Income tax is a direct tax which you are supposed to pay to the Indian Government if you earn an income in India. Whether you are an Indian citizen or a NRI, any income generated in India is taxable as per the Indian Income Tax Act which was passed in the year 1961. Indian citizens pay income tax on their global income (income earned in India and abroad) while NRIs pay income tax in India only on the income which they earn in India. Thus, if you earn an income, you pay an income tax on it.
Income tax is payable by the following –
The term ‘income’, from the point of view of income tax calculation, consists of all types of incomes which you earn in a year. As per the income tax rules, five heads of incomes are recognised and your income is apportioned to each relevant head of income. The five heads in which income is segregated include the following –
This is the most common and also the most popular head of income. If you are a salaried employee, the salary that you earn is categorised under the head income from salary.
If you have a house property and you rent it out, the rental income generated is called income from house property. The house property, in this context, can be a residential property or a commercial one.
If you have a self-proprietorship business or a profession, the income you earn from the business or profession is placed under the head income from business or profession.
Capital gains are incurred when you sell a capital asset at a profit. A capital asset is any type of property (except inventory and accounts receivable) which is owned by the tax payer. If the capital asset is sold at a price higher than at which it was acquired, a capital gain is incurred. The gain can be short term or long term depending on the period for which the capital asset was held before it was sold. Capital gains are added to your income and taxed depending on the type of gains incurred and the type of asset on which the gain is incurred. Alternatively, if the capital asset is sold at a price lower than at which it was purchased, a capital loss is incurred. This loss is used to reduce the taxable income and consequently the tax liability.
Any other income that you earn in a year and which cannot be placed in any of the above-mentioned four heads is placed under the head ‘income from other sources’. Common examples include interest earned from savings account or fixed deposits, dividend earned from equity investments, gifts received, etc.
The total income which you earn in a financial year is segregated into these five heads. Thereafter, the total income is taxed as per the existing tax rates. Firms and companies have a flat tax rate of 30% on the profit which they earn. For other tax payers, i.e. individuals, HUFs, BOIs and AOPs, tax is charged on a progressive basis. This means that as the income increases, the tax rate increases. The tax rate is different for different levels of income and the rates are presented in a tax slab which can be changed by the Government from time to time. The existing tax slab is as follows –
Income level | Applicable rate of tax |
---|---|
For the first INR 2.5 lakhs | Nil |
INR 250,001 to INR 500,000 | 5% of the income exceeding INR 2.5 lakhs |
INR 500,001 to INR 10,00,000 |
On the first INR 2.5 lakhs – nil
+ On the income between INR 250,001 to INR 500,000 – 5% + On the income exceeding INR 5 lakhs – 20% |
INR 10,00,001 and above |
On the first INR 2.5 lakhs – nil
+ On the income between INR 250,001 to INR 500,000 – 5% + On the income between INR 500,001 to INR 10,00,000 – 20% + On the income exceeding 10 lakhs – 30% |
So, if you are earning an income of INR 7.5 lakhs, you wouldn’t be charged a flat tax of 20%. The tax would be calculated in a progressive manner in the following way –
On the first INR 2.5 lakhs | Nil |
On the next 2.5 lakhs | 5% of 2.5 lakhs=INR 12,500 |
On the next 2.5 lakhs (income exceeding 5 lakhs) | 20% of 2.5 lakhs=INR 50,000 |
Total tax payable | INR 62,500 |
Similarly, if you earn an income of INR 12 lakhs annually, the calculation would be as follows –
On the first INR 2.5 lakhs | Nil |
On the next 2.5 lakhs | 5% of 2.5 lakhs=INR 12,500 |
On the next 5 lakhs | 20% of 5 lakhs=INR 100,000 |
On the last 2 lakhs (income exceeding 10 lakhs) | 30% of 2 lakhs=INR 60,000 |
Total tax payable | INR 172,500 |
However, as per the changes proposed in the Interim Budget, 2019, if your net taxable income is up to INR 5 lakhs, you wouldn’t have to pay any tax on your income. In such cases, therefore, there is a rebate and your tax liability becomes nil.
Before calculating your tax liability, there are some common terms related to tax which you should know about. These terms include the following –
Now that you know what is income tax, who pays it, the heads of income and the applicable tax rates you should know the various ways in which tax liability can be reduced. The Income Tax Act, 1961 provides various deductions and exemptions which help in lowering the taxable income which, in turn, lowers the tax liability. Let’s understand the deductions which are available –
Chapter VI A of the Income Tax Act lists down some very popular sections which allow deductions from your taxable income if you invest in specified avenues or incur expenses for specific reasons. Chapter VI A contains deductions under different sub-sections of Section 80. Here are the deductions which are available under the chapter –
The first and also the most important section under Chapter VI A is Section 80C. You can claim a deduction of up to INR 1.5 lakhs under this section if you invest or spend on the following –
The maximum aggregate deduction under all the eligible avenues listed above is limited to INR 1.5 lakhs.
