Introduction to Taxation Structure in India

Taxation in India is a fundamental aspect of the country’s financial system, governed by laws and regulations set by the government. The Indian taxation system is divided into two broad categories

1. Direct Taxes – Paid directly by individuals and organizations on their income and profits.
2. Indirect Taxes – Levied on goods and services collected by intermediaries and ultimately borne by consumers.

Understanding these taxes is crucial for individuals and businesses to ensure compliance and effective financial planning.

Direct Tax Vs. Indirect Tax

Direct Tax

Direct tax is paid directly by individuals or organizations to the government. Unlike indirect tax, it is a burden on income or profits and cannot be transferred to another person.

Types of Direct Taxes in India

• Income Tax – Levied on the income earned by individuals, Hindu Undivided Families (HUFs), and businesses.
• Corporate Tax – Paid by companies on their profits.
• Capital Gains Tax—This is a tax imposed on the sale of capital assets such as property, shares, and bonds. Although it is part of Income Tax, it has a special character and rates.
• Securities Transaction Tax (STT) – Applicable on stock market transactions.

Indirect Tax

Indirect taxes are levied on goods and services and collected by intermediaries such as retailers, wholesalers, and service providers. The end consumer ultimately bears these taxes.

Types of Indirect Taxes in India

• Goods and Services Tax (GST) – A unified tax applicable across goods and services.
• Customs Duty – Levied on imported and exported goods.
• Excise Duty – Earlier levied on manufactured goods (now subsumed under GST).

Understanding GST and Its Applicability

The Goods and Services Tax (GST) is a comprehensive, multi-stage, destination-based tax that replaced indirect taxes like VAT, excise duty, and service tax. It applies to the supply of goods and services in India, ensuring uniformity and reducing cascading effects.

GST Compliance and Returns

• GSTR-1 – Monthly/quarterly return for outward supplies.
• GSTR-3B – Monthly summary return for GST liability.
• GSTR-9 – Annual GST return.
• GSTR-9C – Reconciliation statement for taxpayers subject to audit.

Income Tax and Its Applicability

Income tax is levied on income earned by individuals and businesses based on applicable slabs and rules. Tax rates vary according to income levels and categories of taxpayers.

Income tax is a direct tax imposed on individuals, HUF Partnership Firms, Companies, and other entities based on their income or profits. It is a crucial component of a country’s revenue system and plays a vital role in the economic development of any nation.

While tax regulations and processes can be complex, understanding the fundamental concepts of income tax is essential for individuals, business owners, and tax professionals.

In this article, we will explain each chapter in simple terms, introducing the key concepts of income tax. Whether you are new to the subject or looking for a refresher, this guide will break down essential income tax concepts, including topics such as residential status, various sources of income, tax deductions, returns of income, and more.

Detailed Explanation of Income Tax (Based on Income Tax Act’1961)

1. Concept of Residential Status  (Section 6)

In the context of income tax, taxpayers’ residential status plays a crucial role in determining the scope of their taxable income. Residential status helps decide whether a taxpayer will be taxed as a resident, non-resident, or resident but not ordinarily resident (RNOR).

The tax liability of an individual depends on their residential status, categorized as:

• Resident: A person is considered a resident if they live in the country for at least 182 days per year.
• Non-Resident: A person who does not meet the criteria of a resident is termed a non-resident. Non-residents are only taxed on income earned within the country.
• Resident but not Ordinarily Resident (RNOR): This category refers to individuals who are residents of the country but have not been in India for a specified period of time.

Residential status determines the amount and types of income subject to taxation in the country. Residents are taxed on their global income, while non-residents are taxed only on income earned within the country.

2. Income from Salary (Section 15-17)

Income from salary is one of the most common types of income subject to tax. It refers to wages, salaries, allowances, bonuses, or any other compensation paid by an employer to an employee for services rendered.

The key components of income from salary include:

• Basic Salary: The core amount of salary before any deductions.
• Allowances: Additional amounts given to employees for specific purposes, such as house rent allowance (HRA) and dearness allowance (DA).
• Bonuses: One-time payments made by the employer, often based on performance.
• Perquisites: Non-cash benefits such as company cars, housing, etc.

Total salary income is subject to tax after allowable exemptions and deductions (such as HRA exemptions or deductions for the employee’s contribution to provident funds).

3. Income from House Property (Section 22-27)

Income from house property includes rental income and deemed income from self-occupied property.

Income from house property refers to an individual’s rental income from owning a property. The taxability of this income depends on the following key factors:

• Self-Occupied Property: If the property is self-occupied, it is exempt from tax, except for interest on home loans, which may be deductible under certain conditions.
• Let-Out Property: Rental income from a property that is let out is taxable. However, the taxpayer can claim deductions for repairs, maintenance, and interest on loans taken for the property.
• Annual Value: The annual value of the property is calculated based on its market rental value.

