Introduction to Income Tax and Its Types

We are all aware of the word “income tax”. Paying income tax is a civic duty. It contributes to the nation’s growth and ensures equal distribution of resources. Income tax is levied by the government on the income generated by us, that is, all citizens of the country and all people living within its jurisdiction. 

Income tax is the primary source of revenue for the government. It enables the government to fund essential public services such as education, healthcare and infrastructure development. The government needs income tax revenue to maintain and expand public services, invest in development projects, and ensure the country's economic stability and growth.

The constitutional basis of “charging” this tax lies within the powers granted to the central government. They have the power to levy taxes on income other than agricultural income, which is taxed by state governments. We will learn more about this in the upcoming chapters as well. Over the years, income tax has evolved into a major source of revenue for the Indian government, funding public services and infrastructure development. This reflects its vital role in the country's economic framework.

Basic Concepts of Income Tax

Income Tax Return (ITR)

An ITR is a form that taxpayers must file with the Income Tax Department of India. It details the income earned and taxes paid during the financial year. This document is crucial for compliance with the income tax law, enabling taxpayers to report their earnings, claim tax deductions, and report taxes paid. 

The process of filing ITR helps maintain transparency between the taxpayer and the government, ensuring that individuals and entities contribute fairly to national revenue.

Assessment Year (AY)

The Assessment Year is the period immediately following the financial year in which income is assessed and taxed. It runs from April 1st of the current year to March 31st of the following year.

For example, if the financial year (FY) is from April 1, 2021, to March 31, 2022, then the AY would be from April 1, 2022, to March 31, 2023. The AY is when the income earned in the FY is evaluated and taxed.

Previous Year (PY)

Often referred to as the Financial Year (FY), the Previous Year is the period in which the income is earned. This period runs from April 1st to March 31st of the next calendar year. The income earned during this period is subject to tax in the subsequent Assessment Year, emphasising the tax system's forward-looking nature.

Assessee

This term encompasses any individual, company, firm, or entity that is liable to pay taxes to the government. The assessee could be a taxpayer filing returns for personal income, a corporate entity reporting its earnings, or any other legal entity obligated under the Income Tax Act. The definition broadens the scope of tax liability, ensuring that all income-earning bodies are covered under the tax laws.

Income

In the context of income tax, 'income' is a broad term that encompasses various forms of earnings upon which tax may be levied. This includes wages from employment, profits from business activities, gains from the sale of assets (capital gains), income from house property, interest, dividends, and other sources. 

The Income Tax Act specifies what constitutes income and outlines different categories to ensure a comprehensive taxation process.

Understanding these concepts is crucial for navigating the Indian income tax system, ensuring compliance, and optimising tax obligations. These definitions interconnect to form the backbone of the tax administration, guiding the assessment, collection, and enforcement of income tax laws.

Types of Income Tax in India

In India, taxes are categorised into direct and indirect taxes. Direct taxes include income tax, which is levied directly on an individual's or an organisation's income. Indirect taxes, such as Goods and Services Tax (GST), are levied on the sale of goods and services and are paid indirectly by the consumer. Income tax itself encompasses various forms, such as tax on salaries, business income, capital gains, and income from other sources. Let’s understand these different types of income taxes with examples. These examples illustrate the varied nature of income categories and their tax implications. They will help you to understand practically how different types of income are treated under the Indian Income Tax Act.

Income from Salary

This includes wages, pensions, allowances, and other benefits received from employment. It's taxed at the individual's applicable income tax rate.

For example, an IT professional earns ₹1,20,000 monthly. This includes basic salary, house rent allowance (HRA), and transport allowance. Taxes are computed on the gross income after specific deductions like HRA and professional tax. 

Income from House Property

Rental income from a property is taxable, with provisions for deductions like property taxes paid and interest on home loans. 

For example, owning a second home that's rented out for ₹20,000 per month, totalling ₹2,40,000 annually. After deductions like property tax and interest on home loans, the net income is subject to tax.

Profits and Gains from Business or Profession

Net profits from business operations or professional services are taxable. This includes income after business expenses are deducted. 

For example, a boutique owner's annual revenue is ₹10 lac, with expenses totalling ₹7 lac, including rent, salaries, and utilities. The net profit of ₹3 lac is taxed as business income.

Capital Gains

Any profit from the sale of capital assets (like property stocks) is taxed under this head. The rate depends on how long the asset was held before sale. 

For example, an individual buys shares for ₹2 lakh and sells them for ₹3 lakh a year later. The ₹1 lakh profit is a long-term capital gain, taxed differently than short-term gains.

Income from Other Sources

This includes interest, dividends, lottery winnings, and other miscellaneous income not covered by other heads. 

For example, earning ₹50,000 in interest from fixed deposits and winning ₹1 lakh in a lottery in the same year. The interest and lottery winnings are taxed under "Income from other sources."

Relevant ITR Forms for Various Income Scenarios

ITR-1 (SAHAJ)

For residents with a total income up to ₹50 lakh from salaries, one house property, and other sources (like interest).

ITR-2

For individuals and Hindu Undivided Families (HUFs) not carrying out business or professional activities.

ITR-3

For individuals and HUFs with income from a proprietary business or profession.

ITR-4 (SUGAM)

For presumptive income from Business & Profession.

Different ITR forms cater to various taxpayer profiles, reflecting the complexity of income types and tax scenarios in India. Each form is designed to accommodate the diverse financial activities of the taxpayer, ensuring a streamlined and efficient tax filing process.

Scheme of Charging Income Tax

The income tax in India is based on a systematic annual cycle, taxing income earned in one fiscal year during the next, designated as the assessment year. This approach ensures predictability and fairness, aligning tax obligations with the financial activities of the previous year. 

The Finance Act, enacted annually, specifies tax rates, allowing taxpayers to plan accordingly. This legislative framework facilitates government revenue collection while providing individuals and businesses with a clear structure for their tax liabilities.

Bottom Line

In conclusion, understanding the foundational aspects of income tax in India—from the basic concepts and types of income that are taxed to the procedural elements like the assessment year and applicable ITR forms—is crucial for compliance and effective tax planning. 

This chapter has provided a comprehensive overview to navigate the complexities of income tax, emphasising the importance of staying informed about the legislative changes and requirements that impact tax obligations in India. In the next chapter, we will understand in-depth Income Tax Returns and Income Tax Brackets, so stay tuned!