Premium paid towards a life insurance pension plan is allowed as deduction under this section. However, the limit of this section is considered together with the limit allowed under Section 80C which is INR 1.5 lakhs. This means that the total deduction under Section 80C and 80CCC together would be allowed up to INR 1.5 lakhs.
This section gives an additional deduction of INR 50,000 if you invest in the National Pension Scheme offered by the Central Government over-and-above the INR 1.5 lakhs limit of 80C. So, investment in NPS till INR 2 lakhs is tax-free.
Till financial year 2016-17, investments done in Rajiv Gandhi Equity Savings Scheme were allowed as a deduction under Section 80CCG. However, this section was removed from financial year 2017-18. However, if you have invested in the RGESS scheme before financial year 2017-18, you can claim a deduction under Section 80CCG. The deduction would be 50% of the amount invested subject to a maximum of INR 50,000. Moreover, your income should not exceed INR 12 lakhs to claim this deduction.
Section 80D exempts the premium paid towards a health insurance plan from tax liability. Premiums paid for self, family and dependent parents can be claimed as a deduction from your taxable income under this section. The limit of deduction available is as follows –
If premium is paid for self only or self, spouse and dependent children | Up to INR 25,000 |
If you are a senior citizen and premium is paid for yourself only or yourself, spouse and dependent children | Up to INR 50,000 |
If premium is paid for self only or self, spouse and dependent children
+
Premium is also paid for dependent senior citizen parents |
Up to INR 25,000
+
Up to INR 50,000 |
If you are a senior citizen and premium is paid for yourself only or yourself, spouse and dependent children
+
Premium is also paid for dependent senior citizen parents |
Up to INR 50,000
+
Up to INR 50,000 |
So, you can save a maximum of INR 1 lakh of your taxable income by buying health insurance policies for your family and dependent parents. Moreover, a deduction of INR 5000 is also allowed under this section for preventive health check-ups. If you, your spouse, dependent children and dependent parents undergo preventive health check-ups in a financial year, you can claim a deduction of up to INR 5000 on the costs of such check-ups. However, this deduction is within the limit of deduction allowed on premiums paid towards health insurance policies. It is not over and above the deduction limits mentioned above but included therein. Moreover, the deduction is the maximum aggregate deduction which can be availed for preventive health check-ups of all family members, dependent parents included.
If you have a disabled family member (spouse, children, siblings and/or parents) and you incur expenses in treatment or maintenance of such family member you can claim a deduction under Section 80DD. The available limit of deduction is as follows –If disability is more than 40% but less than 80% | Fixed deduction of INR 75,000 |
If disability is more than 80% | Fixed deduction of INR 1.25 lakhs |
If you suffer from an ailment listed under the provisions of this section, you get a deduction for the expenses incurred on treating such ailment. The limit is as follows –
If your age is up to 60 years | Up to INR 40,000 |
If your age is between 61 and 80 years | Up to INR 60,000 |
If your age is above 80 years | Up to INR 80,000 |
This section allows you a tax deduction if you have availed an education loan for yourself, your children, spouse or legal ward and are paying an interest on it. The interest paid for the loan is allowed as a deduction from your taxable income. There is no limit to the amount of deduction which you can claim. The entire amount of interest paid is allowed as a deduction.
This section allows deduction on the interest paid on a home loan taken by a first time home buyer. If you are buying a house for the first time and are availing a home loan for the same, the interest paid on the loan would qualify for deduction under this section. The limit is up to INR 50,000. The deduction would, however, be available if the following conditions are met –
This section gives you tax relief on your charitable contributions. Donations that you make to recognised charitable institutions can be claimed as a deduction under this section. Some charities allow you 50% deduction while some allow you 100% deduction. However, the maximum donation which can be claimed as a deduction is limited to 10% of your gross total income.
If you are a salaried employee and have no HRA component in your salary structure, you can claim HRA deduction under this section. The amount of deduction which can be claimed as HRA exemption is lower of the following –
So, for instance, if your monthly salary is INR 20, 000 and you pay a rent of INR 8000 every month, the available deduction per month would be lower of the following –
Rent paid – 10% of total income | INR (8000 – 2000)=INR 6000 |
INR 5000/month | INR 5000 |
25% of total income | 25% of 20,000=INR 5000 |
Thus, you can claim HRA deduction of INR 5000/month or INR 60,000 in a financial year.
A company making contributions to political parties or electoral trusts can claim a deduction on their contributions under this section. Deduction is allowed for any type of contribution made other than cash contributions.
If you as an individual tax payer contribute to a political party or electoral trust, you can claim a deduction on your contributions under this section. Any type of contribution, other than cash, is allowed as a deduction.
