Computation of Total Income

Chapter IV is the heart of the Income-tax Act. At 83 sections (Sections 13 through 95), it is by far the longest chapter, and for good reason: it contains the entire computational machinery that transforms raw income into ‘total income.’ Think of it as the engine room where the tax is actually calculated. Chapters I-III told us what income exists and what is exempt. Chapter IV tells us exactly how to compute the taxable amount under each of five mandatory ‘heads of income.’

The Five Heads — A Constitutional Requirement: Section 13 mandates that ALL income must be classified under one of five heads: (a) Salaries; (b) Income from house property; (c) Profits and gains of business or profession; (d) Capital gains; (e) Income from other sources. This classification is not merely administrative — it determines which deductions are available, which rates apply, and how losses are set off. Misclassification of income under the wrong head can result in denied deductions, higher tax rates, and assessment disputes.

The ‘Residuary’ Head: Income from Other Sources (head (e)) is the catch-all. Any income that does not fit under heads (a) through (d) falls here. Dividends, interest, gifts, lottery winnings, family pension — all land in this residuary head unless they are business income. The Act explicitly states in S.92(1): income ‘not chargeable under any of the heads specified in section 13(a) to (d)’ falls here. Nothing escapes.

Structural changes: Under the 1961 Act, the five heads were in Sections 15-59. The 2025 Act retains the same five heads but in Sections 15-95 (a wider range because business income provisions are much more detailed). The 1961 Act used Sections 28-44 for business income; the 2025 Act uses Sections 26-66. Capital gains moved from Sections 45-55A to Sections 67-91.

Substantive changes: The most significant changes are in Capital Gains. The holding period definitions, indexation rules (indexation has been effectively abolished for transfers after 23 July 2024), and tax rates have been materially altered. The 12.5% LTCG rate (replacing the old 20% with indexation) is a fundamental shift. Business income provisions are largely unchanged in substance, though section numbers differ.

The words ‘Save as otherwise provided’: Certain incomes are computed outside the head classification. For instance, income from virtual digital assets (S.194A) is taxed at 30% flat rate without regard to the head under which it might otherwise fall. Similarly, winnings from lottery/gambling (S.194) attract special rates. These are exceptions to the general rule.

4.4.1 When Income is Taxed as ‘Salary’

Income is chargeable under the head ‘Salaries’ only if there is an employer-employee relationship. A partner’s remuneration from a firm is explicitly excluded (S.15(4)). An independent contractor’s fee is business income, not salary. The relationship, not the label, determines the classification.

4.4.2 What Constitutes ‘Salary’ — Section 16

Section 16 provides an inclusive (non-exhaustive) definition. ‘Salary’ covers: wages, pension, gratuity, fees, commission, perquisites, profits in lieu of salary, advance salary, leave encashment, RPF accretion (taxable portion), transferred RPF balance (taxable portion), NPS employer contribution (taxable portion), and Agniveer Corpus Fund contribution.

4.4.3 Perquisites — Section 17

Perquisites are the most complex part of salary computation. Section 17 lists nine categories of perquisites (rent-free accommodation, concessional accommodation, employer-provided benefits, ESOPs/sweat equity, employer-paid obligations, life insurance, and excess retirement fund contributions). Rule 15 prescribes the valuation methods.

ESOP Taxation [S.17(1)(d)]: When an employer allots shares (ESOPs or sweat equity) to an employee, the perquisite value = FMV on the date of exercise minus the amount paid by the employee. This is taxable as salary in the year of exercise. When the employee later sells the shares, capital gains tax applies on the difference between sale price and FMV on exercise date.

The Rs.7.5 Lakh Cap on Retirement Fund Contributions [S.17(1)(h)]: If the employer’s aggregate contribution to EPF + NPS + superannuation exceeds Rs.7.5 lakh in a tax year, the excess is a taxable perquisite. Additionally, interest/accretion on the excess contribution is taxable under S.17(1)(i). This cap was introduced to limit the tax benefit available to very high-income employees.

4.4.4 Deductions from Salary — Section 19

Only three types of deductions are permitted from gross salary:

4.5.1 The Charging Provision — Section 20

Tax is levied on the ‘annual value’ of property (buildings + appurtenant land) owned by the assessee. Three essential conditions: (a) the property must be a building or land attached to it; (b) the assessee must be the ‘owner’ (expanded definition in S.25); (c) the property must not be used by the owner for his own business (S.20(2)). Agricultural land is not covered.

4.5.2 Annual Value — Section 21

Annual value is the cornerstone of house property computation. The Act prescribes:

4.5.3 Deductions — Section 22

Only TWO deductions are permitted from annual value:

(a) Standard deduction of 30%: A flat 30% of annual value. This replaces all maintenance, repair, collection, and insurance costs. No actual expenses need to be proved — the 30% is a deemed deduction. Even if actual maintenance costs are 50% of rental income, the deduction is limited to 30%.

(b) Interest on borrowed capital: Actual interest payable on housing loan. For self-occupied properties: capped at Rs.2,00,000 (if property acquired/constructed within 5 years of borrowing) or Rs.30,000 (in other cases). For let-out properties: NO CAP — full interest is deductible. Pre-construction interest: deductible in 5 equal instalments from the year of completion.