Taxable income from house property is calculated after considering certain deductions, such as House tax paid on such property, standard deduction on account of repair and maintenance, and interest on a loan, if borrowed to buy such property.

4. Income from Business and Profession (Section 28-44D)

Income from business or profession includes profits earned by tax payers engaged in any trade, commerce, profession, or vocation. Whether you own a small business, are a freelancer, or run a large corporation, income from your business activities is taxable.

Income under this chapter includes:

• Business Income: This includes profits from the sale of goods or services.
• Professional Income: Earnings from professions like medicine, law, architecture, etc.

Income from a business or profession is subject to tax after deducting expenses necessary to run the business, such as salaries, rent, utilities, and other operational costs.

5. Income from Capital Gains (Section 45-55)

Capital gains arising from the sale of capital assets:

• Short-term capital gains (STCG) – Holding period less than 12/24/36 months
• Long-term capital gains (LTCG) – Holding period more than 12/24/36 months

Capital gains refer to the profit from selling a capital asset such as property, stocks, bonds, or mutual funds. It is categorized into two types:

• Short-Term Capital Gains (STCG) arise when an asset is sold within a short period (e.g., within 24 months for property or 12 months for equity shares or 36 months for other assets e.g Gold, Bonds etc). STCG is generally taxed at a special rate of Income Tax.
• Long-term capital Gains (LTCG) occur when an asset is held for a long period before being sold. LTCG is usually taxed at a lower rate.

Understanding the difference between short-term and long-term capital gains is crucial, as they are taxed differently.

Deductions on Capital Gains :

There are certain deductions allowed before calculating taxable income under this chapter such as :

• Section 54 – Exemption for reinvestment in residential property
• Section 54F – Exemption for investment in residential property for individuals
• Section 54EC – Exemption for investment in specified bonds

6. Income from Other Sources (Section 56-59)

This is a residual category for any income that does not fall into the abovementioned categories. Common examples include:

• Interest income
• Dividend income
• Lottery winnings
• Gifts exceeding specified limits

7. New Regime vs Old Regime of Taxation – A Comparison

The Income Tax Department offers two tax regimes in India – the New Tax Regime and the Old Tax Regime. Both regimes have distinct features, and taxpayers can choose the one best suits their financial situation.

Old Tax Regime:

The Old Tax Regime allows taxpayers to claim various exemptions and deductions under sections like 80C (for investments in PF, insurance, etc.), 80D (for insurance premiums), HRA (House Rent Allowance), and more. Under this regime, the tax rates are progressive, with higher rates applying to higher income brackets.

New Tax Regime:

Introduced in 2020, the New Tax Regime offers lower tax rates but removes most exemptions and deductions available under the Old Tax Regime. The tax rates are reduced across income slabs, providing a simplified structure, but taxpayers cannot claim deductions like HRA, 80C, 80G, etc.

Comparison:

• Tax Rates: The New Tax Regime offers lower tax rates but does not allow deductions, while the Old Tax Regime has higher tax rates but provides numerous exemptions and deductions.
• Choice: Taxpayers can choose the regime based on their income and deductions. If the deductions under the Old Tax Regime are significant, the Old regime might be beneficial; otherwise, the New Regime may be simpler and result in lower taxes.

Feature	Old Regime	New Regime
Tax Slabs	Higher	Lower
Deductions	Available	Not Available
Applicability	Optional	Optional

The choice between the two regimes depends on individual financial situations and preferences.

8. Deductions Under Chapter VI-A (Section 80C to 80U)

The Income Tax Act provides for various deductions under Chapter VI-A for those who opt for the Old Tax Regime, which can help reduce the taxable income and, in turn, the tax liability. Some common deductions include:

Section 80C: Deduction for investments in life insurance premiums, Provident Fund, National Savings Certificates, etc.

Section 80D: Deduction for premiums paid on health insurance policies.

Section 80G: Deductions for donations to charitable organizations.

These deductions incentivize savings, insurance, and charitable contributions, thereby reducing an individual’s taxable income. However, remember that these deductions are allowed only under the Old Tax Regime.

9. Set-off and Carry Forward of Losses (Section 70-80)

In some instances, taxpayers may incur losses, which can be set off against other sources of income in the same financial year. If the loss cannot be fully set off, it can be carried forward to subsequent years for adjustment. Simple understanding of lossess under Income Tax Act can be as:

• Business losses – Carried forward for 8 years
• Capital losses – Can be set off only against capital gains

Carry Forward Losses: Losses incurred in a specific year can be carried forward for a certain number of years (subject to specific rules) and adjusted against future profits.

