Fundamental Concepts of Indian Income Tax Law (IT Act, 1961)

Posted on Nov 12, 2025 in Accounting and Finance

Income from Salaries: Taxability and Components

Definition of Salary Income

Income from salaries refers to the payment received by an individual from an employer for services rendered. This includes wages, pension, and other monetary or non-monetary benefits. This income is taxable under the head “Income from Salaries” in the Income Tax Act.

Components of Taxable Salary Income

Basic Salary: The fixed monthly salary paid by the employer is fully taxable.
Allowances: Various allowances like House Rent Allowance (HRA), conveyance allowance, and Dearness Allowance (DA) are taxable as per specific rules.
Perquisites: Benefits like rent-free accommodation, company car, or stock options are considered taxable perquisites.
Commission and Bonus: Any commission or bonus received from the employer is taxable as salary income.
Pension: Payments received after retirement, including superannuation pension, are taxable.
Gratuity: Gratuity received is taxable, but certain exemptions apply under the Income Tax Act.
Leave Encashment: Payment for unused leave is taxable, subject to exemptions for government and non-government employees.
Tax Deducted at Source (TDS): Employers deduct TDS on salary income before paying the employee.

Conclusion on Salary Income

Income from salaries includes all monetary and non-monetary benefits received from employment and is fully taxable, subject to exemptions and deductions under the Income Tax Act.

Income Exempt from Taxation (Non-Taxable Income)

What is Exempt Income?

Certain types of income are not taxable under the Income Tax Act, meaning the individual or entity does not have to pay tax on them.

Key Examples of Exempt Income (Section 10)

Agricultural Income: Income earned from agricultural activities in India is fully exempt.
Share of Profit from Partnership: Profit received from a partnership firm is exempt in the hands of the partner.
Gratuity (Under Certain Limits): Gratuity received by an employee is exempt up to specified limits.
Pension (Government Pension): Commuted pension received by government employees is fully exempt.
Scholarships: Scholarships granted to meet educational expenses are exempt.
Leave Travel Allowance (LTA): LTA received for travel within India is exempt as per rules.
Agricultural Land Receipts: Compensation for compulsory acquisition of agricultural land is exempt.
Dividend Income: Certain dividends (e.g., from domestic companies) were exempt under Section 10(34).
Life Insurance Maturity Proceeds: Amount received on maturity of a life insurance policy is exempt under Section 10(10D).
Amount Received on Voluntary Retirement: Compensation received under the Voluntary Retirement Scheme (VRS) is exempt up to specified limits.

Benefit of Exempt Income

These exemptions reduce the total taxable income, helping taxpayers save tax legally.

Determining Residential Status of an Individual

Definition of Resident Status

An individual is considered a resident in India for a financial year if certain conditions related to their physical presence in the country are satisfied.

Conditions and Classifications

Basic Condition 1: Stay in India 182 Days or More: The individual must be in India for 182 days or more during the financial year.
Basic Condition 2: Stay in India 60 Days + 365 Days Rule: The individual must be in India for at least 60 days in the current year and 365 days in the preceding 4 years.
Ordinary Resident (ROR): A person satisfying at least one basic condition and two additional conditions is treated as a Resident and Ordinarily Resident (ROR).
Not Ordinarily Resident (RNOR): If a resident satisfies one basic condition but fails to satisfy the additional conditions (related to prior years’ residency), they are Resident but Not Ordinarily Resident (RNOR).
Non-Resident (NRI): If the individual does not meet either of the basic conditions, they are classified as a Non-Resident (NRI).

Importance of Residential Status

Residential status is crucial as it determines the scope of taxation on the individual’s global or Indian income.

Deductions from Income from Other Sources

Allowable Deductions

Certain deductions are allowed from the income chargeable under the head “Income from Other Sources” to arrive at taxable income.

Expenses for Earning Income: Deduction of expenses wholly and exclusively incurred to earn the income, e.g., commission paid to agents, bank charges.
Interest on Borrowed Capital: Interest on loans taken specifically to earn income from other sources is allowed as a deduction.
Standard Deduction for Dividends: Certain exemptions or standard deductions may be allowed for dividends, if specified by the Act.
Depreciation: Deduction for depreciation on assets used to earn income from other sources.
Allowable Losses: Any allowable losses incurred in earning such income can be deducted as per Income Tax provisions.

Tax Benefit

These deductions reduce the taxable income from other sources, ensuring only net income is taxed.

Deductions under the Head Income from House Property

Key Deductions (Section 24)

Certain deductions are allowed from the income earned from house property to compute taxable income under the Income Tax Act.

