The Five Heads of Income
How income tax law classifies all income into five heads — Salaries, House Property, Business/Profession, Capital Gains, and Other Sources — and how to compute Gross Total Income. Includes Kiran Sharma's complete income map for FY 2025-26.
Module 2 of 7 — Income Tax & ITR. This lesson introduces the five heads of income that structure every income tax computation, and builds Kiran Sharma's complete income map for FY 2025-26. Duration: 50 minutes.
Learning Objectives
- Identify all five heads of income under the Income Tax Act and what falls under each
- Understand the key deductions and exclusions within each head
- Map Kiran Sharma's three income streams (salary, business, dividend) to the correct heads
- Understand how Sunrise Retail Pvt Ltd's trading income is taxed under PGBP
- Arrive at Gross Total Income (GTI) for Kiran Sharma for FY 2025-26
The Five Heads — Overview
The Income Tax Act does not tax "income" as one undifferentiated mass. Every receipt must be classified into one of five heads. The rules for what is included, what is deducted, and how the result is computed differ head by head.
| Head | Sections | Typical taxpayers |
|---|---|---|
| Salaries | 15–17 | Employees drawing salary/wages |
| Income from House Property | 22–27 | Owners of let-out or self-occupied property |
| Profits and Gains of Business or Profession (PGBP) | 28–44 | Business owners, professionals, companies |
| Capital Gains | 45–55A | Anyone selling capital assets (shares, property, gold) |
| Income from Other Sources | 56–59 | Interest, dividends, lottery, gifts — the residual head |
Income that does not fit the first four heads falls into Other Sources by default.
After computing income under each applicable head, you aggregate them to arrive at Gross Total Income (GTI). Losses under one head can sometimes be set off against income under another.
Head 1: Income from Salaries (Sections 15–17)
What Is Included
Any amount received from an employer-employee relationship is taxed under Salaries:
- Basic salary, dearness allowance (DA), house rent allowance (HRA)
- Bonus, commission, overtime
- Perquisites (car provided by employer, rent-free accommodation, club fees, ESOP on exercise)
- Gratuity received before retirement (partially exempt)
- Leave encashment, pension (uncommuted pension fully taxable)
Key Exempt Allowances
| Allowance | Exemption |
|---|---|
| HRA — Section 10(13A) | Least of three conditions (computed fully in Lesson 3) |
| LTA — Section 10(5) | Block years concept — two journeys per 4-year block |
| Gratuity — Section 10(10) | Up to ₹20,00,000 for private sector employees |
| Leave encashment on retirement — Section 10(10AA) | Up to ₹25,00,000 for private sector employees |
Standard Deduction — Section 16(ia)
A flat deduction of ₹75,000 is available to all salaried individuals under both regimes from FY 2025-26.
Computing Taxable Salary
Head 2: Income from House Property (Sections 22–27)
What Is Included
Income from a property that the taxpayer owns (not rents from someone else):
| Type | Treatment |
|---|---|
| Let-out property | Actual rent received or annual value (higher of the two) |
| Self-occupied property (one allowed) | Annual value = Nil |
| Deemed let-out (second house onwards) | Annual value computed as if let out |
Key Deductions Under Section 24
| Deduction | Limit |
|---|---|
| Municipal taxes paid | Actual amount |
| Standard deduction (30% of NAV) | 30% flat — no proof needed |
| Home loan interest — Section 24(b) | ₹2,00,000 for SOP; unlimited for let-out |
Net Annual Value (NAV) = Annual Letting Value − Municipal taxes paid.
A self-occupied property yields a deduction of up to ₹2,00,000 on home loan interest even though the annual value is nil — resulting in a loss from house property that can be set off against salary income (capped at ₹2,00,000 per year).
Head 3: Profits and Gains of Business or Profession (PGBP — Sections 28–44)
What Is Included
- Profits from any trade, commerce, manufacture, or business
- Professional fees (doctors, lawyers, chartered accountants, architects)
- Income from letting machinery or plant forming part of business
- Profits from a discontinued business collected after discontinuation
The Computation Approach
Start with net profit per books of accounts, then apply specific Income Tax adjustments:
Depreciation Under Section 32
Income Tax uses the Written Down Value (WDV) method (declining balance), grouping assets into "blocks":
| Block | IT Depreciation Rate |
|---|---|
| Buildings — residential | 5% |
| Buildings — non-residential | 10% |
| Furniture and fittings | 10% |
| Plant and machinery — general | 15% |
| Computers and peripherals | 40% |
| Motor vehicles | 15% |
| Intangible assets (patents, trademarks) | 25% |
Head 4: Capital Gains (Sections 45–55A)
What Is a Capital Asset?
Any property held by the taxpayer — except stock-in-trade, personal effects (clothes, furniture), and rural agricultural land. Jewellery is included.
