Understanding the foundational terms and structure under the Income-tax Act, 1961 is essential for taxpayers, professionals, and students alike. These terms not only define the time frame for taxation but also guide the timing, computation, and administration of taxes. Among the primary concepts are assessment year and previous year. The Act also provides exceptions where taxation occurs in the same year the income is earned. This article explores these core concepts in detail.
Introduction to the Tax Structure
Income tax in India operates on an annual basis. A person’s income is computed for a specific 12-month period and taxed accordingly. This structure is standardized across all classes of taxpayers, ensuring uniformity and ease of administration. The concepts of assessment year and previous year play a vital role in determining the period of earning and assessment of income.
While the income earned in one year is typically assessed and taxed in the following year, the law provides for special scenarios where this timeline is not followed. These exceptions are designed to prevent revenue loss and ensure timely collection of tax.
Definition and Scope of Assessment Year
Section 2(9)
An assessment year is defined as the period of twelve months starting on the first day of April every year and ending on the thirty-first day of March of the next year. It is during this period that the income earned in the previous year is assessed and taxed.
For example, income earned between April 1, 2024, and March 31, 2025, is assessed in the assessment year 2025–26. The tax payable on this income is determined according to the rates applicable in the assessment year, as announced by the Finance Act passed for that year.
Assessment year is an integral part of the tax cycle, establishing the link between income earned and tax liability. Every assessment year applies to all taxpayers, whether individuals, companies, firms, or other entities. The principle behind having a separate assessment year is to allow sufficient time for income computation, filing of returns, and completion of assessments.
Meaning and Applicability of Previous Year
Section 3
The previous year is the financial year in which income is earned. It begins on April 1 and ends on March 31 of the following year. Under the general scheme of taxation, income earned during this period is taxed in the assessment year that follows.
For example, if income is earned from April 1, 2024, to March 31, 2025, it will be taxed in the assessment year 2025–26. This structure ensures that there is a clear timeline for income accrual and assessment, avoiding overlap and confusion.
The law clearly distinguishes between the earning period and the taxing period, thus laying the foundation for timely and accurate tax compliance.
Uniform Financial Year Requirement
Starting from the assessment year 1989–90, all taxpayers are required to adopt a uniform previous year, which is the financial year from April 1 to March 31. This provision ensures consistency in tax reporting and avoids complications arising from varied accounting years.
Whether a person earns income from salary, business, capital gains, or any other source, the financial year remains the uniform previous year for reporting purposes. This helps the administration in aligning tax processes with other fiscal systems and government departments.
Previous Year in the Case of New Business or New Income Source
In situations where a new business or profession is established or a new source of income arises during the financial year, the determination of the previous year is slightly different.
The first previous year begins from the date the business or source of income comes into existence and ends on the immediately following March 31. For example, if a new business commences on October 10, 2024, the first previous year will span from October 10, 2024, to March 31, 2025. This duration may be less than twelve months, but it cannot exceed that.
From the second year onward, the previous year will be the standard financial year from April to March. This ensures that new businesses are integrated into the mainstream taxation system without unnecessary delay.
Statutory Position of Previous Year
For all cases not involving new businesses or new income sources, the previous year is defined as the financial year immediately preceding the assessment year. For assessment year 2025–26, the corresponding previous year is 2024–25. This structure is universally applicable and serves as the standard model for all tax assessments, ensuring predictability and uniformity in tax administration.
General Rule of Taxation
Under normal circumstances, income earned in the previous year is assessed and taxed in the following assessment year. This gap allows sufficient time for bookkeeping, return preparation, auditing (where applicable), and verification by tax authorities.
The standard taxation cycle promotes administrative efficiency and offers taxpayers the opportunity to reconcile accounts and fulfill obligations in an organized manner. However, there are specific exceptions provided in the Act to address situations where following the standard cycle may lead to loss of revenue or non-compliance.
