Income tax is a form of taxation imposed by the government on the earnings of individuals or businesses within a given financial year. It is calculated annually based on the applicable income tax slab rates for that year.
What is Income Tax?
Understanding the meaning of income tax is straightforward. It is a direct tax applied by the government on the income of individuals and corporations during a fiscal year. The tax collected by the government is used to fund public services such as infrastructure, healthcare, education, agricultural subsidies, and welfare programs.
Taxes are categorized into two main types: Direct Taxes and Indirect Taxes.
A direct tax, such as income tax, is directly imposed on the income earned by individuals. The amount of tax is determined based on the applicable income slab rates for the respective financial year.
Income Tax Rules in India
The Income Tax Act of 1961 was passed by the Indian government to regulate and manage income tax policies in the country. In 1962, the income tax rules were introduced to help implement and enforce the provisions of the Act. These rules must always be read in conjunction with the Income Tax Act.
The Income Tax Rules are formulated within the scope of the Income Tax Act and cannot override its provisions.
Who are the Taxpayers in India?
Any individual in India under the age of 60 earning more than Rs 2.5 lakh per year is obligated to pay income tax. For individuals over the age of 60, the income threshold remains the same for tax payments.
The following entities are also required to pay taxes:
- Hindu Undivided Family (HUF)
- Body of Individuals (BOI)
- Association of Persons (AOP)
- Companies
- Corporate entities
- Local Authorities
- All Artificial Juridical Persons
According to the Indian income tax system, each type of taxpayer is taxed differently.
Individual taxpayers are taxed according to their income bracket, while businesses and companies in India have a fixed tax rate applied to their taxable income.
Earnings are categorized into various tax brackets or slabs, with the tax rate increasing as income rises.
Different Types of Income - Taxable Income Categories
Now that you are familiar with what income tax is and who qualifies as a taxpayer, let's dive deeper into the various income categories according to the Income Tax Act 1961.
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Salary Income
Income from salary and pension falls under this category and is subject to taxation.
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Income from Property Rentals
Income earned from renting out property is taxable under this head.
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Profits and Gains from Business or Profession
This category covers profits made by self-employed individuals, businesses, freelancers, contractors, and professionals like doctors, lawyers, chartered accountants, and others who run their own practices. It also includes income from tuition services.
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Capital Gains Income
Profits earned from selling assets such as stocks, mutual funds, or real estate are taxed under this category.
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Income from Other Sources
This category includes income such as interest from savings accounts, fixed deposits, and lottery winnings, all of which are taxable.
Income Tax Rates
Anyone earning over Rs. 5 lakhs annually is obligated to pay income tax for the financial year, which runs from April 1 to March 31.
The tax amount depends on the income tax slab applicable. Currently, the highest tax rate is 30%, with additional surcharges and cess applied.
For a detailed breakdown, you can refer to the income tax slab rates.
Important Income Tax Terms
Here are some key terms related to income tax:
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Financial Year (FY)
The financial year is the 12-month period used by taxpayers for accounting and reporting income. It starts on April 1st and ends on March 31st of the next year.
The abbreviation used for this term is "FY." For instance, FY 2021-22 refers to the period from April 1st, 2021, to March 31st, 2022.
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Assessment Year (AY)
The assessment year is the period from April 1st to March 31st, immediately following the financial year. This is the period when taxpayers evaluate their income for the previous financial year and pay taxes on it.
For example, if income is earned during FY 2021-22, the assessment year will be AY 2022-23.
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PAN
The Permanent Account Number (PAN) is a unique 10-digit alphanumeric identifier issued to taxpayers by the Income Tax Department. It is used to track all tax-related transactions.
PAN must be provided when paying advance tax or self-assessment tax. It is also required when interacting with various organizations, such as banks or mutual fund companies, to facilitate the tracking of financial transactions.
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Assessee
An assessee is a person or entity who assesses their income and pays tax as per the Income Tax Act.
An assessee can be an individual, company, partnership, or other entities such as trusts or associations.
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Indian Residents vs NRIs
Tax liability in India is based on residency status. Indian residents must pay tax on their global income, including both income earned in India and abroad.
Non-Residents (NRIs) are only taxed on income earned in India. Residency status must be determined for each fiscal year when taxes are calculated.
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TAN
TAN (Tax Deduction and Collection Account Number) is a unique 10-digit alphanumeric number issued to individuals or organizations responsible for deducting or collecting taxes at source (TDS/TCS).
How to Calculate Income Tax?
Taxable income depends on the type of earnings. For example, salaried individuals may claim exemptions for allowances.
Taxpayers, including individuals and HUFs, can claim deductions under sections 80C to 80U, and subtract this from their gross income to calculate their tax liability. Additionally, taxes already paid, such as advance tax or TDS, should be adjusted accordingly. The effect of rebates under Section 87A and reliefs under sections 89, 90, and 91 must also be factored in.
All sources of income must be declared in the tax return, with exemptions for some incomes such as dividend income from Indian companies or LTCG on listed equity shares up to Rs 1 lakh in a fiscal year.
Follow these steps for a quick guideline to calculate your tax:
- List all sources of income, including salary, rental income, interest income, capital gains, or profits from business or profession.
- Remove any legally exempt income.
- Claim all relevant deductions for each source, like claiming a standard deduction of Rs. 50,000 for salary income or municipal taxes for rental income.
- Claim exemptions under each income category, such as exemption on reinvested capital gains.
- Claim applicable deductions from total income, such as under sections 80C, 80D, 80TTA, and so on.
- Finally, calculate your taxable income, determine your tax bracket, and compute the tax payable.
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