Guide on Exempt Income from IT Perspective

Exempt income is not chargeable to tax or the income that doesn't form part of Total Income.

This is to be noted that there's a difference between Exemptions and Deductions (Chapter VI A of act). In simple words, Exemption means exclusion, i.e. if certain income is exempt from tax then it will not contribute to the total income of a person. Deduction means subtraction i.e. an amount that is eligible to reduce taxable income. The deduction is a concession, but Exemption is relaxation.

Guide on Exempt Income from IT Perspective

Different types of exempt incomes

Income from Agriculture
Income from Hindu Undivided Family
Income from Gratuity
Income from insurance policies
Income from capital gain shares
Income from dividend’s via mutual funds
Income from Provident funds
Disaster Compensation / Relief

1. Income from Agriculture

Income earned from agricultural operations is not taxed.
Computing tax on non-agricultural income agricultural income is also taken into consideration.

1a. Agriculture income:

Income derived from the sale of seeds.
Income derived from the sale of flowers and creepers.
Rent received from the land used for grazing of cattle required for agriculture activities.
Income from the growing of bamboo.

1b. Non-agriculture income:

Income from breeding of livestock
Income from poultry forming
Income from fisheries
Income from dairy farming

Example

Suppose, taxpayer earn Salary income of Rs.3,00,000, Agricultural income of Rs.50,000 for a year.

Step 1: Income tax on Rs.3,50,000 i.e. Rs.5,000, (Income exempt up to 2,50,000 and taxable @5% on 1,00,000/-)

Step 2: Income tax on 3,00,000 [2,50,000 + 50,000] i.e. 2,500, (Income exempt up to 2,50,000 and taxable @5% on 50,000/-). The tax liability in this case shall be 2,500 and there’s no extra tax payable owing to the extra income of agricultural income.

But, you might have to pay some tax on agriculture income in certain cases. Say, you’ve earned salary income of 2, 80,000 and agricultural income of 3,50,000 .

Step 1: Income tax on 6,30,000 i.e. 38,500 (Income exempt up to 2,50,000, tax @5% on next 2,50,000 and @20% on the remaining 1,30,000).

Step 2: Income tax on 6, 00,000 [2,50,000 + 3, 50,000] i.e. 32, 500, Income exempt up to 2,50,000, tax @5% on next 2, 50,000 and @20% on the remaining 1,00,000.

Thus, in the above case, final tax liability comes up to 5,000 (38,500-32,500). Therefore, even though agricultural income is exempt, you’ll have to pay some tax on agricultural income.

2. Income from Hindu Undivided Family (HUF) or partnership firm

Any sum received by an individual as a member of a Hindu Undivided Family, where the income of the family, or, income of the impartible estate belonging to the family, is completely exempt from income tax in the hands of an individual member of the family.

A taxpayer being a partner of a firm which is separately assessed as such, taxpayer share in the total income of the firm is completely exempt from income tax.

3. Income from Gratuity, leave encashment, voluntary retirement compensation etc.

3a. Gratuity:

Gratuity is a defined benefit plan and is one of taxpayer retirement benefits offered by taxpayer employer.

Gratuity is payable on:

Superannuation (or) Retirement
Resignation (or) Termination.
Death or Disablement due to accident or disease.
Retrenchment (or) Layoff.
VRS (Voluntary Retirement Scheme).

20 Lakh is the maximum gratuity amount that taxpayer can receive

Refer Tax on Retirement Benefits for more information

3b. Leave encashment

Maximum amount receivable by the employees as cash equivalent to the leave salary in respect of earned leave at their credit up to 10 months' leave at the time of their retirement, whether on superannuation or otherwise, would be Rs.3,00,000.

Refer Tax on Retirement Benefits for more information

NOTE: W.e.f 01st April 2023, the exemption under Leave Encashment at the time of retirement for Non-Government employees is increased to Rs 25,00,000 from Rs 3,00,000.

3c. Voluntary retirement compensation

The maximum amount of money received at such VR which is so exempt is Rs.5,00,000. Amount received by an employee of a public sector company or of any other company at the time of voluntary retirement (VR) or voluntary separation is exempted from tax.

4. Amounts received via claims and bonuses from insurance policies

Any amount received under the Life Insurance Policy (LIP), including the amount allocated by way of bonus on policy, other than u/s 80DDA or under a Key man Insurance Policy, or under an insurance policy issued on or after 01.04.2003 in respect of which the premium payable for any of the years during the term of the policy exceeds 20 per cent of the actual capital amount assured, is fully exempt from tax.

And, the entire amount received on death of the insured are fully exempt from tax.

5. Income from capital gain shares, bonds & other such debt instruments

Upto FY 2017-18 : The long term capital gains on sale of listed equity shares or equity mutual funds on which STT is paid is exempted from Income Tax

From FY 2018-19 to 23rd July 2024 : The Long-term capital gains on sale of listed equity shares or equity mutual funds on which STT is paid is taxable @ 10%. However, there is a exemption of Rs 1 lakhs capital gains

W.e.f FY 2024-25 : W.e.f 23rd July 2024, the long term capital gains on sale of listed equity shares or equity mutual funds on which STT is paid is taxable @ 12.5%. The long term capital gain exemption is increased to Rs 1.25 lakh from Rs 1 lakh

6. Income from dividend’s via mutual funds or shares

Until 31st March 2020 : The amount received from dividends on mutual funds or shares is exempted from tax up to Rs.10,00,000. And above 10 lakhs is 10% tax

W.e.f 01st April 2020 : Budget 2020 has withdrawn the Dividend Distribution Tax. Hence the exemption upto Rs 10 lakhs has been removed and the entire dividend is taxable in the hands of shareholder from FY 2020-21. The dividend is taxable as per slab rates of taxpayer

7. Income from Provident funds

If the taxpayer withdraws the amount in PF account after 5 years continuous service then the entire amount including the principal and interest withdrawn by taxpayer is tax free.

Interest amount is up to 9.5 % is exempt from tax above 9.5 % is taxable.

8. Disaster Compensation / Relief

An individual or his legal successors are 100% exempt from taxation on any sum received as compensation from the Central Government, State Government, or Local Authority in response to a disaster.

8a. Compensation Types

Financial compensation from the government or other organizations
Donations from individuals or organizations
Payments from insurance policies
The value of products or services received (typically from relief efforts)

8b. What were considered under the definition of "disaster"?

The term ‘disaster’ refers to a catastrophe, such as floods (river, ocean, lake), cyclones, landslides, hill rock fall, earthquakes, droughts, fires, human-made disasters such as oil spills and industrial accidents, that causes widespread damage and loss.

The disaster should have the effect of causing any of the following