Exceptions to the General Rule of Assessment
There are certain cases under the Income-tax Act where income is assessed and taxed in the same year it is earned. These exceptions are necessary to deal with situations where the taxpayer may become untraceable or the income might escape taxation if the regular assessment schedule is followed.
These exceptional cases are governed by specific sections of the Act and are applicable only under defined conditions.
Shipping Business of Non-Residents
Section 172
This provision applies when a non-resident owns or charters a ship that carries goods, passengers, livestock, or mail from a port in India. In such cases, the non-resident may not have a permanent presence in the country, making it difficult for authorities to track and assess them later.
To address this, the Act provides that 7.5 percent of the amount paid or payable for such carriage shall be deemed as income and taxed in the same year. The ship’s master is required to file a return of income before departure from the port. If submission before departure is not feasible, a thirty-day window may be provided, subject to satisfactory tax payment arrangements.
Port clearance will not be granted unless the tax is paid or arrangements are in place. This ensures effective collection of tax from shipping operations that may otherwise avoid assessment.
Individuals Likely to Leave the Country
Section 174
If it comes to the notice of the Assessing Officer that an individual is likely to leave the country during the current assessment year and there is no plan of returning, the officer may assess and tax that individual’s income up to the probable date of departure within the same year.
This provision is crucial in preventing the escape of taxable income due to a person’s departure from the country. The law ensures that income earned before leaving is captured and taxed without waiting for the regular assessment year to begin.
Bodies Formed for Short-Term Objectives
Section 174A
This section applies to associations of persons, bodies of individuals, or juridical persons created for a specific event or objective. If it is likely that such an entity will dissolve within or immediately after the assessment year of its formation, then the income earned from the expiry of the last previous year until the date of dissolution is taxable in that assessment year.
These entities, formed for limited purposes or durations, may cease to exist before their income is assessed under the normal timeline. Hence, this provision ensures that such temporary bodies do not escape taxation.
Anticipated Transfers to Evade Tax
Section 175
Section 175 is aimed at cases where a taxpayer may sell or transfer property with the intention of avoiding tax liability. If the Assessing Officer suspects such an intention, the officer may assess the income of the person for the part of the year up to the date when proceedings are initiated.
This action prevents the taxpayer from transferring or hiding assets to reduce or eliminate tax obligations. It also allows the department to secure revenue before the transfer is completed.
Discontinuation of Business or Profession
Section 176
Where a business or profession is discontinued during an assessment year, the income earned from the beginning of the year to the date of discontinuation can be taxed in the same year. Unlike the earlier exceptions, this provision is not mandatory. The decision to assess the income in the same year or defer it to the regular assessment year lies with the Assessing Officer.
This discretionary power allows the officer to decide on the most effective method of tax collection, depending on the circumstances of the discontinuance and the risk of non-compliance.
Nature of Mandatory and Discretionary Exceptions
Among the exceptions discussed, four involve mandatory assessment in the same year:
- Shipping business of non-residents
- Individuals likely to leave the country
- Bodies formed for short-term purposes
- Transfers of assets intended to avoid tax
In the case of business discontinuance, the assessment in the same year is at the discretion of the Assessing Officer. This exception is based on practical considerations and allows the officer to make a judgment depending on whether the business closure poses a threat to tax recovery.
Meaning of Person and Assessee under the Act
One of the most significant aspects of the Income-tax Act, 1961 is the broad scope it provides in terms of defining the entities liable to pay tax. The law does not only apply to individual human beings but also to a wide array of legal entities. To determine the applicability of the Act, two primary concepts are crucial: Person and Assessee. We explain these two terms and explore how they are used for income tax purposes.
Understanding the Term “Person”
Section 2(31)
Under Section 2(31) of the Act, the term person is an inclusive definition and not limited to human beings. It includes natural persons and legal entities, thereby casting a wide net over who can be taxed under the law. The idea is to ensure that any entity capable of earning income can be brought under the tax net.
The term person includes the following categories:
- An individual
- A Hindu Undivided Family (HUF)
- A company
- A firm
- An Association of Persons (AOP) or a Body of Individuals (BOI), whether incorporated or not
- A local authority
- Every artificial juridical person not falling within any of the preceding categories
Each of these categories is discussed below in detail to understand the scope and implications of taxation.
