The assessment year is the twelve months beginning on April 1 of a given year and ending on March 31 of the following year. For example, the assessment year 2025-26 begins on April 1, 2025, and ends on March 31, 2026. This period is fixed by statutory provisions. The income earned by an assessee during the previous year is taxed in the subsequent assessment year, according to the rates specified for that assessment year by the relevant Finance Act.
Previous Year [Section 3]
The term previous year refers to the year in which income is earned. This income is then taxed in the assessment year, which immediately follows the previous year. For instance, income earned during the financial year 2024-25 will be taxable in the assessment year 2025-26.
Uniform Previous Year
Since the assessment year 1989-90, all assessees are required to follow the financial year, i.e., April 1 to March 31, as their previous year. This requirement ensures uniformity in reporting and taxation across different sources of income.
Previous Year in the Case of a Newly Set-Up Business or Profession
In the case of a newly established business or profession, or when a new source of income arises, the previous year is determined differently. The first previous year begins on the date of establishment of the business or on the date when the new income source arises. It ends on the following March 31. The first previous year can be less than or equal to 12 months, but never more. All subsequent previous years will follow the financial year structure, i.e., April 1 to March 31, each lasting 12 months.
Previous Year Defined in Section 3
Except in cases of new business or income sources, the previous year is the financial year that immediately precedes the assessment year. For example, the previous year for the assessment year 2025-26 is 2024-25.
Exceptions to the General Rule of Taxation in the Assessment Year
Although income is generally assessed in the year following its accrual, there are specific cases where income is taxed in the same year in which it is earned. These exceptions are designed to prevent tax avoidance or ensure timely tax collection when the assessee may not be available for assessment in the future.
Shipping Business of Non-Residents [Section 172]
This section applies when a non-resident owns or charters a ship that carries passengers, livestock, mail, or goods loaded at an Indian port. It also applies whether or not the non-resident has an agent in India. In such cases, 7.5 percent of the amount paid or payable for the carriage (including demurrage and handling charges) is deemed as the income of the non-resident. The master of the ship must file a return of income before the ship departs from the Indian port. The Assessing Officer may allow a return to be filed within 30 days of departure if filing before departure is difficult and satisfactory tax payment arrangements have been made. The Collector of Customs will not grant port clearance unless tax has been paid or arrangements made. Under this section, tax is levied in the same year in which the income is earned.
Persons Leaving India [Section 174]
If the Assessing Officer believes that an individual is likely to leave India during the current assessment year or soon thereafter and has no intention of returning, the total income up to the likely departure date is assessed and taxed in the same assessment year. This provision ensures that the individual’s tax liability is settled before departure.
Bodies Formed for a Short Duration [Section 174A]
Section 174A applies to associations of persons, bodies of individuals, or artificial juridical persons formed for a specific purpose or event. If the Assessing Officer believes that the entity is likely to be dissolved during the same assessment year in which it was formed or immediately after, the total income from the end of the previous year to the date of dissolution is taxable in that assessment year.
Persons Likely to Transfer Property to Avoid Tax [Section 175]
This section applies if, during any current assessment year, the Assessing Officer has reason to believe that a person intends to sell, transfer, or otherwise dispose of any movable or immovable asset to avoid tax liability. In such cases, the income from the beginning of the assessment year until the date the assessment proceedings are initiated is taxable in that same assessment year.
Discontinued Business [Section 176]
If a business or profession is discontinued during an assessment year, the income earned from April 1 of that assessment year to the date of discontinuation can be assessed in that same assessment year. This is at the discretion of the Assessing Officer. Alternatively, it can be taxed in the normal assessment year following the previous year. If taxed in the year of discontinuation, the tax is calculated at the rate applicable to that assessment year. Unlike the previous four exceptions, where assessment in the year of income is mandatory, this exception grants discretion to the Assessing Officer.
Person [Section 2(31)]
The Income-tax Act defines a person inclusively. It includes an individual, Hindu undivided family, company, firm, association of persons or body of individuals (whether incorporated or not), local authority, and every artificial juridical person not falling under the preceding categories. These seven types of persons are liable to be taxed under the Act. The inclusive nature of the definition means that other entities may also qualify as persons for taxation.
