Taxes in India: rules, regulations and structure

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If you’re salaried (or even if you’re self-employed), you probably pay your taxes diligently every year when tax season rolls around. Perhaps you have a friend who is well-versed in taxation and finance, and they do your tax filing for you. Or perhaps, you know someone who works in the field of taxation, and they take care of your taxes as a goodwill gesture.

But personally, how much do you really know about the taxes you’re paying? Have you ever wondered why you pay the amount of taxes you’re paying? Or if there’s any way to reduce that liability legally? If you have, then the best way to go about resolving these doubts is to understand the Indian tax system. Taxation in India, particularly with regard to income tax, is intricate and complex.

Nevertheless, for the layman, it’s not really essential to know all the facets of the taxation system in India. That can be a bonus, sure. But to begin with, it’s advisable to first get to know how your individual income is being taxed. And how you can plan your investments and finances in a manner that allows you to take full advantage of the tax benefits integrated into the Indian tax system. The tax scheme in India is governed by the Income Tax Act, which contains a total of 23 chapters and 298 sections. 

Let’s understand the fundamentals of the rules, regulations and structure of the taxation system in India, with regard to personal income tax.

The concept of previous year and assessment year

This is one of the most fundamental things we’ll be looking at before proceeding to understand how taxes are calculated. In India, taxes are levied each year on the income earned over a period of 12 months – from April 1 of any year to March 31 of the next year. This period is known as the previous year or the financial year. For instance, consider the income that you earned from April 1, 2019 to March 31, 2020. That is regarded as your income for the previous year 2019-20.

The year that follows the previous year is called the assessment year. It is the year in which the income of the previous year is assessed. So, in the above example, the assessment year will extend from April 1, 2020 to March 31, 2021. In other words, the assessment year will be 2020-21.

Who is liable to pay income tax in India?

Income tax is a liability that is common across different forms of organisation. Individuals, HUFs, partnership firms, and companies all need to pay this tax. In this chapter, we’ll specifically look at how individuals like you are taxed as per the system of taxation in India.

Your residential status plays a major role in determining your liability to pay taxes in our country. Depending on what conditions you satisfy, you’re classified as any one of the following.

  • Resident and Ordinarily Resident (ROR)
  • Resident and Not Ordinarily Resident (RNOR)
  • Non-resident

People belonging to all these categories are required to pay taxes on the income earned in India. In all likelihood, if you’ve been living and working in India for years now, you’re bound to be a resident. We’ll operate under the assumption that you’re a resident Indian and look at how taxes are calculated for residents.

The five heads of income

Every resident Indian is liable to pay taxes on their income. You may be a retired person living off interest income. You may be a salaried employee. Or you may have just won the lottery. All of these incomes are taxable in the Indian tax system. Specifically, there are five heads of income.

  1. Income from salary
  2. Income from house property
  3. Profits and gains from business or profession
  4. Capital gains
  5. Income from other sources

Income from salary

This head of income essentially includes all the earnings you receive as a part of your salary. Your basic salary, gratuity, pension, annuity, commission, fees, leave encashment, and the profits that you receive from your employer all fall under this head of income. It also includes allowances paid to you. However, some allowances are partially or totally exempt from tax.

Income from house property

As the name signifies, this income head includes the earnings you receive from any house property that you own. Rental income, for instance, is classified under this head of income.

Profits and gains from business or profession

This is the third head of income, and it includes the profits and gains received from an individual’s business or profession. The profit, which is the difference between the expenses and the income earned, is chargeable under this head. 

Capital gains

The profits you make by selling or transferring capital assets held in your name are chargeable to tax as capital gains. For instance, the gains from your investments in property, stocks, mutual funds and other capital assets are considered as capital gains. They can be long-term capital gains or short-term capital gains, and they’re charged to tax accordingly. 

Income from other sources

Any kind of income that does not fall under the above-mentioned categories is classified as an income from other sources. Some examples include winnings from horse racing or lottery, dividend income, and interest from government bonds and securities.

Total income

The sum of the income under all the above five heads of income is classified as the total income for the previous year.

Deductions from total income

Before you can calculate the tax on your total income, you’re eligible to make certain deductions from that figure. These deductions are many and varied. Generally, however, for individual taxpayers, the deductions mentioned under section 80C of the Act are most pertinent. 

The following items are allowed as a deduction under section 80C.