If you have registered a patent and receive a royalty for such registration, the royalty received can be claimed as a deduction from your taxable income. The amount of deduction would be lower of the royalty received or INR 3 lakhs. Moreover, the following conditions should be met to claim a deduction under this section –
Interest earned on your savings account qualifies for deduction under this section. The maximum limit is up to INR 10, 000.
If you are a senior citizen, you can claim deduction of up to INR 50,000 on the interest earned from your deposits. Deposits in this case would include savings account, fixed deposits and any other deposits held with banks and/or post offices. Moreover, as implemented by the Interim Budget 2019, the TDS limit on interest earned has been raised from INR 10,000 to INR 40,000
If you suffer from a disability or mental retardation, you can claim a deduction under this section. The amount of deduction is INR 75,000 which becomes INR 1.25 lakhs in case of severe disabilities.
Apart from these sections of Chapter VI A of the Income Tax Act, you can also claim a deduction for the home loan interest paid under Section 24. While the home loan principal amount is allowed as a deduction under Section 80C, the interest component is allowed as a deduction under Section 24. The maximum deduction limit is up to INR 2 lakhs which increases to INR 2.5 lakhs for first time home buyers due to the provisions of Section 80EE.
Furthermore, salaried individuals can also reduce their salary income by claiming a standard deduction. The new Interim Budget 2019 raised the standard deduction limit to INR 50,000 from the existing INR 40,000. So, from the financial year 2019-20, salaried employees can reduce their taxable income by INR 50,000 through standard deduction. These are few deduction it has a lot of other criteria. Please refer https://www.incometaxindia.gov.in/Pages/acts/income-tax-act.aspx
Now that you know the different deductions which a common tax-payer can avail to reduce the taxable income, here is a glimpse on how tax is calculated for a salaried employee and for a self-employed businessman –
Illustration 1 – Mr. Sharma is a salaried employee earning INR 10 lakhs a year from salary income. He also earns interest from fixed deposits @ INR 20,000 every year and the interest from his savings account in the last financial year was INR 10,000. He has utilised Section 80C to the fullest and has also invested in a health plan for his family and parents the premiums for which are INR 12,000 and INR 15,000 respectively. He has also invested INR 30,000 in the NPS scheme.
Here’s how his taxable income and tax liability in Financial Year 2018-19 would be calculated –
Income from salary | 10,00,000 | |
Less: Standard deduction | (40,000) | |
Net income from salary | 9,60,000 | |
Income from other sources: Fixed deposit interest Savings account interest | 20,000 10,000 |
30,000 |
Gross total income | 9,90,000 | |
Less: Deductions under Section 80C | 1,50,000 | |
Less: Deductions under Section 80D: Health insurance premium paid for self and family Health insurance premium paid for dependent parents | 12,000 15,000 |
|
Less: Deduction under Section 80CCD for investment in NPS | 30,000 | |
Less: Deduction under Section 80TTA for savings account interest | 10,000 | |
Total deductions available | (2,17,000) | |
Net taxable income | 7,73,000 |
Calculation of tax liability
For the first INR 2.5 lakhs | Nil |
For the next INR 2.5 lakhs | 5% of 2.5 lakhs=INR 12,500 |
For the income exceeding INR 5 lakhs=INR 2.73 lakhs | 20% of 2.73 lakhs=INR 54,600 |
Total tax liability | INR 67,100 |
Illustration 2 – If Mr. Sharma had been a businessman, standard deduction would not have been available to him. If he had a business income of INR 10 lakhs along with the above details, here’s how his taxable income and tax liability would be calculated –
Income from business | 10,00,000 | |
Income from other sources: Fixed deposit interest Savings account interest | 20,000 10,000 |
30,000 |
Gross total income | 10,30,000 | |
Less: Deductions under Section 80C | 1,50,000 | |
Less: Deductions under Section 80D: Health insurance premium paid for self and family Health insurance premium paid for dependent parents | 12,000 15,000 |
|
Less: Deduction under Section 80CCD for investment in NPS | 30,000 | |
Less: Deductions under Section 80TTA for savings account interest | 10,000 | |
Total deductions available | (2,17,000) | |
Net taxable income | 8,13,000 |
Calculation of tax liability
For the first INR 2.5 lakhs | Nil |
For the next INR 2.5 lakhs | 5% of 2.5 lakhs=INR 12,500 |
For the income exceeding INR 5 lakhs=INR 3.13 lakhs | 20% of 3.13 lakhs=INR 62,600 |
Total tax liability | INR 75,100 |
So, this is how income tax is determined and calculated. You can use the Income Tax Calculator tool by clicking here to understand your tax liability.
The next time you are wondering about your tax liability, calculate your tax yourself. Ensure that you take the advantage of all the deductions and exemptions available to you so that you can lower your tax liability to the fullest and save your hard-earned money.