Individual
An individual refers to a single human being who may be assessed in respect of income earned by him or on his behalf. It also includes cases where the individual is subject to taxation on behalf of minors or mentally incapacitated individuals.
An individual’s income could arise from various sources such as salary, house property, capital gains, business or profession, or other sources. They are the most commonly taxed category under the Act.
Hindu Undivided Family (HUF)
A Hindu Undivided Family is a unique entity under Indian law, composed of persons lineally descended from a common ancestor. It includes male members and, in some cases, female members as coparceners or members. The HUF is treated as a separate person under the Income-tax Act and assessed independently.
The income earned by a HUF from joint family property or business is taxed in the hands of the HUF and not in the hands of individual members. The concept of HUF is rooted in Hindu law, but it is fully recognized by the tax authorities for the purposes of computation and assessment of income.
Company
A company is a legal entity registered under the Companies Act or any previous law governing companies. It can be domestic or foreign, private or public. Companies are treated as separate legal persons and are taxed at a fixed rate prescribed under the Finance Act.
The definition also includes any institution, association, or body which is assessed as a company under the Income-tax Act. This ensures that all corporate entities are taxed uniformly, irrespective of their legal form or location of incorporation.
Firm
A firm includes a partnership firm registered under the Indian Partnership Act, 1932, or a Limited Liability Partnership (LLP) registered under the Limited Liability Partnership Act, 2008. The firm is taxed as a separate entity, and its partners are taxed on the share of profit or remuneration received.
Firms are subject to a flat rate of tax and may also be eligible for certain deductions and benefits. The concept of a firm under the Act is not restricted to formal partnerships but may also extend to informal arrangements recognized by law.
Association of Persons (AOP) or Body of Individuals (BOI)
An AOP or BOI is a grouping of two or more individuals who come together for a common purpose and earn income collectively. The distinction between AOP and BOI lies in their composition. An AOP may consist of individuals or non-individuals (such as firms or companies), while a BOI consists only of individuals.
These groupings may or may not be formed under a legal agreement. They are recognized as persons for tax purposes if they are capable of earning and being assessed on income collectively. Taxation of AOP or BOI depends on the type of members and whether the share of income is determinate or indeterminate.
Local Authority
A local authority includes municipal corporations, panchayats, cantonment boards, and other similar bodies established under state or central laws. These bodies perform civic duties and provide local governance. Their income is generally exempt from tax, except where specific revenue-generating activities are undertaken.
Despite their exemption status in many cases, local authorities are treated as persons under the Act to ensure accountability and consistency in reporting income where applicable.
Artificial Juridical Person
This is a catch-all category that includes all legal entities not specifically mentioned in the other six categories. Examples include deities, universities, trusts, or charitable institutions that are recognized under law as separate legal entities.
These persons are capable of holding property, earning income, and entering into contracts. Hence, the law recognizes them as persons for the purpose of taxation.
Importance of the Inclusive Definition
The inclusive nature of the definition ensures that no income escapes taxation simply because the earning entity does not fall into a narrow classification. This wide scope supports revenue mobilization and strengthens the legal framework by covering emerging business and legal structures.
The inclusive nature also provides flexibility in dealing with new forms of organization or collaboration that may not have existed when the law was originally enacted.
Meaning of “Assessee”
Section 2(7)
While every assessee is a person, not every person becomes an assessee. An assessee is defined in Section 2(7) of the Act as a person by whom any tax or any other amount is payable under the Act.
This includes:
- A person against whom any proceeding has been initiated under the Act
- A person who is deemed to be an assessee
- A person who is deemed to be an assessee-in-default
The term assessee encompasses not only those who are directly liable to pay tax but also those who may have legal responsibility to pay on behalf of someone else or because of default.
Types of Assessees
The law identifies different types of assessees based on the context of the assessment. These are explained below.
