What is an Income Tax? Meaning, Types, and Features

Income tax in India is a direct tax levied on the income earned by individuals and businesses during a financial year. It is governed by the Income Tax Act, 1961, which outlines the rules for calculating, assessing, and collecting taxes. Taxpayers must file an Income Tax Return (ITR) annually to report their income and claim refunds if eligible.

This article explains the key aspects of income tax, including its meaning, types, features, and calculation methods. 

What is income tax?

Income tax in India is a direct tax collected by the government on the earnings of individuals and businesses during a financial year. The revenue collected from income tax is used to fund essential public services, including infrastructure development, healthcare, education, and welfare programs.

Income is categorized into five main types for tax purposes:

• Income from salary

This includes net salaries,bonuses, pensions, and any other compensation received by employees.

• Income from business or profession

Earnings from self-employment, freelancing, businesses, and professional services such as those provided by lawyers, doctors, and chartered accountants fall under this category. Income from private tuition or contracts is also taxable here.

• Income from house property

Rental income earned from residential or commercial property is taxed under this category.

• Income from capital gains

Profits from selling assets such as stocks, mutual funds, or real estate are considered capital gains and taxed accordingly.

• Income from other sources

Any earnings that do not fall into the above categories, such as interest from savings accounts, fixed deposits, or winnings from lotteries, are included here.

Concept of income tax

The concept of income tax in India is a system of taxation imposed by the government on the income earned by individuals, businesses, and other entities. Here are the key aspects of income tax in India:

1. Taxable income: Income tax is levied on various sources of income, including salaries, wages, profits from business or profession, capital gains, rental income, and other sources. The total income is calculated by aggregating all these sources.
2. Tax slabs: India follows a progressive tax system, where the tax rate increases with the level of income. The government specifies different tax slabs for different categories of taxpayers, such as individuals, Hindu Undivided Families (HUFs), companies, and firms. The tax rates may vary based on the age of the taxpayer (e.g., senior citizens) and the type of income.
3. Deductions and exemptions: Taxpayers can claim various deductions and exemptions under the Income Tax Act to reduce their taxable income. Common deductions include those for investments in specified savings schemes, insurance premiums, and contributions to provident funds.
4. Filing returns: Taxpayers are required to file income tax returns annually, declaring their income and the taxes paid. The due date for filing returns varies based on the type of taxpayer. The returns can be filed online or offline, and taxpayers must maintain proper documentation to support their claims.
5. Taxation of companies: Companies in India are also subject to income tax, which is levied on their profits. The tax rates for corporations may differ from those applicable to individuals, and there are specific provisions for different types of companies (e.g., domestic vs. foreign).
6. Tax collection: Income tax is collected by the central government, and the revenue generated is used for various public expenditures, including infrastructure development, social welfare programs, and public services.

Overall, income tax in India is a crucial component of the country's fiscal policy, aimed at generating revenue for government expenditure while promoting economic growth and social equity.

What does the Income Tax Act say?

The Income Tax Act, 1961 governs how the Income Tax Department administers, collects, and enforces taxes on income earned in India. It comprises 23 chapters and 298 sections that define the framework for income taxation. The Act specifies how taxes are applied to individuals and businesses with taxable income and mandates that taxes be paid directly to the Central Government.

The revenue collected is used by the Central Government to fund public services such as education, healthcare, and infrastructure. The Act ensures that income earned during the previous financial year is taxed equitably, maintaining fairness across income levels.

Types of income taxes in India

In India, income tax is divided into three types, and the amount payable varies depending on the taxpayer's classification:

• Business income tax

This tax applies to income generated by businesses. There are two methods to calculate taxable income:

1. Normal provisions: Taxable income is calculated by deducting business expenses from total sales revenue.

2. Presumptive taxation: For businesses with a turnover of up to ₹2 crores, taxable income is a fixed percentage of sales, simplifying tax compliance.

• Individual income tax

This tax applies to the annual income of individuals. The tax rate depends on the individual's residence status and income bracket. Taxpayers can choose between the old tax regime and the new regime introduced in 2021, which offers lower tax rates but fewer exemptions.

• State and local income tax

These are taxes levied by state governments and local authorities. Examples include: agricultural income tax, state excise duty, stamp duty, land revenue tax, and professional tax.
Additionally, local bodies may collect property taxes and fees for utilities like water and drainage services.

Features of income tax

1. Income tax is borne directly by the taxpayer and cannot be transferred to anyone else.
2. The Central Government is responsible for managing and enforcing income tax laws.
3. Tax is calculated on income earned during the previous financial year.
4. Tax rates are determined according to income tax slabs, which vary based on the taxpayer's income and category.
5. Higher income levels attract higher tax rates, ensuring equitable distribution of the tax burden.
6. Taxpayers can claim deductions under specific provisions of the Income Tax Act, subject to maximum limits set for each deduction.

Who is required to pay income tax in India?

Under the Income Tax Act, anyone earning taxable income in India is required to pay income tax and file tax returns, whether they are a resident or non-resident. Tax liability arises if annual income exceeds ₹3 lakh under the new tax regime.

How is income tax calculated?

You can calculate income tax manually or use an online income tax calculator. Here is how to calculate income tax in India:

1. Determine gross annual income: Start by adding up all sources of income earned during the financial year. 
2. Subtract exemptions: Deduct applicable exemptions such as HRA exemption (House Rent Allowance) and LTA (Leave Travel Allowance).
3. Apply deductions: Include the standard deduction and any other deductions allowed under Section 80 of the Income Tax Act, such as those for investments, insurance premiums, or loan repayments.
4. Calculate net taxable income: Subtract total deductions and exemptions from the gross income to arrive at the net taxable income.
5. Compute tax payable:  Apply the income tax slab rates to the net taxable income to determine the tax liability.

To simplify this process, use an online income tax calculator. The free tool developed by Zoho, lets you accurately calculate your tax liability.

Income tax rates - An overview

Following the Union Budget 2024 announcement, here are the applicable income tax rates under the new regime for FY 2024-25:

Key takeaways

Income tax in India is levied on annual earnings and regulated by the Income Tax Act of 1961. Taxpayers must file their returns each year, reporting their income and claiming eligible deductions. Understanding how to calculate and file income tax returns is essential for compliance and effective financial planning.

For employers, payroll software like Zoho Payroll automates salary calculations, tax deductions, and helps ensure business compliance with the Act.

Frequently asked questions