Income-tax is levied on an assessee’s total income. Such total income has to be
computed as per the provisions contained in the Income-tax Act, 1961. Let us go step by
step to understand the procedure of computation of total income for the purpose of levy of
income-tax –
Step 1 – Determination of residential status
The residential status of a person has to be determined to ascertain which income is to be
included in computing the total income.
The residential statuses as per the Income-tax Act are shown below –
In the case of an individual, the duration for which he is present in India determines his
residential status. Based on the time spent by him, he may be (a) resident and ordinarily
resident, (b) resident but not ordinarily resident, or (c) non-resident.
The residential status of a person determines the taxability of the income. For e.g.,
income earned outside India will not be taxable in the hands of a non-resident but will be
taxable in case of a resident and ordinarily resident.
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Taxation
Step 2 – Classification of income under different heads
The Act prescribes five heads of income. These are shown below –
HEADS OF INCOME
SALARIES INCOME FROM PROFITS AND GAINS CAPITAL INCOME
HOUSE PROPERTY OF BUSINESS OR GAINS FROM OTHER
PROFESSION SOURCES
These heads of income exhaust all possible types of income that can accrue to or be
received by the tax payer. Salary, pension earned is taxable under the head “Salaries”.
Rental income is taxable under the head “Income from house property”. Income derived
from carrying on any business or profession is taxable under the head “Profits and gains
from business or profession”. Profit from sale of a capital asset (like land) is taxable
under the head “Capital Gains”. The fifth head of income is the residuary head under
which income taxable under the Act, but not falling under the first four heads, will be
taxed. The tax payer has to classify the income earned under the relevant head of
income.
Step 3 - Exclusion of income not chargeable to tax
There are certain income which are wholly exempt from income-tax e.g. Agricultural
income. These income have to be excluded and will not form part of Gross Total Income.
Also, some incomes are partially exempt from income-tax e.g. House Rent Allowance,
Education Allowance. These incomes are excluded only to the extent of the limits
specified in the Act. The balance income over and above the prescribed exemption limits
would enter computation of total income and have to be classified under the relevant head
of income.
Step 4 - Computation of income under each head
Income is to be computed in accordance with the provisions governing a particular head
of income. Under each head of income, there is a charging section which defines the
scope of income chargeable under that head. There are deductions and allowances
prescribed under each head of income. For example, while calculating income from
house property, municipal taxes and interest on loan are allowed as deduction. Similarly,
deductions and allowances are prescribed under other heads of income. These
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Basic Concepts
deductions etc. have to be considered before arriving at the net income chargeable under
each head
Step 5 – Clubbing of income of spouse, minor child etc.
In case of individuals, income-tax is levied on a slab system on the total income. The tax
system is progressive i.e. as the income increases, the applicable rate of tax increases.
Some taxpayers in the higher income bracket have a tendency to divert some portion of
their income to their spouse, minor child etc. to minimize their tax burden. In order to
prevent such tax avoidance, clubbing provisions have been incorporated in the Act, under
which income arising to certain persons (like spouse, minor child etc.) have to be included
in the income of the person who has diverted his income for the purpose of computing tax
liability.
Step 6 – Set-off or carry forward and set-off of losses
An assessee may have different sources of income under the same head of income. He
might have profit from one source and loss from the other. For instance, an assessee
may have profit from his textile business and loss from his printing business. This loss
can be set-off against the profits of textile business to arrive at the net income chargeable
under the head “Profits and gains of business or profession”.
Similarly, an assessee can have loss under one head of income, say, Income from house
property and profits under another head of income, say, Profits and gains of business or
profession. There are provisions in the Income-tax Act for allowing inter-head adjustment
in certain cases. Further, losses which cannot be set-off in the current year due to
inadequacy of eligible profits can be carried forward for set-off in the subsequent years as
per the provisions contained in the Act.
Step 7 – Computation of Gross Total Income.
The final figures of income or loss under each head of income, after allowing the
deductions, allowances and other adjustments, are then aggregated, after giving effect to
the provisions for clubbing of income and set-off and carry forward of losses, to arrive at
the gross total income.
Step 8 – Deductions from Gross Total Income
There are deductions prescribed from Gross Total Income. These deductions are of three
types –
Step 9 – Total income
The income arrived at, after claiming the above deductions from the Gross Total Income is
known as the Total Income. It is also called the Taxable Income. It should be rounded off
to the nearest Rs.10.
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Basic Concepts
The process of computation of total income is shown hereunder –
Step 10 – Application of the rates of tax on the total income
The rates of tax for the different classes of assesses are prescribed by the Annual
Finance Act.
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Taxation
For individuals, HUFs etc., there is a slab rate and basic exemption limit. At present, the
basic exemption limit is Rs.1,00,000 for individuals. This means that no tax is payable by
individuals with total income of up to Rs.1,00,000. Those individuals whose total income
is more than Rs.1,00,000 but less than Rs.1,50,000 have to pay tax on their total income
in excess of Rs.1,00,000 @ 10% and so on. The highest rate is 30%, which is attracted in
respect of income in excess of Rs.2,50,000.
For firms and companies, a flat rate of tax is prescribed. At present, the rate is 30% on
the whole of their total income.
The tax rates have to be applied on the total income to arrive at the income-tax liability.
Step 11 – Surcharge
Surcharge is an additional tax payable over and above the income-tax. Surcharge is
levied as a percentage of income-tax. At present, the rate of surcharge for firms and
domestic companies is 10% and for foreign companies is 2.5%. For individuals, surcharge
would be levied @10% only if their total income exceeds Rs.10 lakhs.
Step 12 – Education cess
The income-tax, as increased by the surcharge, is to be further increased by an additional
surcharge called education cess@2%. The Education cess on income-tax is for the
purpose of providing universalised quality basic education. This is payable by all assesses
who are liable to pay income-tax irrespective of their level of total income.
Step 13 - Advance tax and tax deducted at source
Although the tax liability of an assessee is determined only at the end of the year, tax is
required to be paid in advance in certain installments on the basis of estimated income.
In certain cases, tax is required to be deducted at source from the income by the payer at
the rates prescribed in the Act. Such deduction should be made either at the time of
accrual or at the time of payment, as prescribed by the Act. For example, in the case of
salary income, the obligation of the employer to deduct tax at source arises only at the
time of payment of salary to the employees. Such tax deducted at source has to be
remitted to the credit of the Central Government through any branch of the RBI, SBI or
any authorized bank. If any tax is still due on the basis of return of income, after
adjusting advance tax and tax deducted at source, the assessee has to pay such tax
(called self-assessment tax) at the time of filing of the return
Taxation
on 07 November 2007
