What are the Heads of Income under Income Tax Act?

These are the 5 heads of income under income tax:

Income from Salary

Income from House Property

Income from PGBP

Income from Capital Gains

Income from Other Sources

Now that you know what they are, let's understand the various heads of income in detail.

This is the first head of income, and sections 15 to 17 of the Income Tax Act deal with salary income. These sections define the scope, chargeability, and computation of income from salary. They also specify the various allowances, perquisites, and profits in lieu of wages included or excluded from income from salary. What Constitutes Salary? Salary is defined as the remuneration the employer pays to the employee for the services rendered by the employee under a contract of employment. Salary includes both monetary and non-monetary benefits received by the employee from the employer. According to section 17 of the Income Tax Act 1961, salary includes the following components:

Tax Treatment of Key Components of Salary a Type of Income

House Rent Allowance (HRA)

This is the allowance paid by your employer to help you pay your rent if you live in a rented accommodation. HRA is partially taxable, and you can claim an exemption for the least of the following three amounts:

50% of basic salary (if living in a metro city) or 40% of basic salary (if living in a non-metro city)

Actual HRA received

Rent paid minus 10% of the basic salary

Leave Travel Allowance (LTA)

Your employer pays this allowance to cover your travel expenses when on vacation with your family once in a block of two calendar years. LTA is fully exempt, subject to the following conditions:

You must have travelled within India and have proof of travel, such as tickets and invoices.

The exemption is limited to the amount spent on the shortest route by the cheapest mode of transport available, such as air, rail, or road.

The exemption is available for your travel expenses and those of your family members who depend on and live with you, such as your spouse, children, parents, siblings, etc.

Standard Deductions

This is a flat deduction of ₹50,000 from your gross salary, irrespective of the amount of your salary or the actual expenses incurred by you. The standard deduction was introduced in Budget 2018 to replace the earlier deductions for transport allowance and medical reimbursement, which were ₹19,200 and ₹15,000, respectively.

Other Allowances

You may also get various other allowances from your employer, such as allowance for children’s education, hostel expenses, travel, uniforms, etc.

The tax treatment of these allowances depends on their nature and purpose. Some are fully taxable, and some are partly or fully exempt, up to certain limits and conditions.

You can check Section 10 of the Income Tax Act 1961 for the full list and details of the allowances and their tax treatment.

Income from House Property as a head of income under the Income Tax Act refers to earnings from a property owned by an individual or entity. It includes rent received from tenants, vacant property, or any building used for business or profession.

Understanding Gross Annual Value of the Property

The Gross Annual Value (GAV) of a house property is the amount of rent that you can expect to earn from it in a year. It is an important factor for computing your income from house property, as it determines the maximum amount you can deduct.

The GAV of a house property depends on various factors, such as:

The expected rent, which is the rent that you can expect to receive from a similar property in the same or nearby locality

The actual rent, which is the rent that you receive or are entitled to receive from the tenant

The municipal valuation, which is the value of the property as assessed by the municipal authorities for levying property tax

The fair rent, which is the rent that a similar property can fetch in the open market

The standard rent, which is the rent that is fixed by the Rent Control Act or any other law for regulating the rent of the property

Understanding Net Annual Value of a House Property

The Net Annual Value (NAV) of a house property is the income you earn from it after deducting some expenses. It is the final amount that is taxable under the head income from house property.

The NAV of a house property is calculated by subtracting two deductions from the GAV, namely:

Municipal taxes, which are the taxes that you pay to the local authorities for the services and amenities provided by them

Loss due to vacancy, which is the loss of income because of the property being vacant for any part of the year

The formula for calculating the NAV of a house property is:

NAV = GAV - Municipal taxes - Loss due to vacancy

Tax Benefits on Income from House Property

Section 24

There are two types of deductions available under Section 24, namely:

The standard deduction, which is a flat 30% of the NAV, irrespective of the actual expenses incurred on the property

Interest on borrowed capital, which is the interest paid on any loan taken to acquire, construct, repair, renew, or reconstruct the house property

Conditions for claiming deduction under this section:

You can claim the interest deduction only from the year when you complete the construction or make the acquisition. You can claim the pre-construction interest in five equal instalments commencing from the year of completion or acquisition.

The construction or acquisition of the house property must be completed within five years from the end of the financial year in which the loan was taken. Otherwise, the interest deduction will be restricted to ₹30,000 per year instead of ₹2 lakhs per year.