Individual
An individual refers to a human being. It includes minors and persons of unsound mind. Even a group of individuals or the trustees of a discretionary trust can be assessed as an individual. Deities and statutory corporations are not individuals but are taxed as juridical persons.
Hindu Undivided Family
A Hindu undivided family comprises individuals descended from a common ancestor, including their wives and unmarried daughters. A joint Hindu family’s income is taxable as a separate entity. Once assessed as such, the status remains until a partition is recognized by the Assessing Officer.
Firm
A firm is treated as a separate taxable entity, distinct from its partners. The profits of a firm are taxed at the firm level, subject to applicable provisions.
Association of Persons or Body of Individuals
An association of persons implies a union where two or more persons come together for a common purpose or activity. These members may include companies, firms, or Hindu undivided families. The Central Board of Direct Taxes has clarified that consortium arrangements with separate responsibilities, risks, and profits should not be classified as associations of persons.
Local Authority
A local authority is a separate entity with legal status, typically functioning in a specific geographical area. It may include municipal committees, district boards, or other statutory bodies entrusted by the government to manage local funds and civic responsibilities. The authority must have legal existence, autonomy, an elected component, and the power to raise and manage its funds.
Artificial Juridical Person
This category covers entities that are neither individuals nor other specified persons but have legal recognition. Examples include deities, bar councils, and religious scriptures like Guru Granth Sahib. This residual classification ensures that all legally recognized entities capable of holding property or income are included in the tax net.
Profit Motive Not Essential
Entities such as associations of persons, bodies of individuals, local authorities, or artificial juridical persons are deemed to be persons under the Act regardless of whether they were established for earning income. The absence of a profit motive does not exempt them from taxation.
Assessee [Section 2(7)]
An assessee is a person liable to pay tax or any sum under the Act. This includes four broad categories. The first includes anyone liable to pay tax, interest, or penalty, regardless of whether proceedings have been initiated. The second includes anyone against whom proceedings have been initiated for assessing income, loss, or refund, whether the tax is ultimately payable or not. The third category includes persons deemed to be assessees, such as representative assessees. The fourth category includes those deemed to be assessees in default, such as those who fail to deduct or pay tax at source or who do not pay advance tax as required.
Charge of Income Tax [Section 4]
Income tax is an annual charge on income. It is levied on the income earned in the previous year, assessed in the assessment year. The tax rate applicable is determined by the Finance Act passed annually by the Parliament. In the absence of a new Finance Act at the beginning of the assessment year, the rates from the previous year or the proposed rates, whichever is more beneficial to the assessee, are used until the new rates become effective.
Income Tax Charged on Person and Total Income
Tax is levied on every person as defined in the Act and is based on their total income. Total income is computed as per the provisions of the Act as they exist on the first day of the assessment year. This rule is relevant only for computing taxable income. If an amendment is procedural and not related to income computation, it applies from the date of its enactment.
Income [Section 2(24)]
The definition of income under section 2(24) is inclusive, meaning that it not only includes the specific items mentioned in the section but also covers other receipts that fall under the general understanding of the term. Income includes any monetary or non-monetary gain, whether recurring or non-recurring, that enhances the wealth of a person, unless specifically exempted by law.
Income as Generally Understood for Tax Purposes
According to Entry 82 of List I of the Seventh Schedule of the Constitution, Parliament has the power to levy taxes on income other than agricultural income. Courts have held that entries in the Constitution should not be read narrowly. Thus, apart from the receipts mentioned in section 2(24), any other receipt that fits the ordinary meaning of income is also taxable. The Shorter Oxford English Dictionary defines income as a periodic return from one’s work, business, land, or investments, usually in money terms. It may also include periodical receipts accruing to a person or corporation. In the case of CIT v. Shaw Wallace & Co., income was defined as a periodical monetary return coming in with some regularity from definite sources. Although regularity is often associated with income, certain receipts that are not regular can still be treated as income for tax purposes.
Regular and Definite Source
Income usually implies a periodical monetary return from a source capable of producing income on a continuing basis. However, regularity is not always necessary, and income tax cannot be levied on hypothetical income. Courts have clarified that the determination of whether a receipt is income depends on the specific facts of each case.
