Income Tax Act, 1961 – Overview

Historical Background and Evolution of the Income Tax Act, 1961

The Income Tax Act, 1961 stands as the principal legislation governing the levy, computation, and collection of income tax in India. It replaced the erstwhile Income Tax Act of 1922 due to the growing complexity of commercial transactions, development of corporate structures, and expanding economic activities in post-independence India. The Wanchoo Committee (1960) played a significant role in recommending a more robust, comprehensive, and system-driven tax legislation, ultimately giving shape to the 1961 Act. Over the decades, the Act has undergone substantial amendments, often reflecting the government’s fiscal policies, economic reforms, and global tax trends. Major reforms such as the introduction of the Finance Acts, Direct Tax Code proposals, and taxation of digital transactions show that the Act is a living document responsive to changing realities.

Contents

Tip for Students: Always read the Income Tax Act along with the latest Finance Act because the rates and exemptions are frequently updated each financial year.

Constitutional Basis of the Income Tax Act

Article 265 and Legislative Competence

Article 265 of the Constitution provides the essential foundation: No tax shall be levied or collected except by authority of law. The Income Tax Act is the statutory embodiment of this constitutional mandate. Parliament derives its legislative competence from Entry 82 of List I (Union List), which allows taxation of income other than agricultural income.

The Supreme Court in A.V. Fernandez v. State of Kerala underscored the need for strict interpretation of tax statutes, reinforcing that liability under the Income Tax Act must arise only from explicit provisions and cannot be presumed.

Article 366 and Definition of “Income”

Article 366(29) provides a broad constitutional definition of income. In Navinchandra Mafatlal v. CIT, the Supreme Court held that “income” must be interpreted liberally to include every kind of receipt unless expressly exempted, laying the groundwork for the wide ambit of taxation under the 1961 Act.

Structure of the Income Tax Act

The Act consists of 298 sections, numerous subsections, and 14 schedules. Its structure is logically arranged to guide understanding from basic definitions to complex assessments.

Major Chapters

Chapter I – Preliminary (definitions and scope)
Chapter II – Basis of Charge
Chapter III – Incomes not included in Total Income
Chapters IV–VI – Heads of Income, Deductions, Reliefs
Chapter XIV – Procedure of Assessment
Chapter XVII – Collection and Recovery of Tax
Chapter XIX-A – Settlement of Cases
Chapter XX – Appeals and Revisions

Each chapter plays a specific role in guiding how income is classified, computed, and taxed.

Tip for Students: Whenever confused, go back to Sections 4, 5, and 14—they are the backbone of the Act.

Basis of Charge Under the Act

Section 4: Charging Section

Section 4 is the heart of the Act. It states that income tax shall be charged at the rates prescribed in the Finance Act each year. This section also gives legal effect to rates, including surcharges and rebates.

Section 5: Scope of Total Income

The scope of total income depends on an individual’s residential status. Residents are taxed on global income, while non-residents are taxed only on income earned or received in India. The Supreme Court in CIT v. Toshoku Ltd. clarified that commissions earned abroad by non-residents may not be taxable in India if the income does not accrue or arise within Indian territory.

Section 6: Residential Status

Residential status is determined annually and governs tax liability. Factors include physical presence and center of vital interests. This ensures fairness and jurisdictional clarity.

Heads of Income Under the Act

Section 14: The Five Heads

The entire taxable income is classified under five heads:

Income from Salaries
Income from House Property
Profits and Gains of Business or Profession
Capital Gains
Income from Other Sources

Each head contains specialized computation methods. This classification was upheld in United Commercial Bank Ltd. v. CIT, emphasizing that classification ensures consistency and avoids overlapping taxation.

Income from Salaries

Taxed on a “due or received” basis, salary includes wages, pension, gratuity, and allowances. Employers must deduct TDS under Section 192. Courts have clarified in CIT v. L.W. Russel that perquisites must have a monetary value to be taxable.

Income from House Property

Income arises from property ownership. Only net annual value is taxed, with standard deduction and interest benefits under Section 24. In East India Housing & Land Development Trust v. CIT, the Supreme Court emphasized that property income is strictly governed by ownership and cannot be treated as business income unless core activity supports it.

Profits and Gains of Business or Profession

This includes profits from trade, commerce, or any professional activity. McDowell & Co. Ltd. v. CTO remains a landmark case, warning against colorable devices in tax planning and emphasizing substance over form.

Capital Gains

Section 45 taxes profits arising from transfer of capital assets. The CIT v. B.C. Srinivasa Setty judgment held that capital gains cannot be computed when cost of acquisition is indeterminable, creating an important principle for computation provisions.

Income from Other Sources

A residuary head covering dividends, winnings, gifts, and unexplained money. It ensures no income escapes taxation.

Tip for Students: Memorize examples for each head—they are frequently asked in exams and interviews.

Deductions and Exemptions

Section 80C to 80U

Deductions encourage savings, investments, and welfare measures. Popular deductions include:

LIC premiums
PPF and EPF
Tuition fees
Home loan principal
Medical insurance (Section 80D)

Section 10: Exemptions

Certain incomes like agricultural income, allowances, and scholarships remain outside tax. Courts in Mahindra & Mahindra v. CIT clarified that loan waivers are not taxable under certain circumstances unless they fall under business income.

Assessment Procedures

Self-Assessment and Scrutiny

The Act empowers the Assessing Officer (AO) to examine returns, demand additional documents, and reassess income. Judicial review ensures fairness. In ITO v. Lakhmani Mewal Das, the Supreme Court cautioned that reassessment cannot be based on mere suspicion but must have a rational connection to information.

Appeals and Revisions

The Act provides a hierarchical mechanism:

CIT(A) → ITAT → High Court → Supreme Court
This system maintains accountability and ensures legal consistency.

Penalties and Prosecutions

Penalties apply for concealment of income, failure to maintain books, or non-payment of tax. Section 276C deals with willful evasion. However, in Hindustan Steel Ltd. v. State of Orissa, the Court famously held that penalties should not be imposed for minor, technical breaches.

Tip for Students: Remember: mens rea is a key factor in prosecution under tax laws.

Recent Trends and Digital Taxation

Digital economy taxation, TDS on virtual assets, equalization levy, and faceless assessment show the Act’s evolution. Google India Pvt. Ltd. v. CIT highlighted challenges in taxing digital advertising payments, influencing recent legislative changes.

Conclusion

The Income Tax Act, 1961 is a comprehensive, dynamic, and constitutionally grounded legislation that governs how income is taxed in India. Its broad scope, detailed procedures, and judicially refined principles make it essential for every law student to master. Understanding its structure, heads of income, assessment mechanisms, and major case laws provides a strong foundation for tax law practice and academic study.