Capital assets are classified by holding period:
| Asset type | Short-term if held ≤ | Long-term if held > |
|---|---|---|
| Listed equity shares, equity mutual funds | 12 months | 12 months |
| Immovable property, unlisted shares | 24 months | 24 months |
| All other assets (gold, debt funds etc.) | 36 months | 36 months |
Capital Gains Tax Rates (FY 2025-26)
| Type | Rate |
|---|---|
| Short-term on equity (Section 111A) | 20% |
| Long-term on equity >₹1,25,000 (Section 112A) | 12.5% |
| Short-term on other assets | Slab rate |
| Long-term on other assets (Section 112) | 12.5% without indexation (immovable property post 23 July 2024); 20% with indexation for other assets |
Stock-in-Trade Is NOT a Capital Asset
For Sunrise Retail, the phones and laptops in inventory are stock-in-trade. When sold, the gain is PGBP income, not capital gain.
Head 5: Income from Other Sources (Sections 56–59)
The residual head — anything that does not fit the first four:
| Income Type | Treatment |
|---|---|
| Savings account interest | Taxable; deduction u/s 80TTA up to ₹10,000 (old regime) |
| Fixed deposit interest | Fully taxable |
| Dividends | Taxable at slab rate (DDT abolished from FY 2020-21) |
| Lottery / gambling winnings | 30% flat tax, no deductions |
| Gifts from non-relatives >₹50,000 | Taxable as Other Sources |
Gross Total Income — The Aggregation
Chapter VI-A deductions (80C, 80D etc.) are available only under the old regime (with narrow exceptions covered in Lesson 5).
Case Study — Kiran Sharma's Income Map (FY 2025-26)
Kiran Sharma is the director of Sunrise Retail Pvt Ltd. He draws a monthly director's salary from the company. He also runs a side proprietorship — Kiran Electronics — trading in electronic accessories from a rented shop. Additionally, he holds shares in a listed company and receives a dividend.
Income Sources and Head Classification
| Income Stream | Head | Notes |
|---|---|---|
| Salary from Sunrise Retail | Salaries (Head 1) | ₹6,00,000/year gross |
| Business income — Kiran Electronics | PGBP (Head 3) | ₹4,00,000 net profit |
| Dividend from listed company | Other Sources (Head 5) | ₹50,000 |
| Total | ₹10,50,000 |
Salary Head Computation (Lesson 3 covers HRA in full)
| Item | Amount |
|---|---|
| Basic salary (₹30,000 × 12) | ₹3,60,000 |
| HRA (₹12,000 × 12) | ₹1,44,000 |
| Special allowance (₹8,000 × 12) | ₹96,000 |
| Gross Salary | ₹6,00,000 |
| Less: HRA exemption (computed in Lesson 3) | (₹57,600) |
| Less: Standard deduction | (₹75,000) |
| Income from Salaries | ₹4,67,400 |
Business Income — Kiran Electronics
Net profit per books of Kiran Electronics: ₹4,00,000. No significant IT adjustments in this period (Lesson 4 covers the adjustment mechanics for Sunrise Retail in detail).
Income from PGBP (Kiran Electronics) = ₹4,00,000
Dividend Income
Dividends received from a listed company are taxable under Income from Other Sources at slab rates (DDT was abolished from FY 2020-21).
Dividend income = ₹50,000
Gross Total Income (GTI)
| Head | Amount |
|---|---|
| Income from Salaries | ₹4,67,400 |
| Income from PGBP (Kiran Electronics) | ₹4,00,000 |
| Income from Other Sources (dividend) | ₹50,000 |
| Gross Total Income | ₹9,17,400 |
This GTI of ₹9,17,400 feeds directly into the tax computation in Lesson 5 (after any Chapter VI-A deductions under the old regime).
Sunrise Retail Pvt Ltd — Head of Income
Sunrise Retail's income falls entirely under PGBP — all revenue is from trading electronics (stock-in-trade). The company does not own real estate or hold listed shares. The full PGBP computation for Sunrise Retail is developed in Lesson 4.
Practice Exercises
Exercise 1: Kiran receives a ₹50,000 dividend. Under which head is this taxed and at what rate under the new regime?
Solution: Dividends received by an individual are taxed under Income from Other Sources (Section 56(2)(i)). DDT was abolished from FY 2020-21 — dividends are now taxable at slab rates.
Kiran's new-regime taxable income is ₹9,17,400. The ₹50,000 dividend falls in the 10% bracket (₹8L–₹12L band).
Tax on ₹50,000 at 10% = ₹5,000 + 4% cess = ₹5,200 (marginal computation).
Exercise 2: Sunrise Retail sells surplus office chairs for ₹40,000. Original cost was ₹28,000, fully depreciated under IT. Is this PGBP or Capital Gains?
