Understanding the Heads of Income is essential for interpreting the structure and computation of income tax under the Income Tax Act, 1961. The Act classifies taxable income into five distinct heads, each governed by specific rules of computation, deductions, exemptions, and judicial interpretation. This classification ensures that every kind of income—whether earned from employment, business, property, or investments—is taxed uniformly and systematically. Courts have consistently emphasized that these heads serve not as mere categories but as mutually exclusive compartments for assessing tax liability. In United Commercial Bank Ltd. v. CIT, the Supreme Court held that once income falls under a specific head, it must be assessed strictly under that head alone and not under any other.
The structure of these heads is fundamental for students because every computation in taxation begins by assigning an income to its correct head. Misclassification can lead to incorrect assessments, penalties, and litigation. The five heads also reflect the philosophy of the tax system—ensuring certainty, uniformity, and fairness.
Income Under the Head Salaries
Income under the head Salaries includes all monetary and non-monetary payments received by an individual from an employer-employee relationship. This head covers basic salary, allowances, perquisites, bonuses, commissions, and retirement benefits such as pension and gratuity. The existence of an employer-employee relationship is essential; without it, this head cannot apply. In CIT v. L.W. Russel, the Supreme Court explained that perquisites must arise from employment and must convey a benefit or advantage to the employee to be taxable.
Salary is chargeable to tax either on due basis or receipt basis, whichever is earlier. This ensures that employers cannot defer salary payments to avoid tax liability. Allowances such as House Rent Allowance (HRA), Transport Allowance, and Special Allowances may be partially or wholly exempt under sections like Sec. 10(13A) and Rule 2A. The taxation of perquisites, especially accommodation, motor car facilities, and employer contributions to provident funds, is governed by detailed valuation rules.
“Tip: Always check whether a payment is linked to employment. That single test decides if it is taxable under salaries.”
Income From House Property
This head includes income from buildings or land appurtenant thereto, provided the taxpayer is the owner of such property and it is not used for business or professional purposes. The chargeability arises irrespective of whether the property is actually rented out. Even vacancy, deemed rent, and self-occupied property are treated specifically under Sec. 23.
The Supreme Court in East India Housing & Land Development Trust Ltd. v. CIT held that rental income from property must be assessed strictly under this head, even if the property forms part of the business assets of the assessee. The computation is straightforward: Annual Value – Deductions under Sec. 24, which include a standard deduction of 30% and interest on borrowed capital.
Self-occupied properties enjoy significant benefits, allowing Assessing Officers to treat their annual value as nil. However, interest deductions for such properties are restricted, making judicial guidance essential for interpretation.
“Tip: First ask—Is the person the owner? Second—Is the property used for business? If yes, it cannot be taxed under this head.”
Profits and Gains of Business or Profession
This head contains income earned from business activities or professional services. It also includes various incidental or auxiliary incomes such as compensation, export incentives, speculative profits, and income from trade interests. The computation is governed by Secs. 28 to 44DB, offering detailed rules for depreciation, disallowances, deductions, and business expenses.
In Badridas Daga v. CIT, the Supreme Court explained that business income includes all profits arising from ordinary commercial activities, even if unexpected, as long as they are incidental to business. On the other hand, CIT v. Sterling Foods clarified that business income must have a direct nexus with business operations; remote or indirect receipts cannot be treated as business income.
This head is the most dynamic among all five due to the variations in commercial transactions. Deductions under Chapter VI-A, allowances for depreciation, and disallowances under Sec. 40A significantly influence the taxable amount.
“Tip: If an income flows directly from a business activity, it belongs here. Trace the connection—courts always check the nexus.”
Capital Gains
Capital gains arise from the transfer of a capital asset, as defined under Sec. 2(14). The scope is wide and includes property, securities, rights, and certain intangible assets. The classification into short-term and long-term depends on the holding period prescribed in Sec. 2(42A).
The landmark judgment in CIT v. B.C. Srinivasa Setty held that capital gains tax applies only when the computation mechanism under Sec. 48 can be applied meaningfully. If computation fails, chargeability fails. Transfers include sale, exchange, relinquishment, and compulsory acquisition, with specific exclusions like inheritance and gifts.
Indexation, exemptions under Secs. 54, 54F, 54EC, and special tax rates make this head highly technical. It is crucial to identify whether the transaction constitutes a “transfer,” as incorrect classification leads to litigation.
“Tip: Always check—Was there a ‘transfer’? If yes, apply Sec. 48 immediately to calculate the gain.”
Income From Other Sources
This is the residual head, applicable when income cannot fit into any other category. Governed by Sec. 56, it includes dividends, winnings from lotteries, interest income, gifts exceeding the threshold under Sec. 56(2)(x), family pension, and income from letting plant or machinery not forming part of business.
The Supreme Court in CIT v. Govinda Choudhury & Sons held that Other Sources apply only when income cannot logically fall under any other head. It is not a default dumping ground but a carefully regulated category with its own conditions.
Gifts are heavily scrutinized under this head. If the aggregate value exceeds ₹50,000 and the donor is not a “relative” as defined in the Act, the entire amount becomes taxable. Dividends (except certain exempted categories) and casual incomes like lottery winnings are taxed at special rates.
“Tip: If income doesn’t fit anywhere, test whether it fits under Sec. 56(2). Do not classify blindly—courts dislike forced placements.”
Conclusion
The five Heads of Income form the backbone of the Income Tax Act’s computation mechanism. Each head represents a distinct source of income governed by its own statutory provisions and interpreted rigorously through judicial precedents. For students of tax law, mastering these heads is essential, as classification determines how income is assessed, what deductions apply, and when exemptions may be claimed.
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