The Income Tax Act, 1961 is the cornerstone of India’s direct taxation system. It lays out the legal framework for the collection of taxes on income earned by individuals, companies, and other entities. To understand how income tax works, it’s essential to first define the term ‘income’ and then explore how the income tax system functions within the ambit of Indian law.
This article explains the concept of income, the structure and logic behind income taxation, and the major categories, compliance requirements, and deductions available to taxpayers. A mnemonic is also provided at the end to help remember the key components of income tax in a simplified way.
What is Income? – As Per Indian Tax Law
The term ‘income’ is defined in an inclusive way under Section 2(24) of the Income Tax Act, 1961. This means that income not only includes the ordinary sense of money received, but also covers various other gains and receipts that may not be typically categorized as income.
Legal Definition:
According to Section 2(24), income includes profits and gains from business or profession, dividends, voluntary contributions received by charitable trusts, value of perquisites or profits in lieu of salary, capital gains, winnings from lotteries, and other specified incomes.
This inclusive definition allows the law to account for various forms of income—recurring or one-time, monetary or non-monetary.
Common Examples of Income:
- Salary and wages
- Business or professional income
- Rent received from property
- Interest and dividends
- Capital gains from selling assets
- Winnings from lottery or games
Therefore, income includes both regular earnings like salaries as well as windfall gains like lottery winnings.
The Concept of Income Tax
Income tax is a direct tax imposed by the Central Government on income earned by individuals and entities during a financial year. The Income Tax Act, 1961 governs all matters related to its calculation, collection, administration, and enforcement.
Key Features of Income Tax:
- Direct in Nature: The tax is paid by the person who earns the income.
- Annual Charge: It is levied annually on the income earned during a financial year (April to March).
- Progressive Rate System: The tax rate increases with higher levels of income.
- Multiple Taxable Entities: Applies to individuals, HUFs, firms, companies, trusts, and more.
- Self-Assessment System: Taxpayers must calculate and pay their own tax, subject to verification.
Income tax revenues are used for nation-building activities such as public infrastructure, education, healthcare, defense, and social welfare programs.
Categories of Taxable Income
According to Section 14 of the Income Tax Act, income is classified into five broad categories or “heads of income”:
- Income from Salary
Includes wages, pensions, gratuity, allowances, and perquisites. - Income from House Property
Covers rental income from buildings or land attached to buildings. - Profits and Gains from Business or Profession
Includes income from trade, services, freelance work, consultancy, etc. - Capital Gains
Profits earned from the sale of assets such as shares, land, buildings, and mutual funds. - Income from Other Sources
A residual category covering interest, dividends, lottery winnings, gifts, etc.
Each head of income has separate computation rules under the law.
Who is Liable to Pay Income Tax?
As per Section 2(31) of the Act, income tax is applicable to the following “persons”:
- Individuals
- Hindu Undivided Families (HUFs)
- Partnership Firms
- Companies (Private/Public)
- Limited Liability Partnerships (LLPs)
- Association of Persons (AOPs)
- Body of Individuals (BOIs)
- Local Authorities
- Artificial Juridical Persons
Each of these entities is taxed based on specific slab rates, exemptions, and rules.
Assessment Year vs. Previous Year
- Previous Year is the financial year in which the income is earned (e.g., 2024–25).
- Assessment Year is the year following the previous year in which the income is assessed and taxed (e.g., 2025–26).
Income tax returns are filed in the assessment year for income earned in the previous year.
Deductions and Exemptions under Income Tax Act
To reduce tax liability and promote savings or welfare, the Income Tax Act provides various deductions:
- Section 80C: Up to ₹1.5 lakh for investments in PPF, LIC, ELSS, etc.
- Section 80D: Deduction for health insurance premiums
- Section 10(10D): Exemption on life insurance maturity amount
- Section 24(b): Interest paid on housing loan
- Section 10(38)/112A: Exemption on long-term capital gains in certain cases
These provisions ensure that taxpayers are encouraged to invest in insurance, education, health, and long-term savings.
Filing of Income Tax Return (ITR)
It is mandatory for all taxpayers earning above the basic exemption limit to file an ITR. Filing is also required for:
- Those claiming a tax refund
- Individuals holding foreign assets or earning foreign income
- Businesses and companies, regardless of income
- Individuals who wish to claim deductions under Chapter VI-A
The ITR form and due date vary depending on the taxpayer category.
Penalties for Non-Compliance
Failure to comply with tax filing or payment obligations can attract:
- Late filing fees under Section 234F (up to ₹5,000)
- Interest on tax due under Sections 234A/B/C
- Penalty for concealment of income (up to 200% of tax evaded)
- Prosecution in cases of willful tax evasion
Hence, timely and accurate filing is essential to avoid legal consequences.
Summary Table: Key Elements of Income Tax
| Aspect | Details |
|---|---|
| Definition of Income | Inclusive – salary, business income, capital gains |
| Taxable Entities | Individuals, HUFs, companies, firms, LLPs, etc. |
| Classification of Income | Salary, House Property, Business, Capital Gains, Others |
| Return Filing Requirement | Based on income thresholds and entity type |
| Exemptions & Deductions | Available under Sections 10, 80C, 80D, etc. |
| Penalties | For non-filing, concealment, or late payment |
Mnemonic to Remember – “I-SALAD”
To easily recall the concept of income and income tax, remember this mnemonic:
- I – Income includes various sources like salary, capital gains, etc.
- S – Sources classified under five heads
- A – Assessment year follows previous year
- L – Liable entities include individuals, firms, and companies
- A – Allowances and deductions reduce tax burden
- D – Direct tax paid to the government annually