Different Forms of Income
Income can be received in cash or in kind. When income is received in kind, it must be valued in monetary terms, usually at market value or according to the valuation rules prescribed by the Income-tax Rules. If no specific rule exists, the value is determined on a reasonable basis.
Receipt Versus Accrual
Income arises either when it is received or when it accrues, even if not yet received. Income can also be deemed to accrue or arise under the Act. Thus, income may be taxed even if it is not physically received by the assessee but has become legally due.
Illegal Income
The Income-tax Act does not differentiate between legal and illegal income. Profits from illegal businesses are taxable in the same way as profits from legal activities. However, expenses related to illegal businesses cannot be claimed as deductions. The law clearly states that any expenditure incurred for purposes that constitute an offence or are prohibited by law is not allowed as a deduction.
Disputed Title
Tax cannot be postponed because there is a dispute over the ownership of income. The recipient is taxed even if others claim a right to that income. However, a mere claim by another person does not make the claimant liable for tax; the recipient remains liable.
Relief or Reimbursement of Expenses
Reimbursements or relief from expenses are generally not treated as income. For example, if an employer reimburses an employee’s actual business travel expenses, this amount is not treated as income. Similarly, if a court order relieves a person of a financial obligation, the relieved amount is not treated as taxable income.
Diversion of Income by Overriding Title Versus Application of Income
There is a distinction between the diversion of income and the application of income. In the case of diversion of income, the income is directed to another person before it reaches the assessee, and thus it is not taxable in the assessee’s hands. In contrast, when income is first received by the assessee and then applied to meet an obligation, it is treated as the assessee’s income and taxed accordingly. The test for determining this is whether the income reaches the assessee as his own or is diverted at the source to another party under a legal obligation.
Examples of Diversion and Application
If a person receives income and is legally required to pass it on to another entity before it becomes his own, it is diversion by overriding title and is not taxable in his hands. On the other hand, if he first receives the income as his own and then uses it to pay someone else, it is an application of income and taxable in his hands. For instance, income assigned to a beneficiary under a trust arrangement before it reaches the trustee is diversion, whereas salary donated by an employee to charity after receipt is application of income.
Agricultural Income
Agricultural income is specifically excluded from the scope of income tax under Entry 82 of the Constitution. The Income-tax Act defines agricultural income broadly to include income from land used for agricultural purposes, rent or revenue from such land, and income from agricultural operations. The rationale for this exclusion is that states, not the central government, have the power to tax agricultural income.
Types of Agricultural Income
Agricultural income includes three main types. The first is income from land used for agricultural purposes, including rent or revenue. The second is income derived from agricultural operations, such as cultivating crops or other produce. The third is income from the sale of agricultural produce without further processing. However, income from processing agricultural produce to make it marketable remains agricultural income if such processing is done by the cultivator or receiver of rent-in-kind.
Mixed Income
Where an income includes both agricultural and non-agricultural components, it is considered mixed income. The Income-tax Act provides rules for separating the two portions. Only the agricultural portion is exempt from tax, while the non-agricultural portion is taxable.
Deemed Income
Certain receipts are treated as income even though they may not fit the ordinary meaning of the term. For instance, unexplained cash credits, investments, and expenditures for which the assessee cannot offer a satisfactory explanation are treated as deemed income under sections 68 to 69D. These provisions aim to prevent tax evasion by taxing amounts for which the source is not satisfactorily explained.
Capital Receipts Versus Revenue Receipts
Only revenue receipts are generally taxable unless a capital receipt is specifically brought within the scope of income by the Act. Revenue receipts are those that are received in the ordinary course of business or vocation and have the quality of income. Capital receipts, such as amounts received on the sale of a capital asset, are not taxable unless they are chargeable as capital gains.
Exempt Income
Certain categories of income are specifically exempt from taxation under sections 10 to 13B. Examples include agricultural income, certain allowances received by government employees, and specific incomes of charitable or religious trusts. The exemptions aim to provide relief to specific groups or promote social welfare objectives.
Casual and Non-Recurring Income
Casual or non-recurring incomes, such as lottery winnings, are taxable unless specifically exempt. Such incomes are generally taxed at special rates prescribed by the Finance Act, and no deductions are allowed against them.
