Income Tax Act, 1961 has formulated certain provisions for the computation of Total Income of the assessee to levy Income Tax. And there is a specific procedure to be followed for the computation of the Total Income. And the procedure starts from knowing the Residuary Status of the assessee to the deduction of Advance Tax or Tax Deducted at Source from the Tax Payable if any.So let us go through with each step in detail.
Determine the residential status of the Assessee - Step 1.
We have to identify the Residential Status of an assessee, whose income has to be calculated for the levy of tax as per the Income Tax Act, 1961. The computation process starts with this step only. After that only come to know, that whether such an Income is taxable or not as per the provisions of the Act. The Act has classified the residential statutes of assessee, which are enumerated below.
- Resident And Ordinary
- Resident but Not Ordinarily Resident.
- Non Resident
In case of an Individual, the duration for which he is present in India determines his residential status. For instance, Income earned outside India will attract the tax for the Non-Resident assessee, but it is taxable if the assessee is a Resident and Ordinary Resident.
Classify the Income under different Heads of Income - Step 2
The Income Tax Act, 1961 prescribed five major Heads of Income to be considered in the computation of Total Income. Any kind of income to be accrued or to be received will come under any one of the following Heads prescribed here by Act.
- Salaries head contains Salary, and Pension related earnings for the computation of Total Income.
- Income from House Property head contains Rental Income.
- Profits and Gains of Business or Profession head contains income accrued from carrying on any business or profession.
- Capital Gains head contains income gained from the sale of capital assets like Sale of Land.
- Income from Other head is the residuary head income which don’t come under any one of the above four heads will fall under this head for the computation of Total Income.
Tax payer has to classify earned income under the relevant Head of Income as per the provisions of the Tax.
Non tax chargeable Income to be deducted - Step 3
Income Tax Act, 1961 having provisions for exemption for certain Income to be deducted, either completely or partially upto some limit only. And this income will not form Gross Income. Agriculture Income is completely exempted where as House Rent allowances, Education allowances are partially exempted, which has to be deducted from Income for the computation of Gross Income. The balance income over and above the prescribed exemption limits would be considered as income for the computation of Total Income and have to be classified under the relevant head of income.
Computation of Income under each Head of Income- Step 4
There are certain provisions governing the computation of Income for each and every Head of income. In the computation of income under each head, certain exceptions have to be deducted as per the provisions provided in that particular head.
Clubbing of income of spouse, minor child etc., - Step 5
As per the provisions of Income Tax Act, 1961 Income Tax is levied on a slab system on the Total Income if the assessee. The tax system is progressive nature, as the income rises the tax payable on income will also increase in case of Individuals. Some high-earning tax payers have tendency to divert some portion of their Income to their spouse, or minor child to minimize their tax burden. In order to prevent tax avoidance Income Tax Act incorporated clubbing provision, under which income arising to certain persons have to be included in the income of the person who has diverted his income for the purpose of computing tax liability.
Set off or carry forward Losses - Step 6
An assessee may have different sources of Income under a specific Head of Income. He would get profit from one source and loss from some other source of Income under the same Head of Income. In that case the losses occurred have to be set off against the income earned from the other sources of same Head of Income to derive the Net Income chargeable under that Head.
Similarly, there is Inter-head adjustment contained in the Income Tax Act, 1961, under which assessee can set off the losses of a Head of Income from the income accrued from other Head of Income. Even after the adjustment there is still loss stands then such loss can be carried forwarded to the subsequent year as per the provisions contained in the Act.
Computation of Gross Total Income - Step 7
After allowing exemptions, deductions under each Head of Income, clubbing of Income diverted to the spouse, minor child etc., are then aggregated then set off or carry forward of losses under each Head are done to arrive at the Gross Total Income.
Deductions from Gross Total Income - Step 8
There three types of deductions allowed from Gross Total Income which are enumerated below.
Deduction in respect of certain Payments
- Life Insurance Premium paid.
- Contribution to Provident Fund or Pension fund.
- Medical insurance premium paid.
- Payment of interest on loan taken from higher education.
- Rent paid.
- Donation to certain funds, charitable institutions, etc.,
- Contributions to political parties.
Deductions in respect of certain Incomes
- Profits and gains from Industrial undertakings or enterprises engaged in infrastructure development.
- Profits and gains by an undertaking or enterprise engaged in development of Special Economic Zone.
- Certain income of co-operative societies.
- Royalty income of authors of certain books other than text-books.
- Royalty on patents.
- Deduction in case of a person with disability.
Total Income - Step 9
After set the provisional deductions off against the Gross Total Income, we get the Total Income which is also termed as Taxable Income. And it should be rounded off to the nearest multiple of Rs. 10.
Application of Rate of Tax - Step 10
Each year Finance Minister will announce the rates of tax for different classes of assessees in the Finance Act. For the Individuals and HUF etc., there is a slab rate system and basic exemption limit is provided. For Firms and Companies, a flat tax rate is prescribed. And these tax rates are to be applied on the Total or Taxable Income to arrive at the income tax liability.
Surcharge and Rebate under section 87A - Step 11
The surcharge is an additional charge to be calculated over the Income Tax and it is levied as a percentage of income tax for Individuals and Companies. And there is Rebate u/s 87A provided for the tax payer to make them relief from tax burden.
Education cess, Secondary and Higher education cess
After the Income Tax is increased by the Surcharge or reduced by the Rebate u/s 87A, if applicable Education cess @ 2% is to be calculated @ 2% on income tax and it is charged for the purpose of universalized quality basic education and it is levied on all the tax payers irrespective of their level of Total Income. Further, Secondary and Higher Education cess @ 1% of Income Tax plus Surcharge, if applicable, is leviable to fulfill the commitment of the Government to provide and finance secondary and higher education in the Country.
Advance Tax and Tax Deducted at Source
Although the tax liability is determined at the end of the assessment year, Advance Tax is required to be paid in certain installments on the basis of estimated income of the assessee. And in certain cases Tax is to be Deducted at Source from income by the payer at the specified rated in the Income Tax Act, 1961.