Normal Assessee
A normal assessee is a person who is liable to pay tax on income earned during the previous year. This includes individuals, companies, firms, HUFs, and others who have income exceeding the basic exemption limit and are therefore required to file returns and pay tax.
Representative Assessee
A representative assessee is someone who is assessed on behalf of another person. This arises in cases where the actual person is not available or competent to file a return or manage tax affairs. Common examples include guardians of minors, agents of non-residents, or managers of properties held in trust.
In such cases, the representative assessee is deemed responsible for all tax obligations of the person they represent. The liability of the representative assessee is co-extensive with that of the person represented.
Deemed Assessee
A deemed assessee is a person who is treated as an assessee by law, even though the income may technically belong to someone else. This typically arises in cases of succession, inheritance, or transfer of ownership.
For instance, in the case of a deceased person, the legal heir becomes the deemed assessee and is responsible for filing returns and paying taxes on the deceased’s behalf until the date of death. Similarly, when a firm is dissolved, its partners become deemed assessees for pending tax liabilities.
Assessee-in-Default
An assessee-in-default is someone who fails to perform a tax-related duty. This includes failure to deduct tax at source, deposit the tax, or file required documents. In such cases, the person is treated as an assessee-in-default and subjected to penalties, interest, or other legal action.
For example, an employer who fails to deduct TDS on salary or a person who fails to deduct TDS on rent payments above the prescribed limit becomes an assessor-in-default.
Relevance of Classification
The classification of assessees allows tax authorities to identify the correct person responsible for tax compliance. It also ensures legal clarity and accountability in cases involving legal representatives, guardians, or agents.
For taxpayers, understanding their classification helps in fulfilling legal obligations and avoiding penalties or interest due to non-compliance.
Multiple Capacities of Assessee
It is possible for a person to be assessed in more than one capacity. For example, an individual can be assessed as an individual for personal income and also as a representative assessee for income belonging to a minor child or a deceased parent.
Similarly, a trustee may be assessed in a personal capacity as well as in a fiduciary capacity. The law clearly defines responsibilities and obligations in each case to avoid overlap and ensure comprehensive compliance.
Persons Not Assessed Despite Having Income
There may be cases where a person, though defined under the Act, is not liable to pay tax due to specific exemptions. For instance, certain categories of charitable trusts or income earned by approved scientific research institutions may be exempt from tax.
These persons are still required to file returns and maintain compliance, but their income is not subject to tax. Thus, being a person under the Act does not automatically imply tax liability; it depends on the nature of income and applicable exemptions.
Understanding the Concept of Income under the Act
To understand how the Indian income tax system works, it is essential to clearly define what constitutes income. The chargeability of tax under the Income-tax Act, 1961 arises only when a person earns income. Therefore, a thorough understanding of the term “income” is fundamental to determining a person’s tax liability.
Definition and Scope of Income
Section 2(24)
The term income is defined under Section 2(24) of the Act. It provides an inclusive definition, meaning it does not give an exhaustive list of what is income. Instead, it includes various receipts and earnings that are treated as income for taxation purposes.
According to the definition, income includes:
- Profits and gains
- Dividends
- Voluntary contributions received by a trust or institution
- The value of perquisites
- Capital gains
- Winnings from lotteries, crossword puzzles, races, card games, and other games of any sort
- Any sum received under a Keyman Insurance Policy
- Gifts exceeding specified limits
- Certain receipts under specified agreements and employment contracts
The inclusive nature allows the government to tax not only traditional sources like salary or business income but also unusual or non-recurring receipts like lottery winnings or gifts under certain conditions.
Real Income vs. Notional Income
The concept of income includes both real and notional income. Real income refers to actual earnings received or accrued during the year, such as salary or business profits. Notional income refers to income that may not be received but is still taxable, such as deemed rent on vacant house property.
This principle ensures that individuals or entities do not avoid tax simply because income was not physically received during the year but was due or attributable to them.
