Calculation of Income Tax

Last Updated at: October 18, 2019
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income tax calculator

The government considers your salary and calculates the tax based on the investments and other income you get. Each type of income you earn has a specific tax rate associated with it. Understanding the tax liability could be complex for many people but it is possible to simplify the same with the help of an efficient tax calculator.

The government taxes all your earnings, from your salary to interest on investments and any rental income you may have. Each of these types of earnings is taxed at a certain rate, based on the amount, the age of the assesses and, in the case of investment, the length of time it was invested for. Understanding your tax liability is just a function of knowing the tax rate and whether any deductions are allowable. Let’s examine how your tax is calculated:

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Income from salary

Income from salary implies that you are the employee of the firm or company paying you for your work. Salary includes your basic salary, any annuity or pension, gratuity, advance of salary, leave encashment, commission, perquisites and retirement benefits. The basic salary, along with commissions and bonuses, is fully taxable at the rates mentioned here. On allowances and perquisites, some exemptions are available.

Allowances: Your salary package might mention certain allowances, aside from your basic pay. Some of these allowances, including dearness allowance, lunch allowance, and overtime allowance, are fully taxable. Exemptions are, however, available on conveyance (Rs. 9600 per annum), leave travel allowance (travel tax-free twice within India every four years with your family), and medical allowance (Rs. 15,000 per annum). There’s also house rent allowance, of course.

Perquisites: A perquisite is the benefit provided to you by your employer, in addition to your salary. This might be payment of school fees by employer, rent-free or concessional accommodation, or a car loan. Some perquisites are taxed along with your salary, while others are exempt, up to a certain limit. For example, school fees up to Rs. 12,000 per year are exempt from tax. A car owned by you is exempt for up to Rs. 1200 per month if its engine capacity is less than 1600cc and for Rs. 1600 if its capacity is more than 1600cc.

FAQ

What is house rent allowance?
House rent allowance is a common component in a salary. An employer may include it in your package whether or not you actually rent. This is because, even if you live with your parents, you can still claim a tax exemption on the amount of rent you pay your parents. However, this amount would need to be reflected in your parents’ returns. Also, the amount of rent you pay must be over 10% of your income.

The following will give you an understanding of how HRA is to be used:

The tax exemption you can receive on HRA is the lowest of these three:

The actual HRA you receive from your employer

50 per cent of your salary if you live in a metro or 40 per cent if you don’t

The actual rent you pay minus 10% of your salary.

What if I don’t get it? If you’re living on rent, but HRA isn’t part of your salary, you can still claim a deduction under Section 80GG. The maximum deduction available is, however, lower. You can receive no more than the minimum of Rs24,000, 25% of your total income, or the actual rent you pay minus 10% of your salary.

Income from house property

House property, in this case, includes any income you earn from a house, office building, factory, shop, or even a garage, garden, or car parking space. If you’ve earned any income from house property, the amount to be taxed would not be the entire amount. The government will let you subtract the municipal taxes you’ve paid, 30% of the total income you’ve paid, as well as the interest you’ve paid on the home loan, subject to a maximum of Rs1.5 lakh.
You don’t need to pay any tax on property you live in, so this applies only if you own more than one property. If you don’t live in the one property you own, you can still declare that it is self-occupied, if you aren’t renting it out.’ Whether or not you’re renting out a second property, though, you must still pay tax on the rent you receive or the annual letable value of the house, whichever is higher. Also, if you don’t rent a property out, you will need to also pay a wealth tax of 1%.

FAQ

Which should I declare as the self-occupied property?
It’s not necessary that you live in a self-occupied property. If you own two properties, you may even designate the one you’re renting out as the self-occupied property. You can even keep switching from one property to the other each year. Obviously, it would be cheaper to declare the property from which your income is higher as the self-occupied property. This way you’d have to only pay tax on the house from which your income is smaller.

But, in calculating this figure, however, do consider the following: If you aren’t renting a house out, the maximum deduction you can claim per year on the amount paid as interest on a home loan is Rs1.5 lakh. On a house you’re renting out, however, there’s no such limit.

Income from Profits and Gains of Business or Profession

This can get complicated and lengthy, so we’ll stick to the basics. Any income you earn from business or a profession, which will even include teaching music or yoga at home, is charged under the head profits and gains of business or profession. You need to pay tax on the difference between the credits received and expenses incurred on running the business. There are various deductions allowed in the Act, such as rent for premises, insurance and repairs for machinery and furniture, advertisements, travelling expenses, depreciation of assets used in business, and interest on borrowed capital.