  • Investment in Public Provident Fund (PPF)
  • Investment in Employee Provident Fund (EPF)
  • Investment in National Saving Certificate (NSC)
  • Investment in Sukanya Samriddhi Yojana (SSY)
  • Investment in 5-year Tax Saving Fixed Deposit
  • Investment in Senior Citizens Savings Scheme (SCSS)
  • Investment in life insurance
  • Investment in infrastructure bonds
  • Investment in Unit Linked Insurance Plans (ULIPs)
  • Investment in Equity Linked Saving Scheme (ELSS)
  • Investment in National Pension System (NPS)
  • Repayment of the principal of a housing loan
  • Payment of tuition fees for children

There are also many other deductions available under other subsections of section 80. Some of these include:

  • Deductions for interest on savings account, as per section 80TTA
  • Deductions for house rent paid, as per section 80GG
  • Deductions for interest on education loans, as per section 80E
  • Deductions for interest on home loans, as per section 80EE
  • Deductions for premiums paid for medical insurance, as per section 80D
  • Deductions for certain specific donations, as per section 80G

Total taxable income

Once you deduct all the eligible sums from the total income, you’re left with the total taxable income. You then need to check the slab it falls under, and calculate the tax accordingly.

Calculating income tax using tax slabs

The income tax slabs are often revised when the budget for each year is announced. Currently, for the financial year 2020-21, assessees have the option to choose from the old scheme or the new scheme. The rates under these two schemes for resident Indians who are below 60 years of age are tabulated below.

Taxable income

Tax Rate

(Existing Scheme)

Tax Rate

(New Scheme)

Up to Rs. 2,50,000

Nil

Nil

Rs. 2,50,001 to Rs. 5,00,000

5%

5%

Rs. 5,00,001 to Rs. 7,50,000

20%

10%

Rs. 7,50,001 to Rs. 10,00,000

20%

15%

Rs. 10,00,001 to Rs. 12,50,000

30%

20%

Rs. 12,50,001 to Rs. 15,00,000

30%

25%

Above Rs. 15,00,000

30%

30%

Individuals who are senior citizens, between the ages of 60 and 80 must apply the rates given below.

Taxable income

Tax Rate

(Existing Scheme)

Tax Rate

(New Scheme)

Up to Rs. 2,50,000

Nil

Nil

Rs. 2,50,001 to Rs. 3,00,000

Nil

5%

Rs. 3,00,001 to Rs. 5,00,000

5%

5%

Rs. 5,00,001 to Rs. 7,50,000

20%

10%

Rs. 7,50,001 to Rs. 10,00,000

20%

15%

Rs. 10,00,001 to Rs. 12,50,000

30%

20%

Rs. 12,50,001 to Rs. 15,00,000

30%

25%

Above Rs. 15,00,000

30%

30%

Super senior citizens, who are over the age of 80, have more relaxations. The rates below will show you that. 

Taxable income

Tax Rate

(Existing Scheme)

Tax Rate

(New Scheme)

Up to Rs. 2,50,000

Nil

Nil

Rs. 2,50,001 to Rs. 5,00,000

Nil

5%

Rs. 5,00,001 to Rs. 7,50,000

20%

10%

Rs. 7,50,001 to Rs. 10,00,000

20%

15%

Rs. 10,00,001 to Rs. 12,50,000

30%

20%

Rs. 12,50,001 to Rs. 15,00,000

30%

25%

Above Rs. 15,00,000

30%

30%

Wrapping up

This gives you a very basic idea about the structure of the tax laws in India. The taxation system in India is a very intricate set of rules, and there are many sections and subsections under each of the main metrics we saw in this chapter. Nevertheless, this preview will have shown you one thing - certain investments can give you tax benefits. You can make use of this to carefully plan your investments, so you can reduce your tax liability as well as multiply your money. The coming chapters will get into the details of this.

A quick recap

  • In India, taxes are levied each year on the income earned over a period of 12 months – from April 1 of any year to March 31 of the next year. This period is known as the previous year or the financial year.
  • The year that follows the previous year is called the assessment year. It is the year in which the income of the previous year is assessed.
  • Your residential status plays a major role in determining your liability to pay taxes in our country.
  • Specifically, there are five heads of income: income from salary, income from house property, profits and gains from business or profession, capital gains and income from other sources.
  • Salary income includes all the earnings you receive as a part of your salary. Your basic salary, gratuity, pension, annuity, commission, fees, leave encashment, and the profits that you receive from your employer all fall under this head of income. It also includes allowances paid to you.
  • House property income includes the earnings you receive from any house property that you own.
  • The third head of income, and it includes the profits and gains received from an individual’s business or profession.
  • The profits you make by selling or transferring capital assets held in your name are chargeable to tax as capital gains.
  • Any kind of income that does not fall under the above-mentioned categories is classified as an income from other sources.
  • The sum of the income under all the above five heads of income is classified as the total income for the previous year.
  • Before you can calculate the tax on your total income, you’re eligible to make certain deductions from that figure.
  • Once you deduct all the eligible sums from the total income, you’re left with the total taxable income. You then need to check the slab it falls under, and calculate the tax accordingly.
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