Income Tax Act - Basics, Chapters, Scope

Introduction

For the average citizen, the "Income Tax Act" is often viewed as a book of nightmares—a complex web of rules, sections, and penalties designed to take away hard-earned money. However, if you strip away the legal jargon, the Act is actually a structured manual that defines the financial relationship between you and the nation.

Enacted in 1961, this legislation is the backbone of India's direct tax system. It determines not just how much tax you pay, but also what qualifies as income, who is liable to pay, and the exemptions you are entitled to. Whether you are a salaried employee, a freelancer, or a business tycoon, every financial move you make is governed by one of the 298 sections of this Act.

In 2025, with the dual-regime system (Old vs. New) in full swing, understanding the basics is no longer optional. It is a survival skill. In this guide, we will simplify the structure of the Income Tax Act, explain the scope of "Total Income," and break down the critical chapters that affect your wallet.

Table of Contents

1. What is the Income Tax Act, 1961?
2. The Charging Section (Section 4)
3. Key Definitions: Assessee, Person, and Income
4. Previous Year vs. Assessment Year
5. Scope of Total Income (Section 5)
6. The 5 Heads of Income
7. Residential Status (Section 6)
8. Important Chapters Every Taxpayer Should Know
9. The Difference Between Acts and Rules
10. FAQs

What is the Income Tax Act, 1961?

The Income Tax Act, 1961, is the statute under which everything related to income tax is listed. It extends to the whole of India and came into force on 1st April 1962.

It is comprehensive. It tells you:

• How to calculate your income.
• The tax rate applicable to you.
• The deductions you can claim to save tax.
• The procedure to file returns and handle disputes.

While the "Act" is the law passed by Parliament, the "Income Tax Rules, 1962" are the operational guidelines (forms, procedures) issued by the CBDT to implement the Act.

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The Charging Section (Section 4)

Every Act has a "Charging Section" that gives it the power to levy tax. For Income Tax, it is Section 4.

This section states that tax shall be charged:

1. For any Assessment Year.
2. At the rates prescribed by the annual Finance Act (The Budget).
3. On the "Total Income" of the "Previous Year".
4. Of every "Person".

This single sentence is the source of all income tax authority in India.

Key Definitions: Assessee, Person, and Income

To understand the Act, you must learn its vocabulary.

1. Person (Section 2(31))

Tax is not just for humans. The term "Person" includes:

• An Individual (You and me).
• A Hindu Undivided Family (HUF).
• A Company (Private/Public Ltd).
• A Firm (Partnership/LLP).
• An Association of Persons (AOP).
• A Local Authority (Municipality).

2. Assessee (Section 2(7))

An assessee is a person by whom any tax or any other sum of money (penalty/interest) is payable under this Act. Essentially, if you owe the government money or have filed a return, you are an assessee.

3. Income (Section 2(24))

The definition is inclusive. It covers:

• Profits and gains.
• Dividends.
• Voluntary contributions received by a trust.
• Perquisites (Salary perks).
• Capital Gains.
• Winnings from lotteries.

Previous Year vs. Assessment Year

This is the most common confusion for beginners.

• Previous Year (PY): The financial year in which you earn the money. It runs from 1st April to 31st March.
• Assessment Year (AY): The year immediately following the Previous Year, in which you evaluate (assess) and file the return for that income.

Example:

• Income Earned: Between 1st April 2024 and 31st March 2025.
• Previous Year: 2024-25.
• Assessment Year: 2025-26. (You file the return in July 2025).

Scope of Total Income (Section 5)

Does the government tax everything you earn? It depends on your Residential Status.

1. Resident and Ordinarily Resident (ROR)

Global Income is taxable. Whether you earn in India or London, you pay tax in India.

2. Resident but Not Ordinarily Resident (RNOR)

Income earned/received in India is taxable. Foreign income is taxable only if it is from a business controlled in India.

3. Non-Resident (NRI)

Only income earned, accrued, or received in India is taxable. Your US salary is not taxed in India.

The 5 Heads of Income

Section 14 of the Act classifies all income into five specific buckets. You cannot mix them up.

1. Income from Salary: Wages, pension, annuity, gratuity, fees, commission, perquisites paid by an employer to an employee.

2. Income from House Property: Rental income from buildings or land appurtenant thereto. (This is the only head taxed on "notional" income).

3. Profits and Gains of Business or Profession (PGBP): Income from trade, commerce, manufacture, or professional services (Doctors, CAs).

4. Capital Gains: Profits from the transfer of a capital asset (Real estate, Shares, Gold).

5. Income from Other Sources: The residual bucket. Interest, Lottery winnings, Dividends, and Gifts fall here.

Residential Status (Section 6)

Your tax liability is determined by the number of days you stay in India.

• Basic Rule: You are a Resident if you are in India for 182 days or more in the Previous Year.
• Deemed Resident (New Rule): An Indian citizen earning > ₹15 Lakhs from Indian sources who is not liable to tax in any other country is deemed a Resident of India, even if he stays here for 0 days.

Important Chapters Every Taxpayer Should Know

The Act is divided into XXIII (23) Chapters. Here are the ones you will use most:

• Chapter III: Incomes which do not form part of total income (Exemptions like Agriculture Income).
• Chapter IV: Computation of Total Income (The 5 Heads).
• Chapter VI-A: Deductions (The tax-saving section). This includes 80C, 80D, 80E, etc.
• Chapter XIII: Income Tax Authorities (Powers of officers).
• Chapter XVII: Collection and Recovery of Tax (TDS and Advance Tax).

The Difference Between Acts and Rules

• The Act (1961): Defines What to do. (e.g., "You must verify your return").
• The Rules (1962): Defines how to do it. (e.g., "Use Form ITR-V to verify").

Whenever the government changes a form number or a due date, they usually amend the Rules. When they change a tax rate or exemption limit, they amend the Act via the Finance Bill.