UNIT 3 CHAPTER 2 METHODS OF ACCOUNTING

FOR VARIOUS HEADS OF INCOME

Heads of Income

Income is classified under five heads in the Indian Income Tax Act. Under chapter 4 of Income
Tax Act, 1961 (Section 14), income of a person is calculated under various defined heads of
income. The total income is first assessed under heads of income and then it is charged for
Income Tax as under rules of Income Tax Act. According to Section 14 of Income Tax Act,
1961 there are following heads of income under which total income of a person is calculated:

1. Income From Salary

2. Income From House Property

3. Income From Capital Gain

4. Income From Business/ Profession

5. Income From Other Sources

1. Income from Salary

What is Salary:
Income under heads of salary is defined as remuneration received by an individual for
services rendered by him to undertake a contract whether it is expressed or implied.
According to Income Tax Act there are following conditions where all such remuneration are
chargeable to income tax:

When due from the former employer or present employer in the previous year,
whether paid or not

When paid or allowed in the previous year, by or on behalf of a former employer or

present employer, though not due or before it becomes due.

When arrears of salary is paid in the previous year by or on behalf of a former employer
or present employer, if not charged to tax in the period to which it relates.

What Income Comes Under Head of Salary:

Under section 17 of the Income Tax Act, 1961 there are following incomes which comes
under head of salary:

Salary (including advance salary)

Wages
Fees

Commissions

Pensions

Annuity

Perquisite

Gratuity

Annual Bonus

Income From Provident Fund

Leave Encashment

Allowance

Awards
The aggregate of the above incomes, after exemptions available, is known as Gross
Salary and this is charged under the head income from salary.

Basic salary along with commissions and bonuses is fully taxable.

Allowances : An allowance is a fixed monetary amount paid by the employer to the

employee for expenses related to office work. Allowances are generally included in the
salary and taxed unless there are exemptions available.

The following allowances are fully taxable : dearness allowance, city

compensatory allowance, overtime allowance, servant allowance and lunch
allowance.

Specific exemptions are available for some allowances as shown

below. Conveyance Allowance : Upto Rs 800/- a month is exempt

from tax.

House Rent Allowance (HRA) : Hop over the House Rent Allowance article to check
on calculation and exemptions available.

Leave Travel Allowance (LTA) : LTA accounts for expenses for travel when you and your
family go on leave. While this is paid to you, it is tax free twice in a block of 4 years.
Medical Allowance : Medical expenses to the extent of Rs 15,000/- per annum is tax free.
The bills can be incurred by you or your family.

Perquisites : Perquisites (or personal advantage) are benefits in addition to normal salary
to which an employee has a right by way of his employment. Examples of these are rent
free accommodation or car loan. There are some perquisites that are taxable in the hands
of all
categories of employees, some which are taxable when the employee belongs to a
specific group and some that are tax free.

The employer will give the employee Form 16 which will contain all the earnings,
deductions and exemptions available.
2. Income From House Property

According to Chapter 4, Section 22 - 27 of Income Tax Act, 1961 there is a provision of

income under head of house property. In every section from 22-27 there are detail specification
of house property income. It is defined as income earned by a person through his house or land.

What Income Comes Under Head of House Property:

Annual value of building or land owned by assessee. There is a charge on the potential of property
to generate income not on the rent received. But if property is used for making profit in business
then it will be taxable not under this head but will be taxable under head of profit in business/
profession. The building can be house, office building, go downs etc.

Points to be remembered

Assessee should be Owner of the Property

Should be not be used for Business or Profession by the assessee In

case of dispute regarding title

Any residential or commercial property that you own will be taxed as well. Even if your piece of
real estate is not let out, it will be considered earning rental income and you will need to pay tax
on it. The income tax blokes are a bit easy going on this – they tax you on the capacity of the real
estate to earn income and not the actual rent. This is called the property’s Annual Value and is the
higher of the fair rental value, rent received or municipal rent.

Fair Rent – The rent which a similar property will fetch at the same or nearby similar locality

Municipal Rent – The value fixed by municipal or local authority

Fair Rent or Municipal Rent whichever is higher taken into consideration

Standard Rent – Rent which a owner can claim maximum from his tenant

Actual Rent – Rent for which property has been let out.

Standard Rent or Actual Rent whichever is lesser is taken into Consideration

The Annual Value can go through a standard deduction of 30% and if you reduce the interest on
borrowed capital, then you get the value which is charged under the head income from house
property.
3. Income From Business/Profession

Income earned through your profession or business is charged under the head “profits and gains
of business or profession”. The income chargeable to tax is the difference between the credits
received on running the business and expenses incurred.

According to Income Tax Act, 1961 income under this head is defined as the income earned by
assessee as a profit or gain in his business or profession. Income under this head must follow
these conditions:

There must be a business/ profession

Business/ profession is being carried by assessee

Business/ profession have been carried out by assessee in assessment year for which
income tax is filling

What Income Comes Under Head of Profit in Business

Profits and gains of assessee from any business or profession during assessment year

Any payment or compensation due or received by a person for his services to

 organization as a part of his business

Making profit in trade Income of professional or organization against services

provided by that professional/organization

Profits on sale of a license granted under the Imports (Control) Order, 1955, (EXIM
control Act, 1947)

Cash received or due by any person against exports under government schemes

Any benefit whether it is not in cash coming from business/ profession

Any profit, salary, bonus or commission received by company partners

4. Income from Capital Gain

What is Capital Gain:

According to Income Tax Act,1961 heads of capital gain is defined as gains derived on
transfer of capital asset. Capital Gain is the profit or gain of an assessee coming from the
transfer of a capital asset effected during the previous year or assessment year. "Capital
Asset" and transfer are predefined in income tax act.
What is Capital Asset:
Under section 2(14) of the Income Tax Act,1961 Capital Asset is defined as property of any kind
held by assesse including property held for his business or profession. It includes all type real
property as well as all rights in property. It is also defined as gains on transfer of assets in which
there in no cost of acquisition like:
Goodwill of business generated by assessee
Tenacy rights

Stage carriage permits

 Loom hours

Right to manufacture

Processing & production of any article or things

Assets Which Don't Come Under Heads of Capital Assets

According to Income Tax Act,1961 there are few assets which don't form a part of Capital
Assets, which are as follows:

Stock of goods and raw materials used by assessee for his business or profession
Those properties which are movable like wearing apparel, furniture, automobile, phone,
household goods etc. Held by assessee. But Jewelry which is also an movable assets
comes under heads of Capital Assets
Few Gold Bonds issued by government
Few special bonds issued by central government like Special Bearer Bonds, 1991

5. Income from other Sources

Every type of income comes under a specified heads. But there are few incomes, which don't
come under any of following heads:

• Salary
• House Property
• Profit In Business/ Profession
• Capital Gains

Any income that does not fall under the four heads above is taxed under the head “ Income
From Other Sources.