Currently, any business or profession with an annual turnover/gross receipts exceeding Rs. 10 lakh and net profit of Rs.1.2 lakh must have books of account. However, there are certain exceptions to this rule under Section 44. If the turnover of the business exceeds Rs. 40 lakh per annum in a business and gross receipts exceed Rs. 10 lakh per annum in a profession, however, the books need to be audited.

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FAQs

If I sell a large piece of land by dividing it into smaller plots, would it be a business activity?
Yes, under the Income Tax Act, even if you don’t consider yourself as part of the real estate business, this would be considered a business activity. For the year, you would need to include this in your income tax return filing. The profit you earn, instead of being considered as capital gains, would be taxed as business income.

I’m a smalltime trader, do I need to maintain proper accounts?
A smalltime trader doesn’t with a turnover of less than Rs40 lakh doesn’t need to maintain accounts. Under Section 44 AF, you will be permitted to declare your income presumption at 5% of your actual sales. Similarly, under Section 44 AD, 8% of the turnover may be disclosed as profits. No such benefit is available to a professional.

Income from capital gains

If you sell a capital asset held as investment at a profit, this gain is taxed under the head income from capital gains. A capital asset includes any property, excluding jewellery, drawings and paintings. It, therefore, includes shares, mutual funds, and immovable property. Income tax on capital gains depends on the length of time you hold the asset for. A short-term capital asset is one that is held for no longer than 36 months, whereas a long-term capital asset is one that has been held for long. Mutual funds, zero-coupon bonds and shares, however, qualify as long-term assets after 12 months.

Calculation of capital gains: The method to compute capital gains for short- and long-term capital assets is different. In case of short-term capital gains, the sale value of the asset is reduced by what you paid for it, what you paid to improve it, and any expense you may have incurred in transferring it. So if you sold shares in under a year, the tax would be calculated on the amount arrived at after taking into account the above-mentioned expenses.

For long-term capital assets, you also need to take into account indexation benefits. This is all that’s different about the calculation. By providing an indexation benefit, the government intends to factor in the effect of inflation on the purchase. So, for example, if you purchased a house in 2002 for Rs55 lakh and sold it in 2011 for Rs1 crore, you wouldn’t pay capital gains tax on Rs45 lakh. Here’s what would happen instead:

The inflation-adjusted value is arrived at using the Cost Inflation Index (CII), which was 426 in 2002 and 711 in 2011. Therefore, the inflation-adjusted value of the property or indexed cost of acquisition would be Rs55 lakh x 711/426. This equals Rs91,80,000. Therefore, you’d need only pay capital gains tax on Rs8,20,000 rather than Rs45 lakh.

What you do need to remember, however, is that, if the indexation method is used, the tax is levied at 20%. If the value is not adjusted for inflation, the tax is levied at 10%. Generally, the greater the profit, the more you’ll save from indexation, especially if inflation is as high as it has been the past few years.

FAQ

I’ve sold my house. Is there any way to avoid tax on capital gains?
Yes, there is. The gain on your house (or any other property) should be reinvested in another residential property to qualify for the exemption under Section 54 of the act. You may also invest the amount in capital gains bonds, such as bonds from Rural Electrification Corporation Ltd and National Highways Authority of India, within six months of the sale. However, the interest rates on these bonds are low, at just 6%. Your money will be locked in for three years.

Income from other sources

This comprises income earned from bank deposits, winnings from game shows or the lottery. You’ll also need to mention any cash you’ve received, if it is in excess of Rs50,000, unless the money was from a relative.

FAQ

My uncle gave me a cheque for Rs2 lakh on my wedding. Do I need to pay tax on it?
Not at all. Both, money received from a relative and on the occasion of your wedding are exempt from tax. Money received under a well or inherited by you is also completely free from the tax net.

If you want to understand the tax amount that is getting deducted from your salary, then you need to have proper clarity regarding the same from the right guide or company. It involves factors such as allowances, perquisites, investments and other income that you get apart from your salary.

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    A lawyer with 14 years' experience, Vikram has worked with several well-known corporate law firms before joining Vakilsearch.