Accrual vs. Receipt
For income tax purposes, income is taxable either on the basis of accrual or actual receipt, depending on the accounting method followed by the assessee.
- Accrual basis: Income becomes due to the assessee during the year, even if it is not actually received.
- Receipt basis: Income is taxed only when it is actually received.
The method must be consistently followed, and any deviation must be justified and allowed under law.
Five Heads of Income
For the purpose of computation and classification, all income is grouped under five heads as per Section 14 of the Act. These heads help in identifying the source and nature of income, allowing appropriate deductions and taxation mechanisms.
1. Income from Salaries
This head covers income earned by an individual in return for services rendered as an employee. The employer-employee relationship must exist for income to be taxed under this head.
The following items are included under income from salaries:
- Basic salary or wages
- Allowances (house rent allowance, travel allowance, etc.)
- Perquisites (company car, accommodation, etc.)
- Bonus and commissions
- Pension or annuity
- Gratuity
- Leave encashment
- Advance salary or arrears
Certain components like house rent allowance or travel allowances may be eligible for exemptions, subject to prescribed conditions.
2. Income from House Property
This includes rental income earned from property consisting of buildings or land appurtenant thereto. The owner of the property is liable to pay tax on this income, even if the property is not actually rented out, under certain deemed income rules.
Key components of computation include:
- Gross Annual Value (GAV)
- Municipal taxes paid
- Standard deduction of 30%
- Interest on borrowed capital (home loans)
Self-occupied property is treated differently from let-out property, and there are specific provisions for computing income or loss under this head.
3. Profits and Gains from Business or Profession
This head deals with income earned from any trade, commerce, manufacture, or professional service. It includes any profit or gain arising from systematic economic activity carried out with the intention of earning income.
Examples include:
- Income from retail or wholesale trade
- Freelance professional services
- Consultancy services
- Manufacturing business
- Income from speculative business or futures trading
Allowable deductions include expenses incurred for earning income, depreciation on assets, interest on business loans, and rent paid for business premises.
This head also includes presumptive taxation schemes for small businesses and professionals under specific sections of the Act.
4. Capital Gains
Capital gains refer to the profit or gain arising from the transfer of a capital asset. The asset may be tangible (like land, buildings, jewelry) or intangible (like shares, patents).
Capital gains are classified as:
- Short-term capital gains (STCG): If the asset is held for a period not exceeding a specified duration (typically 36 or 24 or 12 months, depending on the asset type)
- Long-term capital gains (LTCG): If the asset is held for longer than the prescribed short-term period
The tax treatment of capital gains includes considerations such as indexation, exemptions under specific sections, and varying tax rates for STCG and LTCG.
5. Income from Other Sources
This is a residual head used to tax income not falling under any of the other four heads. Common examples include:
- Interest from bank deposits or bonds
- Dividends not exempt under other provisions
- Winnings from lotteries or games
- Gifts exceeding the prescribed monetary limit
- Family pension
- Income from sub-letting
This head ensures that all types of income, even if irregular or infrequent, are taxed appropriately.
Gross Total Income and Total Income
The total income of a person is not simply the sum of all incomes. There are adjustments and deductions allowed before the final tax liability is computed.
Gross Total Income (GTI)
GTI is the aggregate of income computed under all five heads, before allowing deductions under Chapter VIA (such as sections 80C, 80D, 80G, etc.).
GTI = Income from Salary + House Property + Business/Profession + Capital Gains + Other Sources
Deductions under Chapter VIA
These deductions are incentives to encourage savings, investment, insurance, health care, education, donations, etc. Common deductions include:
- Section 80C: Life insurance premium, PPF, ELSS, principal repayment on housing loan
- Section 80D: Health insurance premiums
- Section 80G: Donations to approved charitable institutions
- Section 80E: Interest on education loan
- Section 80TTA: Interest on savings bank account
The sum of these deductions is subtracted from the GTI to arrive at the Total Income.
Total Income
Total Income = Gross Total Income – Deductions under Chapter VIA
This is the final amount on which tax liability is computed as per the applicable slab rates or tax rates.
