What is income tax?

According to the Income Tax Act, 1961, every salaried person needs to pay an amount from their salary as tax to the country. This amount of tax is called the income tax. The law consists of a lot of amendments and variations with subsections describing the details about tax payment, deductions, and computations. A lot of deductions from subsection 80C to 80U are available. The final amount after subtracting all the available tax-saving provisions and deductions is given to the government as the income tax on salary.

Components for calculating the income tax

While calculating the income tax, a few basic terminologies should be kept in mind. Here’s a list:
  • The tax year The tax year is the previous financial year for which the income tax is calculated. The financial year starts from April 1 and ends on March 31 of the next year. So if you are calculating your income tax in 2019, you need to take your salary income from April 1, 2018, to March 31, 2019.
  • Assessment year Assessment year is a very popular term but it confuses most people. Assessment year is not the same as the financial year. It is totally different. In fact, an assessment year starts after the previous financial year gets over. The year during which your income tax is calculated for the previous financial year is called the assessment year. So if you are calculating your salary income tax for the financial year 2018-19, then your assessment year will be 2019-20 and the last date for filing your ITR will be July 2019.
  • Salary breakup The first step towards calculating your income tax on salary would be to get hold of your salary breakup. The salary breakup is available from the salary slip or salary statement. If you don’t have those, go to your HR and ask for it. By taking a close look at the slip or the statement, you will understand the major components and the basic structure of your salary. The tax deductions on salary available to you like HRA (House Rent Allowance), DA (Dearness Allowance), etc. will be helpful for you while calculating the tax.
  • Taxable income Once you have the breakup of your salary, you need to calculate your taxable income. Taxable income is the income on which you need to pay tax which includes all other incomes apart from your salary too.
    Income Source Description
    Income from Salary All income you receive from your job like salary, leave encashment, allowances and so on.
    Income from Property Income from house or land (rented or self-occupied)
    Income from Business/Profession Earnings form part-time job or profession
    Income from Gains Earnings from the sale of a capital asset
    Income from other sources Residual income like earnings from the fixed deposit, gifts, pension, etc.
  • Deductions Income tax is not just you paying money to the government. It is also about all the savings you get to do because of the income tax deductions. These deductions available under section 80 of the Income Tax law are subtracted to get to the taxable income.

    Taxable Income = Gross Income – Deductions

    (Gross income is the sum of all the incomes from all the sources)
    For calculating the taxable income, you need to have detailed knowledge about Section 80, the best friend of taxpayers. This section includes all types of deductions like investments made on mutual funds, life insurance policies, interest on savings, PPF, NSC, SIPs, mutual funds returns, home loans, etc. As per the latest tax regime, your deductions can go up to 2.5 lakhs per year. If you plan your investments carefully, you can save a lot of your annual income.
  • TDS TDS or Tax Deducted at Source means the tax is deducted directly from your salary. For maintaining a hassle-free tax pattern, most employers use TDS. Don’t worry, you get a refund on this, so if there is a chance that more TDS has been deducted, it will come back to you. TDS is not practiced just by employers. Even banks follow the phenomenon while paying interest. And if there is any discrepancy in the amount, you can show the proper investment documents and get a refund for the extra money deducted. To avoid TDS you can show the documents in advance also.
  • The payable tax calculation The last and final step is to calculate the payable tax. After you deduct all the applicable deductions and TDS, the amount that you get is the tax amount you need to pay to the Indian government. If your total income is lesser than 2.5 lakhs, then you do not need to pay any income tax. Beyond this limit, you are liable to pay income tax according to your salary slab.

    The tax rate for a salaried individual under 60 years

    Income Slab Tax Rate
    Up to  2.5 lakhs None
    2.5 lakhs – 5 lakhs 10% of exceeding amount
    5 lakhs – 10 lakhs 20% of the exceeding amount
    Above 10 lakhs 30% of the exceeding amount

Income tax savings

Every citizen wants to increase the income and at the same time pay lesser tax. There are some ways to do this. These tax savings methods save money for your future and also saves a significant amount on the income tax. Some of the most popular tax savings instruments are:

  • ELSS Equity Linked Savings Schemes are equity mutual funds with distinctive features. ELCC qualify below section 80C and are exempted up to 1.5 lakhs. They have a 3-year lock-in period and is offered by almost every mutual fund company. The returns are based upon the market changes and that is why there is no fixed return rate on ELSS. But these returns from ELSS are completely tax-free which is the major driving force for people to choose investment in ELSS.
  • PPF Public Provident Fund (PPF) is also a very popular method of investment. Since its launch, PPF has been the preferred method of investment and tax savings for millions of salaried individuals. Being a government scheme, it enjoys a lot of trust from people. PPF gives interest at a fixed rate which currently is 7.9%. The maximum limit for investing in PPF is 1.5 lakhs while the minimum limit is INR500 annually. PPF has a lock-in period of 15 years which can be extended in the block of 5 years. PPF is the best option for people who do not like volatility in their investments and want to invest in safe options.
  • ULIP ULIP or Unit Linked Insurance Plan is a hybrid of insurance plan and market-linked investments. With a lock-in period of 5 years, it offers both protection as well as savings. The lock-in period can be extended up to 15 and even 20 years. There are 9 fund options in ULIP between which an investor can switch any time and the returns on them are completely tax-free.