Total Income
Total income is the aggregate of income from all sources computed under the Act, reduced by exemptions and allowable deductions. It is this total income on which tax is levied. The computation follows specific heads of income, deductions, and set-off provisions.
Heads of Income
The Act classifies income under five heads: salaries, income from house property, profits and gains of business or profession, capital gains, and income from other sources. Income must be classified correctly to apply the correct computation provisions.
Importance of Heads of Income
Each head of income has distinct rules for computation, deductions, and allowances. Misclassification can lead to incorrect tax liability or loss of allowable deductions. Therefore, proper classification is essential in the process of tax assessment.
Chargeability and Taxable Events
Income becomes chargeable to tax when it falls under one of the specified heads and arises in the previous year. The taxable event is either the receipt or accrual of income. The timing of taxation depends on the method of accounting followed by the assessee.
Methods of Accounting
The Income-tax Act recognizes two methods of accounting: the cash system and the mercantile system. Under the cash system, income is taxed when it is received. Under the mercantile system, income is taxed when it becomes due, regardless of actual receipt. Assessees are generally allowed to choose their method of accounting, but they must follow it consistently.
Change in Method of Accounting
If an assessee wishes to change their method of accounting, they must obtain the approval of the Assessing Officer. The change must not result in tax evasion or double taxation. Courts have held that such changes must be bona fide and result in a true reflection of income.
Income from Business or Profession
Income from business or profession is one of the heads of income under which profits and gains arising from any business or professional activities are taxed. The term ‘business’ includes trade, commerce, manufacture, or any adventure or concern like trade. ‘Profession’ refers to activities that require intellectual or specialized skill, such as those of doctors, lawyers, engineers, accountants, etc. The income under this head is computed as per the method of accounting regularly employed by the taxpayer. Both cash and mercantile methods are permitted under the Act. However, certain businesses like those under presumptive taxation schemes are required to follow specific provisions. Deductions are allowed for expenses incurred wholly and exclusively for the business or profession. However, capital expenditure and personal expenses are not deductible. Additionally, there are provisions under Section 44AD, 44ADA, and 44AE that provide for presumptive taxation, which allows small taxpayers to declare income at a prescribed rate, simplifying compliance.
Income from Capital Gains
Capital gains arise when a capital asset is transferred, and the difference between the sale consideration and the cost of acquisition is positive. Capital assets include property of any kind, whether fixed or circulating, movable or immovable, tangible or intangible, with some exclusions like stock-in-trade, personal effects, agricultural land in rural areas, etc. Capital gains are classified into two types: short-term capital gains (STCG) and long-term capital gains (LTCG). The classification depends on the period for which the asset is held. For example, if a listed share is held for more than 12 months, it is considered a long-term capital asset; for unlisted shares or immovable property, the period is more than 24 months. The rates of tax for STCG and LTCG differ. STCG is generally taxed at normal rates except for specific cases like shares (taxed at 15%). LTCG may enjoy indexation benefits and are taxed at 20%, or 10% without indexation in some cases like listed securities. Exemptions under Sections 54, 54EC, and 54F are available to reduce the capital gains tax liability if the proceeds are reinvested in specified assets.
Income from Other Sources
This is a residuary head of income and includes all taxable income not covered under the other four heads. Examples include interest income, dividend income, winnings from lotteries, crossword puzzles, games, races including horse races, gifts received more than the prescribed limit, etc. The taxability of income under this head depends on the nature and amount of income. For example, gifts received from non-relatives exceeding ₹50,000 in a year are taxable, but gifts from relatives or on certain occasions like marriage are exempt. Certain deductions are allowed against income from other sources, such as family pension deduction and deduction for interest on compensation or enhanced compensation. However, most incomes under this head are taxed at slab rates applicable to the individual. Specific incomes like winnings from lotteries or horse races are taxed at flat rates without any deduction.
Clubbing of Income
To prevent tax avoidance through diversion of income, the Act provides for clubbing provisions. This means income that legally belongs to another person may be taxed in the hands of the taxpayer in certain situations. For example, income of a minor child is generally clubbed with the income of the parent whose total income is higher, except in specific circumstances like the child suffering from a disability or earning through manual work or application of skill. Similarly, income transferred to a spouse without adequate consideration is clubbed with the transferor’s income. The clubbing provisions are important to ensure the correct computation of total income and to plug loopholes in tax planning through artificial transfers.
