Deductions & Exemptions under the Indian Income Tax Act

Deductions and Exemptions under the Indian Income Tax Act

In the context of the Indian Income Tax Act, Deductions and Exemptions reduce one’s taxable income and more importantly one’s income tax liability. Though these terminologies are sometimes used interchangeably there is a basic difference.

The purpose of this article is to explain the basic difference between these two and provide some common examples. 

 

Deductions:

As the name suggests, deduction means an amount that is deducted or reduced from the Gross Income to arrive at the taxable income.

Availability of deductions to a tax payer can be on the basis of nature of income offered to taxation.

Income from Salaries is eligible for deductions under section 16. This includes standard deduction, Entertainment Allowance & Profession Tax paid.

Income from House Property is eligible for deductions under section 24. This includes 30% of annual value and interest paid on any specified loans taken in respect of the house property, mostly loan taken from a financial institution or bank for buying a house.

 

Income from Business is eligible for deductions under sections 35AD, 35E, 36, etc. These are mostly expenses incurred for earning the particular business income.

Income from Other Sources is eligible for deductions under section 57. Again, these are on account of expenses incurred for earning the income from other sources.

The deductions mentioned above come into play when calculating the income earned by the tax payer under each of these heads namely Salary, House Property, Business & Other Sources.

The income from all the above heads are totalled together to form Gross Total Income. Chapter VI A lists out a plethora of deductions which come into play after the stage of Gross Total Income. Deductions under Chapter VI A include the popular ones under sections 80C to 80 U.

Deductions can also be categorised depending on the status of a tax payer i.e Individuals, HUFs, Companies, Societies, etc. For instance, deduction under section 80 P is available only to Societies, deduction under section 80 M is available only to domestic companies, deduction under section 80 U is available only to individuals.

A Deduction can be on account of expenditure incurred (donation made to a registered NGO), investment made (Investment in National Savings Certificate) or based on some peculiarity of the tax payer (Blind or physically disabled individual).

Most deductions are subject to an upper limit.

 

Exemptions:

As the name suggests, exemptions are those that “do not form part of total income”. In other words, unlike deductions which are “reduced” from the Gross Income, exempt incomes do not form part of the Gross Income.

The Income Tax Act states that in computing the Total Income of any person any income falling under the specified sections and classified as exempt income, shall not be included as income.

Section 10 of Chapter III of the Income Tax Act lists some of the exempt incomes. Some of these exempt incomes are agricultural income, House Rent Allowance received by an employee (subject to certain calculations), amount received by a member of HUF which has been paid to him out of the income of the HUF, any income paid to an individual being interest on amount lying to his credit in a Non-Resident External account in any bank in India, etc.

Like deductions, exemptions can also be categorised depending on the status of a tax payer i.e Individuals, HUFs, Companies, Societies, etc. For instance, exemption under section 10 (13A) is available only to Individuals, exemption under section 11 is available only to Trusts, exemption under section 13A is available only to political parties.

Again, like a deduction, an exemption can also be on account of expenditure incurred (rent paid by employee to claim HRA exemption), investment made (Investment in electoral bonds by political parties) or based on some peculiarity of the tax payer (trust has to spend a specific percentage of its receipts to be eligible to claim exemption).

Needless to mention, taxation is a complex subject and requires a deep and detailed study to understand the finer points. As mentioned earlier the purpose of this article was to only explain the basic difference between these two & provide some easy to understand examples.

 

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