Computation of Total Income and Tax Liability

Income -tax is levied on an assessee’s total income. Such total income has to be computed as per the provisions contained in the Income Tax Act, 1961. The procedure for computation of total income for the purpose of levy of income-tax is detailed hereunder-

Step 1- Determination of residential status

The residential status of a person has to be determined to ascertain which income is to be included in computing the total income. In the case of an individual, the duration for which he is present in India determines his residential status. Based on the time spent by him, he may be (i) resident and ordinarily resident, (ii) resident but not ordinarily resident, or (iii) non-resident. The residential status of an individual determines the taxability of income earned by him. For example, income earned outside India will not be taxable in the hands of a non-resident but will be taxable in case of a resident and ordinarily resident.

Step 2 – Classification of income under different heads

The Act prescribes five heads of income. These heads of income exhaust all possible types of income that can accrue to or be received by an individual. An individual has to classify the income earned by him under the relevant head of income.

Step 3 – Exclusion of income not chargeable to tax

There is certain income which is wholly exempt from income-tax e.g. agricultural income. This income has to be excluded and will not form part of Gross Total Income. Also, some incomes are partially exempt from income-tax e.g. House Rent Allowance, Education Allowance. These incomes are excluded only to the extent of the limit specified in the Act. The balance income over and above the prescribed limits would enter computation of total income and have to be classified under the relevant head of income.

Step 4 – Computation of income under each head

Income is to be computed in accordance with the provisions governing a particular head of income. Under each head of income, there is a charging section which defines the scope of income chargeable under that head. There are deductions and allowances prescribed under each head of income. These deductions and allowances have to be considered before arriving at the net income chargeable under each head.

Step 5 – Clubbing of income of Spouse, minor child etc.

In the case of individuals, income-tax is levied on a slab system on the total income. The tax system is progressive i.e. as the income increases, the applicable rate of tax increases. Some taxpayers in the higher income bracket have a tendency to divert some portion of their income to their spouse, minor child etc. to minimise their tax burden. In order to prevent such tax avoidance, clubbing provisions have been incorporated in the Income-tax Act, 1961, under which income arising to certain persons (like spouse, minor child etc) have to be included in the income of the person who has diverted his income to such persons for the purpose of computing tax liability. The effect has to be given to these clubbing provisions.

Step 6 – Set-off or carry forward and set-off of losses

An individual may have different sources of income under the same head of income. He might have profit from one source and loss from the other. For example, an individual may have profit from his let out house property and loss from his self-occupied property. This loss can be set-off against the profits of the let-out property to arrive at the net income chargeable under the head “Income from house property”.

Similarly, an assessee can have loss under one head of income, say, income from house property and profits under another head of income, say, profit and gains of business or profession. There are provisions in the Income-tax Act, 1961 for allowing inter-head adjustment in certain cases. Further, losses which cannot be set-off in the current year due to the inadequacy of eligible profits can be carried forward for set-off in the subsequent years as per the provisions contained in the Income-tax Act, 1961.

Step 7 – Computation of Gross Total Income

The final figures of income or loss under each head of income, after allowing the deductions, allowances and other adjustments, are then aggregated, after giving effect to the provisions for clubbing of income and set-off and carry forward of losses, to arrive at the gross total income.

Step 8 – Deductions from Gross Total Income

There are deductions prescribed from gross total income – Deductions in respect of expenditure, Deductions in respect of income and other deductions. Income tax deductions from 80C to 80U

Step 9 – Total Income

The total income of an individual is arrived at, after claiming the above deductions from the gross total income.

Step 10 – Application of the rates of tax on the income

For individuals, there is a slab and basic exemption limit. At present, the basic exempt limit is ₹2,50,000. This means that no tax is payable by individuals with total income of up to ₹2,50,000.

Step 11 – Rebate under Section 87A

In order to provide tax relief to the individual taxpayers who are in the 10% tax slab, section 87A provides a rebate from the tax payable by an assessee, being an individual resident in India, whose total income does not exceed ₹ 5,00,000. The rebate shall be equal to the amount of income-tax payable on the total income for any assessment year or an amount of ₹2000.

Step 12 – Education cess and Secondary and higher education cess

The income-tax is to be increased by education cess@2% and secondary and higher education cess@1% on income-tax plus surcharge minus rebate under section 87A, wherever applicable. This is payable by all individuals who are liable to pay income-tax irrespective of their level of total income.

Step 13 – Credit for advance tax and TDS

From the total tax due, deduct the TDS and advance tax paid for the relevant assessment year. The balance is the net tax payable by an individual which must be paid as the self-assessment tax before submitting the return of income.