Set-off and Carry Forward of Losses
A taxpayer may incur losses under various heads of income. The Income-tax Act allows such losses to be set off against income from other sources in the same year, subject to certain conditions. For example, loss from one house property can be set off against income from another house property or even other heads of income. However, losses from business cannot be set off against salary income. If the loss cannot be fully set off in the same year, it can be carried forward to future years. Business loss can be carried forward for eight assessment years and set off against business income only. Loss under house property can be carried forward for eight years, but loss under capital gains can only be set off against capital gains in future years. Filing of return within the due date is mandatory to carry forward most types of losses.
Deductions from Gross Total Income
The gross total income is the aggregate of income under all five heads, after clubbing and set-off provisions. From this gross total income, certain deductions are allowed under Chapter VI-A to arrive at the net taxable income. These deductions include: Section 80C: Deduction for specified investments like LIC premiums, PPF, NSC, ELSS, tuition fees, principal repayment on housing loan, up to ₹1.5 lakh. Section 80D: Deduction for medical insurance premium. Section 80E: Deduction for interest on education loan. Section 80G: Deduction for donations to certain funds and charitable institutions. Section 80TTA/80TTB: Deduction for interest on savings accounts and fixed deposits (for senior citizens). These deductions help reduce the tax burden and promote savings and investments among taxpayers. However, one needs to carefully evaluate eligibility and limits before claiming these deductions.
Income from Other Sources
This is a residual head of income. Any income that is not specifically taxable under any of the four other heads is charged to tax under the head ‘Income from Other Sources’ as per section 56(1) of the Act. Examples of such incomes are: dividends, interest on securities, interest on bank deposits and loans, winnings from lotteries, crossword puzzles, races including horse races, card games, and other games of any sort, gambling or betting of any form or nature, income by way of interest received on compensation or on enhanced compensation, gifts exceeding the specified limit in specified situations, family pension, income of letting out of machinery, plant, or furniture, income from sub-letting, etc. This head also includes deemed income like unexplained cash credits, investments, expenditures, etc., under sections 68 to 69D.
Exempt Income
The income which does not form part of total income is called exempt income. These incomes are not included in the gross total income and hence are not chargeable to tax. Exemptions are provided under section 10 and other relevant sections of the Act. Examples include agricultural income, share of profit from a partnership firm, HUF income received by a member, income from certain specified funds, long-term capital gains exempt under section 10(38) (for prior assessment years), certain allowances, and payments received from a provident fund subject to specified conditions.
Clubbing of Income
To prevent tax avoidance through diversion of income to others (especially to relatives or entities in lower tax brackets), the law provides for clubbing of income under sections 60 to 64. As per these provisions, the income of one person may be included in the total income of another person in specified circumstances. For example, income transferred without adequate consideration is clubbed in the hands of the transferor. Income arising from assets transferred to spouse, son’s wife, or a minor child is clubbed in the hands of the transferor. Income earned by a minor child (except in specific cases like child suffering from disability or earnings from manual work or application of skill) is clubbed in the hands of the parent whose total income is higher.
Set-off and Carry Forward of Losses
Taxpayers are allowed to adjust losses incurred under one source of income against income from another source under the same head (intra-head adjustment) and against income under a different head (inter-head adjustment) as per sections 70 and 71. If the loss cannot be set off in the same year, it can be carried forward to subsequent years for set-off against the same type of income (as per section 72 onwards). There are different provisions for different types of losses. Business loss can be carried forward for 8 years, speculation loss for 4 years, loss from house property for 8 years, and capital loss for 8 years. However, losses can be carried forward only if the return of income has been filed within the due date (except for loss from house property).
Deductions from Gross Total Income
To compute the total taxable income, certain deductions are allowed from the gross total income under Chapter VI-A (sections 80C to 80U). These deductions are available in respect of various payments like life insurance premium, provident fund contributions, tuition fees, repayment of housing loan principal (section 80C), contributions to National Pension Scheme (section 80CCD), interest on savings account (section 80TTA), medical insurance premium (section 80D), interest on education loan (section 80E), donations (section 80G), and for individuals with disability (section 80U). These deductions reduce the total taxable income and hence the tax liability.
