Exempt Income Meaning Types How It Works In Tax

Exempt Income Meaning

Explanation

The income of an individual or a business entity is classified under different heads in different countries under their state / central taxation laws, and there are certain incomes which the country determines as not to be taxed. Such income is considered classified as exempt income in the law.

There are various types of income which are considered as exempt; few can be enlisted below,

The employer for the employees extends health benefits.Employer-sponsored insurance plansIncome earned by government / local bodiesIncome earned by the bodies incorporated for employee benefit plans. E.g., EPFOThe income of individuals holding governing positions in the countryThe Revenue Department exempts certain incomes that help the economy grow by attracting foreign direct investmentForeign Direct InvestmentA foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth.read more in-country, providing technological advancement to the country, helps in generating employment, etc. Such a decision is taken in agreement with government ideology to provide a boost to the economy.Income earned by the scientific research organization or other such government bodiesRetirement benefits for individuals are specifically classified as exempt.Ex-gratia incomesCertain incomes which are related to education and personal development;

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Exempt Income (wallstreetmojo.com)

Types of Exempt Income

Exempt income as per Indian laws are given under Chapter III, Section 10 of the income tax act 1961, the following is the extract of certain income given under the said section,

Agriculture IncomeSums received by an individual as a member of Hindu Undivided FamilyIncome received under revised pension rule of the central government in the form of GratuityAny compensation received by a workman under the Industrial Disputes Act, 1947The compensation received in case of any disasterStatutory Provident FundRecognized Provident FundSuperannuation FundHouse rent allowance (HRA)The income of the Mutual FundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread moreAllowance for MP, MLA’sThe income of investor protection fundThe income of provident and superannuation fundThe income of the Employees State Insurance FundThe income by way of dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more from Indian Company (subject to max 10 lakhs)The income from units of Mutual fundThe income from Securitization trustScholarshipThe income of the local authority

Difference Between Exemptions and Deductions

To understand exemptions, we need to know the difference between exemptions and deductions –

The word exemptions and deductions are sometimes interchangeably used, but there is a significant difference between the two. Deduction means the reduction of a specific amount from the income, which is chargeable under the income tax act. In contrast, exemption means the entire income is excluded from being tax viz. The amount is not subject to the levyLevyA levy is a lawful process where the debtor’s property is seized when the debtor cannot pay the outstanding debts. It is different from liens, as a lien is only a claim against a property, whereas a levy is an actual property takeover to fulfill the obligation.read more of Income-tax.

Therefore, we can say that in the case of exempt income, the entire income will be tax-free irrespective of the amount. In deduction, a certain portion of the expense, specified in the law, is considered as a deduction to the taxable income.

Which Income Tax Act Governs Exempt Income?

Exempt incomes in India are governed by the Income Tax Act 1961, under chapter III, section 10. Below are most commonly found exempt items –

Agriculture IncomeSums received by an individual as a member of Hindu Undivided Family;Income received under the revised pension rule of the central government in the form of Gratuity.The income of the local authorityThe income of Scientific Research AssociationHouse rent allowance (HRA)

There are various amendments made every year under the Finance Act whereby there can be additions or deletion or modification of conditions for an exempt income. Therefore the latest Income Tax Act should be considered for understanding for a particular financial year, and the same should be read with the relevant Finance Act.

Investments with an Exempt Income

The income accrued from certain investments is considered as exempt for taxation. Individuals use such investments for income tax savings and planning. Generally, the tax savings investments are required to be made within the financial year to avail tax benefitTax BenefitTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more of the principal portion, and the income portion of the investment is 100% exempt when received at the maturity of the investment

There are various investment avenues; a few are enlisted below,

Tax savings Fixed DepositsLife insurance policiesEmployee pension fundsEmployee provident fundsPost office depositTax-free bonds issued by government enterprisesTax saving mutual fundsELSS Investments

Such investment is long term in nature and has a lock-in period, which ranges from 5 years to 15 years depending upon the type of security.