Direct Taxation Explained: Salary, House Property, Capital Gains and Business Income
Direct and Indirect Taxation – I (Direct Tax)
Meaning: Salary is the income received by an employee from an employer in return for services rendered.
Important Components of Salary
- Basic salary
- Dearness allowance (DA)
- Bonus and commission
- Pension
- Allowances, such as House Rent Allowance (HRA)
- Perquisites, such as rent-free accommodation
Important Points
- There must be an employer–employee relationship.
- Salary is generally taxable on a due or receipt basis, whichever is earlier.
- Advance salary is taxable when received.
- Arrears of salary are taxable when received if not taxed earlier.
- Allowances and perquisites may be fully taxable, partly exempt, or exempt, depending on the applicable provisions.
Deductions from Salary
- Standard deduction, subject to the applicable tax regime.
- Professional tax, where deductible under the applicable rules.
- Certain other deductions under the old tax regime, where eligible.
Income from House Property
Meaning: Income earned from owning a building or land attached to a building, such as a house, flat, shop, or office.
Types of House Property
- Self-occupied property – used by the owner for residence.
- Let-out property – rented to another person.
- Deemed let-out property – treated as let out under applicable tax rules.
Important Points
- The assessee must generally be the owner or deemed owner of the property.
- Income from a property used for the owner’s own business or profession may be taxed under the head of business or profession.
- Municipal taxes are deductible when paid by the owner, subject to applicable rules.
- A standard deduction of 30% of Net Annual Value (NAV) is allowed for let-out property.
- Eligible housing-loan interest may be deductible, subject to applicable conditions and tax regime.
Formula
Gross Annual Value (GAV) − Municipal Taxes Paid = Net Annual Value (NAV)
NAV − Standard Deduction − Eligible Interest on Borrowed Capital = Income from House Property
Example
- Annual rent = ₹2,40,000
- Municipal taxes paid = ₹10,000
- NAV = ₹2,30,000
- Standard deduction = 30% × ₹2,30,000 = ₹69,000
- Income from house property before housing-loan interest = ₹1,61,000
Exam tip: Learn the meaning of GAV, NAV, standard deduction, self-occupied property, and let-out property.
Income from Other Sources
Meaning: Income that is taxable but does not fall under the other four heads of income is generally classified under Income from Other Sources, such as interest on securities, where not taxable as business income.
Important Points
- It is the residual or fifth head of income.
- Income is taxed according to the applicable provisions and rules.
- Certain expenses incurred to earn the income may be deductible, subject to restrictions.
- Lottery winnings and certain gaming winnings are subject to special tax rules and rates.
- Gifts received from specified relatives are generally exempt, while certain gifts from non-relatives may become taxable if statutory conditions are met.
Common Deductions
- Certain expenses incurred wholly and exclusively to earn taxable income.
- In the case of family pension, a prescribed deduction may be available.
- Personal expenses are generally not deductible.
Capital Gains
Meaning: Capital gains arise when a capital asset is transferred and a profit or gain results, subject to the applicable tax provisions.
Examples of Capital Assets
- Land and buildings
- Shares and securities
- Jewellery
- Certain investments and other valuable assets
Types of Capital Gains
- Short-Term Capital Gain (STCG): Gain from transferring an asset classified as short-term under the applicable holding-period rules.
- Long-Term Capital Gain (LTCG): Gain from transferring an asset classified as long-term under those rules.
The holding period depends on the type of asset and the applicable law.
Formula
Full Value of Consideration
− Transfer Expenses
− Cost of Acquisition
− Eligible Cost of Improvement
= Capital Gain, subject to applicable adjustments and exemptions.
Income from Business and Profession
Important Points
- Income is calculated according to applicable accounting and tax rules.
- Business expenses incurred wholly and exclusively for business purposes are generally deductible, subject to tax restrictions.
- Personal expenses are not allowed as deductions.
- Capital expenditure is generally not deductible as an ordinary business expense, though depreciation may be allowed on eligible assets.
- Expenses relating to prohibited or illegal activities may not be deductible.
- Certain taxpayers may use presumptive taxation schemes if they satisfy the prescribed conditions.