Standard Deduction: 30% of the Net Annual Value (NAV) is allowed as a deduction to cover repairs and maintenance.
Interest on Home Loan: Deduction for interest paid on borrowed capital for self-occupied or let-out property under Section 24(b).
Municipal Taxes: Deduction allowed for taxes paid to local authorities in the year of payment.
Pre-construction Interest: Interest on a loan taken before construction is allowed in 5 equal installments starting from the year of completion.
Set-off of Loss: Loss under house property can be set off against other heads of income (subject to limits) and carried forward for 8 years.

Purpose of Deductions

These deductions reduce taxable income and encourage investment in housing and property maintenance.

Understanding Capital Assets (Section 2(14))

Definition of Capital Asset

A capital asset refers to any property, whether movable or immovable, tangible or intangible, held by a person, excluding certain specified assets. Examples include land, building, machinery, shares, bonds, and jewelry.

Assets Excluded from Capital Asset Definition

Stock-in-trade of a business or profession.
Consumable stores or raw materials held for business purposes.
Personal effects (except jewelry, archaeological collections, drawings, paintings, sculptures, or any work of art).
Agricultural land in rural areas (subject to conditions).
Certain bonds or financial instruments specifically exempted under the Act.

Features and Characteristics

Must be owned by the assessee.
Can be movable or immovable property.
May be tangible (land, building) or intangible (patent, shares).
Certain exclusions as per the Act are not treated as capital assets.
Capital gains arise only on the transfer of a capital asset.

Conclusion

Identification of a capital asset is essential for computing capital gains under the Income Tax Act and determining the correct tax liability.

The Definition and Characteristics of Income

Meaning of Income (Section 2(24))

Income refers to the money or money’s worth that a person receives or earns during a particular period, generally one financial year. It includes earnings from various sources such as salary, rent, profit, interest, and dividends.

According to Section 2(24) of the Income Tax Act, 1961, income includes both regular and occasional receipts, whether received in cash or kind. Examples: Salary from employment, rent from house property, profit from business, interest on savings, dividend from shares, lottery winnings, etc.

Features and Characteristics of Income

Regular or Periodic Return: Income is generally earned at regular intervals (e.g., monthly salary), but even one-time income (like lottery winnings) is taxable.
Monetary and Non-Monetary Form: Income may be received in money (cash, cheque) or kind (car, flat, gifts, etc.).
Legal or Illegal Source: Income earned from both legal and illegal activities is taxable under the Income Tax Act.
Received or Accrued: Income may be received or may accrue (become due) during the previous year; both are taxable.
Definite Source: Every income arises from a specific source such as employment, property, or business.
Taxable under Five Heads: Income is classified under five heads: (a) Salary, (b) House Property, (c) Business/Profession, (d) Capital Gains, and (e) Other Sources.
Gross and Net Income: Income may be gross (before deductions) or net (after deductions).
Receipts from Any Place: Income may arise in India or outside India, depending on the residential status of the assessee.
Income Includes Gifts: Certain gifts received exceeding ₹50,000 (without consideration) are also taxable as income.
Real or Deemed Income: Income actually received or deemed to be received (like employer’s contribution to provident fund) is also taxable.

Summary

Income is the total monetary benefit earned or accrued from various sources during a year. It forms the basis for determining tax liability under the Income Tax Act, ensuring that individuals and entities contribute fairly to national revenue.

Tax Treatment of Gratuity and Pension

Gratuity and Pension are retirement benefits given by an employer to an employee as a reward for long and faithful service.

Gratuity Provisions

Meaning: A lump-sum payment made by an employer to an employee at the time of retirement, resignation, or death.
Eligibility: Payable only if the employee has completed at least 5 years of continuous service (except in case of death or disability).
Taxability: Fully exempt for government employees; partly exempt for private employees under Section 10(10).
Limit of Exemption: Maximum exemption limit is currently ₹20,00,000 (Rupees Twenty Lakhs).
Balance Amount: Any amount above the exemption limit is taxable as salary income.

Pension Provisions

Meaning: A regular monthly payment made to an employee after retirement.
Types:
- (a) Uncommuted Pension: Periodic payment, which is fully taxable.
- (b) Commuted Pension: Lump-sum payment, which is partly exempt under Section 10(10A).
Government Employees: Commuted pension is fully exempt.
Non-Government Employees: 1/3 or 1/2 of the commuted pension is exempt (depending on whether gratuity is also received).
Remaining Amount: The remaining pension amount is taxable under the head “Income from Salary.”

