Understanding different heads of income from the taxation angle

The income you earn can come from different sources and the income tax department classifies the various income sources, its nature and respective taxability.

Why is there a need for different heads of income?

There are numerous reasons behind having different heads of income:

- Income has been classified on the basis of its nature. Hence, law provisions take place depending on the nature of income rather than its source.

- The Government can identify a particular class of individual according to the heads of income, then allow specified exemptions of tax liability.

- Availability of heads enables the tax administrators to lay down procedures, compliances, return forms and methods of calculations of tax, income head wise.

- The statistical data generated by compilation of such differentiating information becomes a useful tool for planning any constructive amendments.

Though there is only one tax levied on the income of individuals, there are different rules to calculate the taxable income and tax thereon. Since these rules differ, the income is classified in five different heads according to the rules for calculations in force. 

The heads of income as per the law are mentioned below:

1. Income from salary:

The most important thing to classify any income to be derived as a salary is to have an employer-employee relationship. All types of payments, whether in cash or in kind, by employer to employee as the compensation for the services discharged by the employee are categorised as income from salary in the hands of employee.

Stipend: Stipend is not considered as salary as there is no employer employee relationship.

Expense reimbursement: Since these payments made by employer to employee are not for the compensation for services of employee but for the expenses incurred on behalf of the employer.

2. Income from house property:

Any sum received in form of rent for a house property will fall under this head of income. If the individual is using a property for own residence then it is termed as Self-Occupied Property and the said property is not liable to tax because it is used as a self-occupied property. But having more than one self-occupied property attracts tax even though the other properties are not let out and the income will be calculated as deemed to be let out and income tax is charged thereon. If you let out your property then the actual rent will be treated as income under the head house property and you will also be allowed to claim the benefits of municipal taxes paid, home loan interest and standard deduction of 30%, which will reduce your taxable property income.  

3. Income from profit & gains from business or profession

The individuals who are not in employment are broadly categorised as businessmen or professionals. Thus, those who are earning income i.e. profits from manufacturing or trading activities or from providing professional services are categorised under the head of profit and gains of business or profession.

4. Income from capital gains:

Income arising from transfer of any capital asset considered is taxed under the head i.e. ‘income under the head capital gains’. Any item which falls under the definition of capital asset like car, jewellery, building etc will come under this head. For example, if you would have sold your fixed assets then the gain may be earned over the span of years but it will be considered as an income for the year in which such assets or investment is sold. For example, a house purchased 10 years ago and sold now has appreciated its value over 10 years but all such gain arising on its sale is taxed in the year of sale.  

5. Income from other sources:

This head of income is considered as the residual head. Any taxable income which cannot be categorised under any above mentioned head is parked under this head. For example: Interest received on your Bank FDs, saving accounts, gifts received etc.