Computation of income tax involves calculating the taxable income of an individual or entity and then applying the applicable tax rates to determine the tax liability. The process can be complex, and illustrations can be helpful in understanding the different steps involved.

Here is an illustration of the computation of income tax for an individual:

Step 1: Calculate income under each head of income

Income under the Income Tax Act is computed under the following five heads:

• Salaries: This includes income from employment, such as wages, bonuses, and commissions.
• House property: This includes income from rental properties, minus any allowable deductions for repairs, maintenance, and municipal taxes.
• Profits and gains from business or profession: This includes income from businesses or professions, minus any allowable deductions for expenses, depreciation, and interest.
• Capital gains: This includes profits from the sale of capital assets, such as property, stocks, and mutual funds.
• Income from other sources: This includes income from sources such as interest on bank deposits, winnings from lotteries, and income from foreign sources.

Step 2: Deduct deductions and exemptions

There are a number of deductions and exemptions that can be claimed against income tax liability. These include deductions for medical expenses, education expenses, charitable donations, and contributions to certain retirement plans.

Step 3: Calculate gross total income

Gross total income is the sum of income from all heads of income, minus any deductions and exemptions.

Step 4: Calculate total income

Total income is gross total income minus any deductions that are not specifically allowed under the Income Tax Act.

Step 5: Determine tax liability

Tax liability is calculated by applying the applicable tax rates to total income. The tax rates vary depending on the individual’s residential status and total income.

Step 6: Pay tax

The individual or entity is responsible for paying the tax liability to the Income Tax Department.

Here is an example of how to compute income tax using illustrations:

Example:

An individual has the following income and expenses for the financial year:

• Salary: Rs. 5,00,000
• Income from rental property: Rs. 1,00,000
• Deductions for repairs and maintenance: Rs. 20,000
• Municipal taxes: Rs. 10,000
• Profit from sale of capital asset: Rs. 2,00,000
• Interest on bank deposits: Rs. 50,000
• Deduction for medical expenses: Rs. 15,000

Computation:

Step 1: Calculate income under each head of income

• Salaries: Rs. 5,00,000
• House property: Rs. 1,00,000 – Rs. 20,000 – Rs. 10,000 = Rs. 70,000
• Profits and gains from business or profession:
• Capital gains: Rs. 2,00,000
• Income from other sources: Rs. 50,000

Step 2: Deduct deductions and exemptions

• Deduction for medical expenses: Rs. 15,000

Step 3: Calculate gross total income

Gross total income = Rs. 5, 00,000 + Rs. 70,000 + Rs. 2,00,000 + Rs. 50,000 – Rs. 15,000 = Rs. 7,65,000

Step 4: Calculate total income

Total income = Gross total income – Deductions

Step 5: Determine tax liability

Tax liability = Total income * Tax rate