Mar 14, 2013, 03.07 PM | Source: Moneycontrol.com

Taxable and tax free income can make difference to returns

There is a clear distinction between different heads of income on the taxation front. The main question for the individual is to see whether an amount received is income and once this has been determined to be income then whether this is taxable or tax free in nature.

Arnav Pandya

There is a clear distinction between different heads of income on the taxation front. The main question for the individual is to see whether an amount received is income and once this has been determined to be income then whether this is taxable or tax free in nature. The term might seem to be simple but making a distinction between these two areas is very important for the individual to ensure that they are able to give the right tax effect to their various transactions. This is the reason why there has to be specific focus on the term taxable as well as tax free income.

Taxable income

Once there is a certain amount that has been determined to be income this means that the amount here is not a receipt that is usually capital in nature. For example if there is a loan taken from a bank then this will reflect as an inflow of money for the individual but this is not income but is a receipt that has to be repaid back to the bank. This is also not an amount that is earned by the receiver but is just a figure that has been given for some time with the cost coming in the form of interest and hence is repayable. The first work for the individual is to see whether an amount received is actually income or not. If this is a capital receipt and is not considered as income then the matter ends there but once it is classified as income then the next step comes into picture.

This involves seeing whether the income is taxable. When there is a taxable income it means that the amount that is received has to be considered for the purpose of calculation of the tax on the amount earned. All the amounts that are taxable are to be added together and then they would be totalled up to see the total income earned and the various deductions would be reduced from this figure. Salary for example is a taxable income so the total amount that is earned as salary would be taken along with the other taxable income like interest or house rent or capital gains. From this figure the various deductions for specified investments and other areas are reduced and the net figure will be checked for the amount of tax that has to be actually paid.

Tax free income

There is another head that is equally important because the individual can get the benefit of having income and at the same time not having to pay tax on it. This is called tax free income and it consists of flows that are considered as income but there is a special tax effect for such inflows as they will not be considered for the purpose of calculation of the total tax to be paid by the individual. There are several heads of income like dividend or agricultural income or even long term capital gains from equities and equity oriented funds that are tax free in nature.

The real benefit of the tax free income is that the amount earned here does not have to be added to the other figures that would be taxable so this goes outside of all the workings for the different heads of income. There is a separate space in the income tax return where the tax free income has to be mentioned and hence this is something that will have to be disclosed by the individual. Another point is that since there is no inclusion of such a figure in the taxable workings there is also no way in which any of the deductions can be set off against such income because for the purpose of taxation this is not entered into the workings at all.

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