Computing Taxable Income

Under chapter 4 (Section 14) of the Income Tax Act, 1961, an individual’s income, for the purpose of taxation, is calculated under different heads and aggregated thereafter. Before aggregation, applicable deductions are allowed under each head separately to arrive at the net tax liability.

Net Taxable Income: Components

Under the Income Tax Act, an assessee’s income is divided into five heads, each having a different mode of calculation and distinct rules governing deduction.  

Income from Salary

Salary for the purpose of tax computation includes wages, allowances and all measurable benefits, such as company-leased accommodation and car. Profits in lieu of salary, such as compensation for employment termination, are also taxed under the head of salary as per the Income Tax Act.

Income from House Property

Rental income earned by an assessee on any form of accommodation is taxable under this head. The taxability under this head is computed according to the Annual Value of the house, which is the maximum of:

• HRA rent received
• Municipal valuation of rent
• Fair Rent (determined by the IT department)

Note: the annual value of a self-occupied home is taken as ‘nil.’  However, if an individual has more than one self-occupied house, the annual value of the other house/s is taxable.

Income from Business or Profession

Besides profits and gains from a business or profession, the following modes of income are considered under this head for tax computation.

• Income derived by trade or earned in lieu of specific services performed
• Any interest, bonus, commission or salary received by a partner/s of the firm
• Any amount received for not conducting an activity in relation to the business, such as safeguarding a patent, copyright or know-how

Income from Capital Gains

Transfer of a capital asset, resulting in capital gains, is taxable under this head. A capital asset, as defined under section 2 (14) of the Income Tax Act, is any property held by an assessee, such as real estate, bonds, equity shares and jewelry. Note: Gains arising from the sale of an asset such as stock-in-trade, used for business or personal effects, are not taxed under this head. 

 Income from Other Sources

This is the residual head; wherein incomes that fail to meet the criteria of other heads are taxed. Some specific incomes taxed under this head are:

• Dividends
• Lottery winnings
• Income from horse races
• Amount received under Keyman insurance policy

Note: Not all sources of income are recognized under the head of ‘income from other sources.’ The Income Tax Act has a specific list of earnings qualified under this head.