Computation of Tax Liability
Once the total income is determined after allowing all permissible deductions, tax liability is computed by applying the relevant tax rates. For individuals and HUFs, a slab system is followed wherein different rates apply to different ranges of income. There are also two alternative tax regimes: the old regime (with exemptions and deductions) and the new regime (with lower tax rates but without most exemptions and deductions). Tax rebate under section 87A is available to resident individuals whose total income does not exceed the prescribed limit. Surcharge and health and education cess are added where applicable. After computing the total tax liability, advance tax and TDS/TCS are adjusted to arrive at the net tax payable or refund.
Tax Deducted at Source (TDS)
TDS is a mechanism of collecting tax at the source of income. It is applicable on specified payments like salary, interest, commission, rent, professional fees, and contract payments, among others. The payer is required to deduct a certain percentage of tax before making payment and deposit it with the government. The deducted tax is reflected in the Form 26AS of the payee and can be claimed as credit against the final tax liability. Various sections govern different payments like section 192 (salary), 194A (interest), 194C (contract payments), 194J (professional fees), etc. Failure to deduct or deposit TDS attracts interest, penalty, and disallowance of expenditure.
Advance Tax and Self-Assessment Tax
Advance tax is the tax payable during the financial year on estimated income. It is applicable when the total tax liability after reducing TDS exceeds Rs. 10,000. It is payable in installments as per the schedule prescribed under section 211. Delay or non-payment of advance tax attracts interest under sections 234B and 234C. After the end of the year, if there is any balance tax payable after considering TDS and advance tax, it is paid as self-assessment tax under section 140A before filing the return.
Filing of Return of Income
Every person whose total income exceeds the basic exemption limit is required to file a return of income under section 139. The due date for filing varies depending on the type of taxpayer. Individuals and HUFs not subject to audit are required to file by July 31 (unless extended). Certain categories of persons are required to file even if their income is below the basic exemption limit (e.g., persons holding foreign assets, claiming refund, or having certain transactions). Returns can be filed online using the income tax portal. Late filing attracts a fee under section 234F and may result in denial of carry forward of losses.
Assessment and Scrutiny
After return filing, the income tax department processes the return under section 143(1) and may issue an intimation of refund or demand. Further scrutiny may be conducted under section 143(3) (regular assessment) or 147 (reassessment) if there is reason to believe that income has escaped assessment. Notices are issued to the taxpayer to provide information and documents. Based on the findings, the assessing officer may make additions, disallowances, and compute revised tax liability. The taxpayer has the right to appeal against the order.
Appeals and Revisions
A taxpayer aggrieved by an assessment order can file an appeal before the Commissioner of Income Tax (Appeals) within the prescribed time under section 246A. Further appeal lies to the Income Tax Appellate Tribunal (ITAT), and subsequently to the High Court and Supreme Court on questions of law. The taxpayer can also file a revision petition before the Commissioner under section 264. The department can revise an order prejudicial to revenue under section 263. All these provisions ensure that the taxpayer has a legal recourse in case of incorrect assessment.
Penalties and Prosecutions
Various penalties are prescribed for non-compliance with the provisions of the Act such as failure to file returns, concealment of income, incorrect reporting, non-deduction or non-payment of TDS, etc. Penalties are imposed under sections 270A, 271A, 271B, etc., depending on the nature of default. In serious cases, prosecution provisions under sections 276C, 277, etc., may be invoked. However, compounding of offenses is permitted in certain cases as per CBDT guidelines. These provisions aim to ensure voluntary compliance and discourage tax evasion.
Conclusion
The Income-tax Act, 1961, is a comprehensive legislation governing the levy, computation, and collection of income tax in India. It lays down the rules for determining residential status, scope of total income, classification under different heads, deductions, exemptions, computation of taxable income, procedures for return filing, assessment, appeals, and penalties. A basic understanding of these concepts is essential for every taxpayer to ensure compliance and optimize tax liability within the legal framework. With the continuous evolution of law through amendments, notifications, and judicial interpretations, it is important to stay updated and seek professional advice wherever necessary.