Section 80EE

This section provides a further deduction of up to ₹50,000 per year for interest on a home loan, provided that:

You have taken the loan between April 1, 2016 and March 31, 2017

The loan amount does not exceed ₹35 lakhs

The value of the property does not exceed ₹50 lakhs

You do not possess any additional residential properties at the time of the loan sanctioning.

Section 80 EEA

This section offers a deduction of up to ₹1.5 lakhs per year for interest on a home loan, provided that:

You have taken the loan between April 1, 2019, and March 31, 2022.

The loan amount does not exceed ₹45 lakhs.

The value of the property does not exceed ₹45 lakhs.

The property's carpet area does not exceed 60 sq. metres in metropolitan cities or 90 sq. metres in other cities.

Understanding Deemed Ownership in Income from House Property

In certain situations, you are considered as the deemed owner of a house property, even if you are not the legal owner. These situations are:

Suppose you transfer a house property to your spouse or minor child without consideration. In that case, you will be treated as the deemed owner of the property unless the transfer is in connection with an agreement to live apart or for the benefit of the minor child.

If you hold an impartible estate, a property you cannot divide among the heirs, you will be treated as the deemed property owner, even if you are not the legal owner.

Suppose you are a member of a cooperative society, company, or association of persons and are allotted a house property by such an entity. In that case, you will be treated as the deemed owner of the property, even if the legal title remains with the entity.

If you are a beneficiary of a trust, and the trust owns a house property for your benefit, you will be treated as the deemed property owner, even if the legal title remains with the trust.

The income from PGBP as a type of income includes the profits and gains of any profession you carry during the previous year. It consists of any compensation or other payments due to or received by you from certain specified persons, such as the termination of your agency, the dissolution of your firm, the modification of the terms and conditions of your contract, etc.

It also includes any sums received by you under a keyman insurance policy, which is a policy taken by a business entity on the life of a key employee or partner.

The income from PGBP is one of the most comprehensive and inclusive heads of income, as it covers almost all income derived from your business or profession.

We will discuss some critical sections in the following few subheads.

Charging Section 28

Section 2(13) of the Act specifies the term' business' as any trade, commerce, manufacture, adventure, or concern.

Section 2(36) of the Act defines the term' profession' as any vocation, such as law, medicine, engineering, architecture, accountancy, etc. The term 'carried on' implies that the activity must have some continuity and regularity and not just a one-time or occasional transaction.

The sources of income that are included under Section 28 are as follows:

The profits and gains of any business or profession carried on by you

Any payment due to or received by you from the following persons:

Any person for the termination of your agency or the modification of the terms and conditions of your agency

Any person for the termination of your contract or the modification of the terms and conditions of your contract relating to the management of any company, corporation, or other association of persons

Any person for the termination of your contract or the modification of the terms and conditions of your contract relating to the development of any business site, complex, or building

Any person for terminating your contract or modifying the terms and conditions of your contract relating to the production, distribution, exhibition, or telecast of any film, serial, program, or show.

Any sum received by you under a keyman insurance policy, which is a policy taken by a business entity on the life of a key employee or partner who is essential for the success and profitability of the business

Any profits on the transfer of the Duty Entitlement Pass Book Scheme, the Duty-Free Replenishment Certificate, or the Duty Drawback Scheme, which are schemes introduced by the government to promote exports and provide incentives to exporters

Any profits on the transfer of a capital asset, being any work of art, archaeological, scientific, or historical collection, book, manuscript, drawing, painting, photograph, print, or film, held by you as stock-in-trade.

Any interest, salary, bonus, commission or remuneration due to or received by you from a firm where you are a partner from the firm's profits.

Any sum received or receivable by you for the use of any model, patent, invention, design, secret formula, process, or similar property by the person who is the owner of such property or by the person who has the exclusive right to use such property.

Any sum received or receivable by you for imparting any information concerning the technical, industrial, commercial, or scientific knowledge, experience, or skill by the person who possesses such knowledge, experience, or skill or by the person who has the exclusive right to impart such knowledge, experience, or skill.

Any sum received or receivable by you for the use of any trademark, brand name, or franchise or for providing any service with such trademark, brand name, or franchise by the person who is the owner of such trademark, brand name, or franchise, or by the person who has the exclusive right to use or provide such trademark, brand name, or franchise.

