Understanding how your income is categorized for tax purposes is the first step towards efficient tax planning. In India, income tax law divides all your earnings into five distinct “heads of income.” Knowing these categories and the deductions available under each can significantly impact your tax liability. This blog post will provide a clear overview of these five heads and shed light on the deductions you can claim under Chapter VI-A.
Download UNIT 3 – Five Heads of Income and Deductions Notes
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The Five Pillars of Your Income:
Think of these as the main buckets where all your earnings fall:
1. Income from Salary:
This is perhaps the most common head of income, encompassing any remuneration received by an employee from their employer. This includes your basic salary, allowances (like House Rent Allowance or Dearness Allowance), perquisites (like company car or accommodation), and retirement benefits.
- Computation: Your taxable salary is generally calculated by adding up all these components and then subtracting any exemptions specifically allowed (e.g., a portion of HRA).
- Key Deductions (related to salary, but often claimed under Chapter VI-A): Contributions to Provident Fund (PF), National Pension Scheme (NPS), and investments in certain tax-saving schemes.
2. Income from House Property:
If you own any property (residential or commercial) that is let out, or even if it’s lying vacant (deemed let out), the income or deemed income from that property is taxed under this head.
- Computation: For let-out property, the annual value (generally the rent received or receivable) is considered. From this, you can deduct property tax paid and a standard deduction of 30% for repairs and maintenance. Interest paid on a home loan can also be deducted. For self-occupied property, only the interest on a home loan can typically be claimed as a deduction (with certain limits).
- Key Deductions (related to house property, but interest on housing loan can also be claimed under Section 24): Principal repayment of a home loan (under Section 80C).
3. Income from Business or Profession:
This head covers income earned from carrying on any business or practicing a profession. This includes profits from your trade, fees received for professional services (e.g., by doctors, lawyers, consultants), and any other income related to your business or profession.
- Computation: This involves calculating your total revenue from the business or profession and then deducting allowable business expenses. Maintaining proper books of accounts is crucial for this head.
- Key Deductions (specific to business/profession and also under Chapter VI-A): Various business expenses like rent, salaries, depreciation, and investments in certain schemes.
4. Income from Capital Gains:
Any profit or gain arising from the sale or transfer of a capital asset is taxed under this head. Capital assets include property, shares, mutual funds, jewelry, etc. The taxability depends on whether the asset was held for a short term or a long term.
- Computation: Capital gain is calculated as the difference between the sale price and the cost of acquisition (including any improvement costs), adjusted for inflation in the case of long-term capital assets.
- Key Deductions/Exemptions (specific to capital gains and also under Chapter VI-A): Investments made in certain specified assets after selling a long-term capital asset can provide exemption from capital gains tax (e.g., under Sections 54, 54F). Investments in tax-saving schemes can also be made.
5. Income from Other Sources:
This is a residual head that captures any income that doesn’t fall under the previous four categories. Common examples include interest income from savings accounts and fixed deposits, dividend income, winnings from lotteries or crosswords, and income from agricultural land exceeding certain limits.
- Computation: The method of computation varies depending on the nature of the income. Generally, it’s the gross amount received, with some allowable deductions.
- Key Deductions (under Chapter VI-A): Investments in various tax-saving schemes.
Unlock Tax Savings with Chapter VI-A Deductions (Sections 80C to 80U):
Chapter VI-A of the Income Tax Act provides a range of deductions that you can claim from your total income, thereby reducing your taxable income. Some of the popular deductions include:
- Section 80C: Investments in Public Provident Fund (PPF), Employees’ Provident Fund (EPF), National Savings Certificates (NSC), life insurance premiums, Equity Linked Savings Schemes (ELSS), tuition fees for children, and principal repayment of home loan (with a combined limit).
- Section 80D: Premium paid for medical insurance for self, family, and parents.
- Section 80CCD: Contributions to the National Pension Scheme (NPS).
- Section 80E: Interest paid on education loan.
- Section 80G: Donations made to eligible charitable institutions and funds.
- Section 80TTA/80TTB: Interest earned on savings accounts (with specific limits and applicability based on age).
- Section 80U: Deduction for persons with disabilities.
Understanding these five heads of income and the various deductions available is crucial for effective tax planning. By correctly classifying your income and availing eligible deductions under Chapter VI-A, you can minimize your tax liability and make informed financial decisions. It’s always advisable to consult with a tax professional for personalized guidance based on your specific financial situation.