4.6.1 The Largest Part of the Largest Chapter

With 41 sections, Part D is the most detailed part of the Act. It covers: what is business income (S.26-27), what is deductible (S.28-48), what is NOT deductible (S.49-52), depreciation (S.33-34), specific anti-avoidance rules (S.35-37), presumptive taxation (S.58-63), and the treatment of capital assets used in business (S.64-66). A full commentary on every provision would require a separate volume; we focus here on the most important and frequently applied provisions.

4.6.2 The Charging Provision — Section 26

Section 26 enumerates 12 categories of income chargeable under this head. Beyond ‘profits and gains of business’ (the obvious case), it includes: compensation for termination of management/agency/contracts; deemed profits on recovery of previously deducted amounts; balancing charges on asset disposal; insurance/salvage receipts for business assets; sums received for scientific research assets; income from trade/professional associations; profits on debt obligations converted from rupees; Keyman insurance proceeds (if business-connected); benefits/perquisites in business context; and export incentives.

Section 27 — Specific Deemed Business Income: This section addresses income received after discontinuation of a business. It deems such income as business income of the recipient, taxable in the year of receipt, even though the business has stopped. This prevents the escape of post-cessation income that relates to the earlier business activity.

4.6.3 Deductible Expenses — The Master List

Sections 28-48 provide a comprehensive catalogue of allowable deductions. The key provisions:

4.6.4 Depreciation — Section 33

Depreciation is the single largest deduction for capital-intensive businesses. The 2025 Act retains the WDV (Written Down Value) block method:

4.6.5 Key Disallowances — Sections 35-37, 49-52

Three disallowance provisions cause the most litigation and the highest tax adjustments:

4.6.6 Presumptive Taxation — Sections 58-63

Presumptive taxation is a simplified scheme that allows small businesses and professionals to declare income at a deemed percentage of turnover/gross receipts, without maintaining books of account. Three key schemes:

4.7.1 The Most Amended Part of Indian Tax Law

Capital gains taxation in India has undergone more amendments than perhaps any other area of the Act. The 2025 Act consolidates these changes, but the most important shift occurred on 23rd July 2024 (Budget 2024-25), which fundamentally altered the rate structure and eliminated indexation for most assets. Understanding the current regime requires careful attention to these recent changes.

4.7.2 The Basic Computation Formula

4.7.3 Transfers NOT Regarded as Transfer — Section 70

Section 70 lists approximately 30 transactions that are NOT treated as ‘transfers’ for capital gains purposes. The most important:

(a) Distribution of capital assets on total/partial partition of HUF.

(b) Transfer under a gift, will, or irrevocable trust.

(c) Transfer between holding company and wholly-owned subsidiary (Indian companies).

(d) Transfer in amalgamation/demerger meeting S.2(6)/S.2(35) conditions.

(e) Conversion of bonds/debentures into shares.

(f) Transfer by way of conversion of sole proprietorship/partnership into company (subject to conditions).

(g) Transfer of land for industrial development by Central/State government.

(h) Reverse mortgage.

4.7.4 Exemptions from Capital Gains — Sections 82-89

Even when a capital gain arises, the Act provides exemptions if the taxpayer reinvests the gains in specified assets. The most commonly used:

4.8.1 The Residuary Head

Section 92(1) captures everything not taxable under heads (a)-(d): ‘Income of every kind which is not to be excluded from total income under this Act, shall be chargeable under the head Income from other sources, if it is not chargeable under any of the heads specified in section 13(a) to (d).’

4.8.2 Specifically Enumerated Items

Section 92(2) lists items specifically chargeable here:

(a) Dividends: All dividends are now taxable in the hands of shareholders at slab rates (since abolition of DDT). This is the single biggest change from the 1961 Act regime where dividends were exempt in shareholder hands.

(b) Winnings: Lottery, crossword, races, card games, gambling, betting. Taxed at special rates (30% flat) with NO deductions permitted (S.94(4)).

(h) Forfeited advance for capital asset transfer: If you receive an advance for selling property but the deal falls through and you forfeit the advance, it’s income from other sources (not capital gains).

(l) Life insurance maturity (non-exempt): Taxable amount = proceeds minus aggregate premiums paid (and not already claimed as deduction).

4.8.3 The Gift Tax Provisions — Section 92(2)(m)

This is the provision that replaced the abolished Gift Tax Act. Any person receiving money or property without consideration (or for inadequate consideration) is taxed under ‘other sources’:

Seven exceptions (S.92(3)): The gift tax does NOT apply to receipts from: (a) relatives (as defined); (b) on occasion of marriage; (c) under a will or inheritance; (d) in contemplation of death; (e) from local authorities; (f) from registered non-profit organisations; (g) in certain tax-neutral transfers under S.70.

Deduction for interest on dividend income (S.93(2)(b)): For dividend income (other than deemed dividend under S.2(40)(f)), the ONLY deduction allowed is interest expense, capped at 20% of dividend income. No other expenses are deductible. This is a significant restriction — even if you borrowed Rs.1 crore to invest in dividend-paying shares, your interest deduction against dividend income is capped at 20% of the dividends received.

[End of Chapter IV. Chapter V: Income of Other Persons Included in Assessee’s Total Income (Clubbing Provisions) follows.]