Everyone pays taxes on goods, services and also on their income. But, do you understand the tax you pay and why you pay it?
In India, there are two types of taxes: direct tax and indirect tax.
Direct tax means a tax where the incidence of tax and its impact are on the same entity. The tax is imposed on you, and you pay the due to the Government. The tax burden cannot be shifted to anyone else. Income tax is the example of direct tax where you pay tax on the income you earn.
Indirect tax is where the impact of tax is on someone, while the incidence is borne by someone else. The tax is levied on the provider of goods and services, and the consumer using the goods and services bears that tax and ultimately pays for it. Thus, the tax burden is shifted to the end consumer. GST is a very common example of indirect tax.
You don’t have any control over indirect tax. If you consume goods and services, you would have to bear the tax. However, you have control over your income tax. Let’s discuss income tax and its features.
Income tax in India
If you earn an income and that income is above a specified limit (as dictated by the Finance Ministry), you are liable to pay income tax. The limit over which tax is applicable and the rate of tax is fixed by the Finance Minister in every annual budget. It is called the tax slab, and it is dynamic in nature.
When we talk about income, it can be from various sources. You can earn an income from your employment (salary), from owning a house property or selling it off, from your business or profession, from winnings and prizes and from other sources too. Any type of income you earn is clubbed together to calculate your total income and the subsequent tax liability. To make it more understanding and uniform, the Income Tax Act, 1961, has broken down the different types of income and put it under five different heads. Let’s understand these heads.
Income from salary
This head covers the income you receive via your salary when you are in legal contractual employment. A salary includes the basic wage, pension, commission, annual bonus, gratuity, perquisites or any advance salary. There are allowances, too, using which you can avail tax exemptions from your salary income. These allowances include House Rent Allowance (HRA), Leave Travel Allowance (LTA), and so on. Use rent free accommodation calculator here.
Income from house property
If you have a house property, commercial property or a piece of land and you rent it out, the rental income you receive is called your income from house property. However, if you do not rent out your property, a notional rent is considered to be your income which you would have earned in case you had let out your property. Thus, this head takes into account notional or actual rent received from a house property owned by you.
Profits or gains of business or profession
This head is relevant for businessmen and professionals who are not employed in a contractual employment. The profits earned by the business or professional practice (net of allowable expenses) would be taken as income which is chargeable to tax.
Income from capital gains
This head is applicable when you sell or transfer a capital asset and earn an income in a financial year. Capital gain can be earned by selling real estate, shares, mutual funds, land, and so on.
Income from other sources
Income, which does not qualify for the above-mentioned heads, is put under income from other sources. Common examples include interest earned on bank deposits, prizes or awards received, lottery winnings, saving account interest, among others.
Your total income is segregated into these heads, exemptions and deductions are allowed wherever applicable, and your taxable income is calculated. Your tax liability is then computed on your taxable income. To know more about income tax calculations, read the next article.