Deductions under section 80

Under section 80 of the Income Tax Act, 1961, many deductions are available which brings down the taxable income for an individual and thus reduces the tax payable.

These deductions are as under:

Section Maximum Limit Deductions
Section: 80C 1,50,000 ULIP, ELSS, NSC, Employee share of PF, LIC Premium, Children’s tuition fees, Home loan principal repayment, 5-year deposit Scheme, purchasing of deferred annuity, Senior citizen’s saving scheme, Pension fund set up by UTI or mutual fund, annuity plan of LIC, Subscription to Home Loan Account scheme of the National Housing Bank, Subscription to notified bonds of NABARD, Subscription to deposit scheme of a public sector or company engaged in providing housing finance.
Section: 80CCC NA
Section: 80CCC NA On the amount deposited in the annuity plan of LIC or any other insurance plan for a pension fund.
Section: 80CCD(1) 1,50,000 Employee’s contribution to NPS account
80CCD(2) 10% salary Employer’s contribution to NPS
Section: 80CCD(1B) 50,000 Any other contribution to NPS by employee
80TTA(1) 10,000 Income from interest earned on savings account
80TTB 50,000 Interest received from banks, post office, etc. but applicable only to senior citizens
Section: 80GG 5000 per month / 25% of total income / rent paid – 10% of total income (W.E.L.) For rent paid when HRA is not received from an employer
Section: 80E Amount equal to the interest paid for 8 years Interest paid on education loan
Section: 80EE 50,000 Interest paid on home loans by the first time homeowners
Section: 80CCG 25,000 / 50% of amount invested in equity shares (w.e.l.) Rajiv Gandhi Equity Scheme for investments in Equities
Section: 80D 25,000 Medical insurance of self, spouse and children
Section: 80D 50,000 Medical insurance of parents over 60 years or uninsured parents over 80 years of age.
80DD 75,000 Medical treatment of handicapped dependent
Section: 80DD 75,000 (40%-80% disability), ` 1,25,000 (more than 80%) Payment made to specific scheme taken for maintenance of handicapped dependent
Section: 80DDB 40,000 or amount paid (w.e.l.) Medical expense on self or dependent less than 60 years old
Section: 80DDB 1,05,000 or amount paid (w.e.l.) Medical expense on self or dependent more than 60 years old
Section: 80U 1,25,000 (severe disability), ` 75,000 (less severe disability) Self suffering from physical disability including blindness and mental instability
Section: 80GGB Contributed amount (Not in cash) Contribution made to political parties by companies
Section: 80GGC Contributed amount (Not in cash) Contribution made to political parties by individuals
Section: 80RRB Income received / 3,00,000 (w.e.l.) Income received from royalty or patent

Calculating the income tax

Calculating the income tax is actually very easy. The formula is:

Basic salary
+ Special Allowance 
+ Transport Allowance 
+ any other allowance
Gross income from salary 
(-) Deductions
Net income 
(Tax calculated according to the income tax slab)

If Mr. Bajaj has a salary of Rs. 25,000 per month with DA of Rs. 4500 per month, entertainment allowance of Rs. 2250 per month and pays Rs. 3500 towards professional tax, then his taxable income would be calculated as follows:

Basic Salary 25000 * 12 = 3,00,000
DA 4500 * 12 = 54,000
EA 2250 * 12 = 27,000
Gross Salary = 3,81,000
Professional Tax 3500
Net income = 3,77,500

As his taxable income is Rs. 3,77,500, he falls in the slab of 2.5 lakhs – 5 lakhs of income tax. Thus he has to pay 10% of his net income as income tax.
Income tax on above net income = 10% of 3,77,500
= 37,750

To conclude

It is essential to declare all the investments at the beginning of the assessment year so that the tax to be paid can be calculated properly. For building a proper wealth foundation, knowledge of tax, its deductions and returns are important. Wrong tax payments, providing wrong formation and falsehood are considered a legal offense. Income tax fraud includes the following scenarios:

  • Avoiding to submit the IT return on purpose
  • Letting the tax dues fail wilfully
  • Not reporting total income intentionally
  • Falsification of tax returns
  • False claims

Legal actions like heavy penalty and imprisonment can be resulted in doing such tax frauds.
Every person wishes to lead a luxurious life but thinks that it is impossible because a major chunk of their income goes to tax payments. Knowing about proper calculations and deductions helps in proper money investment and tax saving which helps in achieving the luxurious life everyone dreams of. It also saves from committing tax fraud.

CA Abhishek Soni
CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2Win.in. Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.