Any sum received or receivable by you for the use of any scientific, technical, industrial, or commercial right, information, or service by the person who is the owner of such right, information, or service or by the person who has the exclusive right to use or provide such right, information, or service.

Any property or right you own or hold, regardless of its connection to your business or profession, constitutes a capital asset. There are two categories of capital assets: movable and immovable.

Movable assets, like cars, jewellery, shares, etc., can be physically transferred from one place to another. Immovable assets, such as land, buildings, etc., are fixed to the earth.

However, not every property or right is considered a capital asset for capital gains tax. Some items are excluded from the definition of a capital asset under section 2(14) of the Income Tax Act. These are:

Stock-in-trade, raw materials, consumable stores, or any other goods held for business or profession

Personal goods such as clothes, furniture, books, etc., except jewellery, archaeological collections, drawings, paintings, sculptures, or any work of art

Special Bearer Bonds, 1991, issued by the Central Government

Agricultural land in India, not being land situated within the specified urban limits

Deposit certificates issued under the Gold Monetisation Scheme, 2015 or gold Deposit Bonds issued under the Gold Deposit Scheme, 1999.

6½% Gold Bonds, 1977, or 7% Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government

Computing Capital Gains

The capital gains computation depends on the capital asset's type and duration. These factors classify capital gains into two categories: short-term capital gain (STCG) and long-term capital gain (LTCG).

A capital asset is considered short-term if it is held for less than 36 months before the date of transfer. However, for some assets, such as shares, securities, units, etc., the holding period is reduced to 12 months. If the capital asset is held for more than the specified period, it is considered long-term.

The formula for calculating capital gains is given by section 48 of the Income-tax Act as follows:

Capital Gain = Full value of consideration - (Expenditure on transfer + Cost of acquisition + Cost of improvement)

The components of the formula are explained below:

The full value of consideration

Cost of acquisition

Expenditure on transfer

Cost of improvement

Note: For computing LTCG, an additional factor is considered, which is the indexation. Indexation is adjusting the cost of acquisition and improvement concerning the inflation rate, per the cost inflation index (CII) notified by the Central Government.

The formula for computing the indexed cost of acquisition and indexed cost of improvement is as follows:

Indexed cost of acquisition (ICOA) = Acquisition Cost x (CII of the transfer year/ CII of the acquisition year)

Indexed cost of improvement (ICOI) = cost of improvement x (CII of the transfer year/ CII of the improvement year)

Tax Benefits Income from Capital Gains

Section 54

This section allows an exemption from LTCG arising from residential house property transfer, provided that the taxpayer invests the capital gain into another property.

The new house property should be purchased either one year before or two years after the date of transfer or constructed within three years from the date of transfer.

The exemption is limited to the amount of capital gain or the cost of the new house property, whichever is lower.

Section 54B

This section allows an exemption from capital gain arising from the transfer of agricultural land if the taxpayer invests the capital gain in another agricultural land within two years from the date of transfer.

The exemption is limited to the amount of capital gain or the cost of the new agricultural land, whichever is lower.

Section 54EC

This section allows an exemption from capital gain arising from long-term capital asset transfer. The transferee must invest the capital gain in certain notified bonds within the specified time limit.

The notified bonds are issued by the National Highways Authority of India (NHAI), the Rural Electrification Corporation (REC), the Power Finance Corporation (PFC), the Indian Railway Finance Corporation (IRFC), or any other specified entity.

The investment must be within six months from the transfer date and should not exceed ₹50 lakhs in a financial year. The exemption is limited to the amount of capital gained or invested in the bonds, whichever is lower.

As per section 56 of the Income Tax Act of 1961, income from other sources means any income not taxable under any other head of income. In other words, it is a residual head of income that covers any income not taxed explicitly under the heads of salary, house property, business or profession, or capital gains.

• Some common types of income included under income from other sources are

• Dividends from domestic or foreign companies

• Interest from savings accounts, fixed deposits, bonds, debentures, etc.

• Winnings from lotteries, crossword puzzles, races, games, gambling, betting, etc.

• Gifts received in cash or kind from any person or entity

• Income from subletting of house property

• Income from royalty, patent, or copyright

• Income from undisclosed sources or unexplained investments

• Income from any other source that is not covered under any other head of income

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