Definition of ‘Person’ (Section 2(31) of IT Act)

Entities Included in the Term ‘Person’

According to Section 2(31) of the Income Tax Act, the term ‘Person’ includes the following seven categories:

Individual: A single human being (e.g., salaried person, professional).
Hindu Undivided Family (HUF): A family consisting of all persons lineally descended from a common ancestor.
Company: Any Indian or foreign company registered under the Companies Act.
Firm: Partnership firm or Limited Liability Partnership (LLP) carrying on business or profession.
Association of Persons (AOP) or Body of Individuals (BOI): A group of individuals joining together for a common purpose.
Local Authority: Municipalities, Panchayats, Port Trusts, or similar bodies.
Artificial Juridical Person (AJP): Any non-living entity recognized by law (e.g., deity, trust, university).

Deduction for Dependent Disability (Section 80DD)

Purpose and Eligibility

Section 80DD of the Income Tax Act provides a deduction to a resident individual or Hindu Undivided Family (HUF) for expenses incurred on the medical treatment, training, and rehabilitation of a dependent person with a disability.

Eligible Person: The deduction is available only to resident individuals or HUFs who have a dependent with a disability.
Dependent Includes: Spouse, children, parents, brothers, or sisters who are dependent on the taxpayer for support.
Amount of Deduction:
- ₹75,000 for normal disability (40% or more).
- ₹1,25,000 for severe disability (80% or more).
Conditions: The taxpayer must incur expenses for medical treatment or pay premiums for an insurance policy under an approved scheme for the dependent.
Proof Required: A valid medical certificate from an authorized government hospital is mandatory to claim the deduction.

Allowable Business Expenditure and Deductions

Meaning of Allowable Expenditure

Allowable business expenditure refers to the expenses that are incurred wholly and exclusively for business or profession and are deductible while computing taxable business income under the Income Tax Act, 1961.

Conditions for Allowability

It must be incurred wholly and exclusively for business purposes.
It must not be personal in nature.
It must not be capital expenditure (i.e., not spent on assets).
It must be actually incurred during the previous year.
It must not be prohibited by any section of the Income Tax Act.

Examples of Allowable Expenditures

General Expenses:

Rent, rates, taxes, and repairs of business premises.
Salaries, wages, bonus, and commission paid to employees.
Traveling and conveyance expenses.
Advertisement expenses.
Telephone and electricity bills.

Specific Allowable Deductions (Sections 30–37):

Section 30: Rent, rates, repairs, and insurance for business premises.
Section 31: Repairs and insurance of machinery, plant, and furniture.

Previous Year (P.Y.) vs. Assessment Year (A.Y.)

1. Previous Year (P.Y.)

Meaning: The Previous Year is the financial year in which income is earned by the taxpayer.

Period: It starts on 1st April and ends on 31st March of the next year.

Example: Income earned between 1 April 2024 to 31 March 2025 is the Previous Year 2024–25.

Key Point: Income is always earned during the previous year but taxed in the next year.

2. Assessment Year (A.Y.)

Meaning: The Assessment Year is the year immediately following the previous year, in which the income earned is assessed and taxed by the Income Tax Department.

Period: Also runs from 1st April to 31st March.

Example: Income earned in P.Y. 2024–25 is assessed and taxed in A.Y. 2025–26.

3. Relationship Between P.Y. and A.Y.

Particular	Previous Year (P.Y.)	Assessment Year (A.Y.)
Purpose	Year of earning income	Year of assessment and taxation
Period	1 April – 31 March	Next 1 April – 31 March
Example	2024–25	2025–26

4. Exception to the Rule

In certain cases (like newly started businesses or discontinued businesses), income is taxed in the same year it is earned — meaning there is no gap between the P.Y. and A.Y.

Deductions under Income from House Property (Section 24)

Allowances for House Property Owners

While calculating taxable income from house property, certain deductions are allowed to reduce the tax burden on the owner. These deductions are provided under Section 24 of the Income Tax Act.

Standard Deduction: A flat 30% of the Net Annual Value (NAV) is allowed as a deduction for repairs and maintenance, irrespective of actual expenses.
Municipal Taxes: Taxes paid to the local authority by the owner are deductible from Gross Annual Value (GAV).
Interest on Borrowed Capital: Interest paid on a housing loan for purchase, construction, or repair is deductible (up to ₹2,00,000 for self-occupied property and without limit for let-out property).
Pre-construction Interest: Interest paid during the period before construction completion can be claimed in 5 equal installments from the year of completion.
Vacancy Allowance: Even if the property is vacant but not earning rent, deductions like interest and standard deduction are still applicable.