Solution: Office furniture is a depreciable capital asset used in the business. Under Section 50, gains from sale of a depreciable asset are deemed short-term capital gains (regardless of holding period).
The entire WDV of the block reduces by ₹28,000 (original cost). If the sale proceeds (₹40,000) exceed the WDV of the block, the difference is short-term capital gains taxable at the applicable corporate rate.
It is not PGBP income — furniture is not stock-in-trade. The correct head is Capital Gains (but deemed short-term under Section 50).
Exercise 3: Kiran owns two flats — he lives in one and the second is rented at ₹15,000/month. How are they treated?
Solution: Only one property is allowed as self-occupied (annual value = nil). The rented flat is a let-out property — its annual value is the higher of actual rent received or fair rent.
- Flat 1 (self-occupied): Annual value = nil; home loan interest up to ₹2L deductible under Section 24(b).
- Flat 2 (let-out): Gross annual value = ₹15,000 × 12 = ₹1,80,000. After 30% standard deduction under Section 24(a): ₹1,26,000 taxable income from house property.
Both head computations are aggregated into GTI.
Key Terms
| Term | Definition |
|---|---|
| Gross Total Income (GTI) | Sum of income computed under all applicable heads before Chapter VI-A deductions |
| Net Total Income | GTI minus Chapter VI-A deductions — this is the taxable income |
| PGBP | Profits and Gains of Business or Profession — the head for all business income |
| Capital Asset | Any property held by the taxpayer, excluding stock-in-trade and personal effects |
| Short-Term Capital Gain (STCG) | Gain from a capital asset held within the short-term holding period |
| Long-Term Capital Gain (LTCG) | Gain from a capital asset held beyond the threshold; lower rates apply |
| Annual Value | The deemed yearly rental income from a house property |
| NAV | Net Annual Value — annual value after deducting municipal taxes paid |
| Stock-in-trade | Goods held for sale in the ordinary course of business — NOT a capital asset |
Module Summary
- All income is classified under exactly one of five heads: Salaries, House Property, PGBP, Capital Gains, or Other Sources.
- The Salaries head covers all employment income; the ₹75,000 standard deduction applies in both regimes.
- PGBP captures all business and professional income — for Sunrise Retail, this is the only head.
- Capital Gains arise on capital assets; stock-in-trade (Sunrise Retail's electronics inventory) is NOT a capital asset.
- All five heads are aggregated to get GTI; Chapter VI-A deductions (old regime only) reduce GTI to taxable income.
- Kiran Sharma's GTI for FY 2025-26 is ₹9,17,400 (salary ₹4,67,400 + business ₹4,00,000 + dividend ₹50,000).
Quick Quiz
Q1: Which head of income applies to the trading profit of Sunrise Retail Pvt Ltd?
Answer: C — Profits and Gains of Business or Profession (PGBP).
All business profits are taxed under PGBP. Electronics trading is stock-in-trade, not a capital asset, so Capital Gains does not apply.
Options: A) Capital Gains | B) Other Sources | C) PGBP ✓ | D) Salaries
Q2: Kiran owns two houses. He lives in one; the second is vacant (not rented). How many are self-occupied?
Answer: B — One is self-occupied; the second (even if vacant) is deemed let-out.
The law allows only one property as self-occupied. A second property — even if not actually rented — is deemed let out and its annual value is computed at the fair rent.
Options: A) Both SOP | B) One SOP, second deemed let-out ✓ | C) Both deemed let-out | D) Vacant property exempt
Q3: Kiran sells listed equity shares held for 14 months. The gain is ₹90,000. What is the tax treatment?
Answer: D — Long-term capital gains; below the ₹1,25,000 exemption threshold — nil tax.
Listed equity held >12 months = LTCG under Section 112A. First ₹1,25,000 of LTCG is exempt. Gain ₹90,000 < ₹1,25,000 → nil tax.
Options: A) STCG at slab rate | B) LTCG; exempt since below ₹1,00,000 | C) LTCG at 12.5% | D) LTCG; below ₹1,25,000 exemption — nil ✓
Q4: What is the sequence to arrive at Net Total Income (the taxable figure)?
Answer: B — Sum all heads = GTI; subtract Chapter VI-A deductions = Net Total Income.
Compute income under each applicable head, add them to get GTI, then deduct Chapter VI-A (old regime) to get Net Total Income.
Options: A) Gross salary minus standard deduction | B) GTI minus Chapter VI-A ✓ | C) Income minus Chapter VI-A = GTI | D) Total receipts minus business expenses
Next up: Module 3 — Salary Deductions — HRA exemption with the three-condition formula, standard deduction, LTA block years, Form 12BB, and Kiran's complete salary head computation under both regimes.