Exempt Incomes
Certain categories of income are specifically exempt from tax under Section 10 of the Act. These include:
- Agricultural income (subject to conditions)
- Dividend income (up to specified limits or conditions)
- Leave travel concession (LTC)
- Long-term capital gains on sale of listed securities (subject to conditions)
- Share of profit from a firm (partner’s share)
- Scholarship for education
- Amount received by a member from HUF
These incomes are not included in the total income, even though they may technically qualify as income under Section 2(24).
Clubbing of Income
To prevent tax avoidance, the Act provides for clubbing of income in specific situations where a person may try to shift income to a lower-income individual or relative. In such cases, income is included in the hands of the transferor or parent/spouse.
Examples include:
- Income of a minor child is clubbed with that of the parent
- Income arising from assets transferred to spouse without adequate consideration is clubbed with the transferor
- Income from revocable transfers of assets
Proper application of clubbing provisions ensures accurate tax liability and prevents artificial reduction of income.
Set-off and Carry Forward of Losses
To compute net income, losses under one head of income may be set off against income under another head (intra-head and inter-head adjustments). If loss cannot be completely set off in the same year, it can be carried forward to subsequent years, subject to conditions.
Examples:
- Business loss can be carried forward for 8 years
- Speculative business loss can be set off only against speculative income
- Capital losses can be carried forward for 8 years but set off only against capital gains
- House property loss can be carried forward for 8 years and set off against income from house property
These provisions help taxpayers smooth out fluctuations in income and reduce undue tax burden in a loss-making year.
Income Deemed to Accrue or Arise in India
The Act also deals with income deemed to accrue or arise in India, especially for non-residents. Certain incomes, although received outside India, are taxable in India if they relate to business operations or assets located in the country.
Examples include:
- Income from a business connection in India
- Royalty or fees for technical services paid by a resident
- Salary for services rendered in India
- Interest earned from an Indian resident
This ensures that India retains its right to tax economic activity conducted within its borders, even if the person earning it is situated outside.
Key Points on Income
- The definition of income is inclusive and not exhaustive
- It includes regular and irregular, recurring and non-recurring receipts
- Income is grouped under five heads for computation
- Specific rules apply for deductions, exemptions, and clubbing
- Taxable income is determined after allowing all permissible deductions
- Losses can be adjusted and carried forward, subject to conditions
- Income may be taxed on the basis of receipt, accrual, or deemed accrual
- Exempt income does not form part of total income
Conclusion
Understanding the basic concepts of income tax under the Income-tax Act, 1961 is crucial for both taxpayers and professionals involved in tax compliance and planning. The foundational pillars of the Act, including terms like assessment year, previous year, person, assessee, and income, serve as the starting point for determining tax liability and ensuring proper compliance with the law.
The classification of persons under the Act helps establish the scope of taxability for individuals, Hindu Undivided Families, companies, firms, associations, and other entities. The concepts of assessment year and previous year define the timeline of taxation, while identifying the assessee ensures the correct party is held responsible for payment and compliance. These core definitions collectively lay the groundwork for computing taxable income and levying tax as per the prescribed rates.
Moreover, the Income-tax Act provides a comprehensive and inclusive definition of income, which goes far beyond salary or business profits. Income under the Act encompasses a wide range of sources, from house property and capital gains to winnings, gifts, and notional accruals. The five-head classification system further enables proper computation, facilitates the allowance of deductions, and ensures income is taxed in the correct manner.
Additionally, provisions relating to exempt income, clubbing, set-off and carry forward of losses, and income deemed to accrue in India reinforce the depth and complexity of the Act. These rules ensure fairness, prevent tax avoidance, and provide structured relief in cases of income loss.
By grasping these essential concepts, taxpayers can make informed financial decisions, avoid unintentional non-compliance, and take full advantage of lawful tax planning opportunities. A solid understanding of the Income-tax Act’s framework not only ensures proper tax payment but also empowers individuals and entities to interact more confidently with the tax system.