income received by an individual as a result of employment, including basic salary, allowances, perquisites, bonus, commission, and profits in lieu of salary. It also includes income received by a person who is in receipt of a pension.
- Income from House Property: This head of income includes all income earned from a property owned by an individual, such as rent received for the property or income from the transfer of ownership of the property. If an individual owns more than one property, the income from each property is considered separately.
- Profits and Gains of Business or Profession: This head of income includes income earned by an individual from a business or profession that they are engaged in. It includes income from trade, commerce, manufacturing, or any other business activity, as well as income from the provision of professional services.
- Capital Gains: This head of income includes profits or gains that arise from the sale or transfer of a capital asset. A capital asset is defined as any asset that is held by an individual, such as property, stocks, bonds, mutual funds, or other investments.
- Income from Other Sources: This head of income includes all income that does not fall under the other four heads of income. It includes income from interest on savings accounts, fixed deposits, dividends, royalties, and any other income that is not covered under the other heads of income.
Income which do not form a part of Total Income
Under the Indian Income Tax Act, there are certain incomes that do not form a part of an individual’s total income and are therefore not taxable. These are known as exempt incomes and are specified in the Income Tax Act.
It is important to note that while these incomes may be exempt from tax, they must still be disclosed in the individual’s income tax return.
The following are some of the incomes that are exempt from tax:
- Agricultural income: Income earned from agricultural land in India is exempt from tax. However, if the income earned from agriculture is above a certain threshold, the individual may be required to file income tax returns.
- Interest on tax-free bonds: Interest earned on certain government bonds is exempt from tax. These bonds are issued by the government and are used to finance specific projects, such as infrastructure development.
- Dividends from domestic companies: Dividends received from Indian companies are exempt from tax in the hands of the recipient. However, the company distributing the dividends is required to pay dividend distribution tax.
- Long-term capital gains on listed securities: If an individual sells listed securities (such as shares, bonds, and debentures) after holding them for more than one year, the resulting long-term capital gains are exempt from tax.
- Gifts: Gifts received from specified relatives or on certain occasions, such as marriage or inheritance, are exempt from tax.
- Leave travel allowance (LTA): LTA received from an employer to cover travel expenses incurred during a holiday is exempt from tax. However, this exemption is subject to certain conditions and limits.
- Gratuity: Gratuity received by an employee from their employer on retirement or termination of employment is exempt from tax up to a certain limit.
- Scholarships: Scholarships received by students to cover the cost of education are exempt from tax.
- Provident fund: Contributions made by an employer to a recognized provident fund on behalf of an employee are exempt from tax up to a certain limit.
- Life insurance proceeds: Any amount received as a maturity or death benefit from a life insurance policy is exempt from tax.