Unabsorbed Losses: These refer to losses from previous years that have not been fully utilized. They can be carried forward and set off in future years

10. Presumptive Taxation (Section 44AD, 44ADA, 44AE)

Certain small businesses and professionals can report their income using simplified presumptive taxation schemes under sections 44AD (for small businesses) and 44ADA (for professionals). These provisions deem a fixed percentage of turnover or gross receipts as taxable income, reducing the need for detailed bookkeeping.

• 44AD – 6%-8% deemed profit for businesses subject to business receipts through banking channels or in Cash
• 44ADA – 50% deemed profit for professionals
• 44AE – 7500/- per mongh per vehicle for hiring or leasing goods carriage

Both of the above sections are optional for taxpayers. If they wish not to opt for these sections, they can use other methods of computing their income from business or profession. 

Other income where presumptive taxation is applicable is 44AE for hiring or leasing goods carriage, suject to limit of 10 such vehicles.

11. Tax Audit (Section 44AB)

A tax audit is required for taxpayers whose turnover or income exceeds a prescribed limit. Under Section 44AB, a tax audit ensures that financial records are maintained accurately and that the tax returns filed are correct.

Businesses with a turnover exceeding Rs. 10 crores (for digital transactions) require a tax audit.

Professions with Gross receipts exceeding Rs. 75 Lakhs require a tax audit.

There is a common exception of receipts in cash upto 5% applicable to both the sections 44AD and 44ADA.

12. Return of Income (Section 139)

Taxpayers must file income tax returns based on their income threshold. Every taxpayer must file a return of income annually, providing details about their income and taxes paid. Under Section 139, the return to be filed online, depending on the taxpayer’s category. Filing a return is a legal requirement and helps the government assess a taxpayer’s tax liability.

13. Advance Tax and TDS

Advance tax is a system of paying taxes in advance instead of waiting until the end of the year. Taxpayers must pay advance tax if their estimated tax liability exceeds a specific amount. This is usually paid in installments throughout the year

TDS (Tax Deducted at Source) – TDS is a mechanism in which tax is deducted at the source of income, i.e., by the payer before the income is paid to the recipient. Common examples of TDS include tax on salaries, interest, rent, and professional fees. TDS helps the government collect tax continuously.

14. Intimation, Rectification & Assessments

Under Section 143(1)(a), the tax department sends an intimation to the taxpayer after processing their income return. This intimation provides information regarding any discrepancies or additional taxes payable. This process is also called a Preliminary assessment.

Under Section 154 –Rectification of mistakes. If a taxpayer notices any mistake or error in their tax return or assessment, they can file a rectification request under Section 154. This allows for the correction of errors in the assessment or return.

Assessment Under Sections 143(3), 147, 144, and Faceless Assessment

Assessment refers to the process of determining an individual’s actual tax liability. There are different types of assessments, including:

• 143(3) – Scrutiny assessment
• 147 – Reassessment for escaped income
• 144 – Best judgment assessment
• Faceless assessment – Digital scrutiny without physical interface

Section 143(3): Regular/Scrutiny assessment, where the tax officer reviews and assesses the tax return filed.

Section 147: Reassessment, typically when there is evidence of concealment of income or other discrepancies.

Section 144: Best judgment assessment, when the taxpayer fails to comply with requests for information.

Faceless Assessment: A recent initiative to conduct assessments online without physical interaction between taxpayers and tax officers to minimise corruption charges.

15. Appeals and Dispute Resolution (Section 246, Form 35)

If a taxpayer disagrees with any of the assessment proceedings or tax demands, they can file an appeal under Section 246. Form 35 is used for filing such appeals. Taxpayers can appeal against assessments via Form 35 before the Commissioner of Income Tax (Appeals).

16. TDS on Sale of Property by NRI

NRIs selling property in India are subject to TDS at rates applicable to LTCG/STCG.

When an NRI sells a property in India, TDS is deducted at the rate specified by the tax authorities. This ensures that taxes are paid on the sale proceeds before the payment is made to the NRI.

17. Lower Deduction Certificate for NRI (Section 197)

NRIs who believe that their income will be below the taxable threshold can apply for a lower deduction certificate under Section 197. This allows for TDS to be deducted at a lower rate or exempted altogether. NRIs can apply for a lower deduction certificate to reduce TDS rates based on their tax liability.

Understanding the taxation system in India is crucial for effective compliance and financial management. With structured direct and indirect taxes, the system aims to collect fair revenue while providing eligible taxpayers with deductions and exemptions. Proper tax planning can help taxpayers optimize their liabilities and benefits when choosing the new or old regime.

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About the Author

Naveen Goel

Naveen Goel has been a tax consultant for more than 25 years, delivering transparent consultancy to diversified clients in different industries. 

Updated on: March 21, 2025