Meaning of Exemption and Deduction in Income Tax

Generally, people are confused between two terms of Income Tax Act; Exemption and Deduction. They think both are the same as both are the tax benefit. But, it is not so. Exemptions and Deductions are different in nature from each other. In this post, I am explaining the differences between these two with the help of main sections.

What is Exemption

Exemption is the term under which your some incomes are exempted to tax. So, it reduces a part of your income from your taxable income. And this part of income is called Exempt Income.

Out of the different income sources, some incomes become exempt to tax. Hence, you have not to pay tax on such incomes and allowances. At the time of calculating tax, firstly you have to subtract these incomes from taxable income.

For example, if Shyam earns ₹ 8 lakh in a years which also includes ₹2 lakh agriculture income. In this case, the tax would be calculated only on ₹6 lakh as Agriculture income is exempt from tax.

Let us see what the main exemptions are available to you-

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Important Sections of Exemption

1. Sec. 10 (13A)- This section explains about House Rent Allowance to the salaried persons. You can avail exemption on it under some certain conditions.
2. Sec. 10 (5)- If you get Leave Travel Allowance from your employer. You can claim it as an exemption to tax.
3. Sec. 10 (10)- This section explains about Gratuity payable to government employees as a death cum retirement benefit. It is also available for exemption with certain limits.
4. Sec. 10 (10C)- The amount you receive under Voluntary Retirement Scheme is exempt to tax of the least of three conditions.
5. Sec. 10 (10D)- Any amount received from an insurance company in the form of maturity, surrender value or death claim is fully exempted to tax. But subject to certain conditions.
6. Sec. 10 (14)- This section makes provision about Children Education Allowance along with some other like hostel expenditure, transport, etc. for a maximum of 2 children. The exempted amounts are different for each allowance.
7. Sec. 10 (10A)- Commuted Value of Pension. It is fully exempted for government employees. However, for other employees, the exemption is limited to 1/2 or 1/3 of pension amount, as the case may be.
8. Sec. 24- Interest payment on Home Loan. The exemption is available up to ₹2 lakh.
9. Sec. 10 (1)- Agriculture Income. Any rent or revenue derived from the land situated in India is fully exempted to tax. But the land should be used for agricultural purposes.
10. Sec. 10 (15)(i)- Interest received from Post Office savings account are exempted to tax. It is different from the claim of deduction on interest incomes u/s 80TTA.
11. Sec. 10 (19)- Family pension to the family members of Armed Forces is fully exempt.
12. Sec. 57 (iia)- Family Pension in other cases is exempt to tax @33.33% or ₹15,000 whichever is less.

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What is deduction

Deduction is different from Exemption. It does not bother about your source of Income. Rather It depends upon the expense of your income.

If you use a specific amount for certain investments are expense, that amount would be deducted from your taxable income. It results into reduced tax liability,

For instance, In the above example the taxable income of Shyam is ₹6 lakh. He can use the tax deduction to further reduces the taxable income. For this he can invest ₹1 lakh in PPF account. The contribution in this scheme is eligible for tax deduction. Thus, this amount would be deducted from his taxable income of ₹6 lakhs. So, now his taxable income would be only ₹5 lakh thanks to the Tax deduction. you would be aware that, if your income is ₹5 lakh or less there would not be any tax liability.

Now let us discuss the main deductions that we generally use.

Important Sections of Deductions

1. Sec. 16 (ia)- This section defines the Standard Deduction of ₹50,000. You can straightly deduct this amount from your taxable income. But it is available only for salaried persons and pensioners.
2. Sec. 80C- The most popular and used section for the deduction. This section has many investment options. It gives you deduction benefit up to ₹1.5 lakh. Let us see-

(i) Public Provident Fund Account- An account in bank and post office with long term maturity of 15 years. Along with the investment, interest and maturity are tax free as well.

(ii) Employees Provident Fund- A saving scheme for salaried persons. Investment is deductible from taxable income. Also, the interest and maturity are tax free but under certain conditions.

(iii) Insurance Premium- As I said above the claim from insurance is eligible for exemption. The investment amount i.e. Premium is eligible for deduction as well.

(iv) Children Tuition Fees- Up to 2 children for a full time education.

(v) Sukanya Samriddhi Account- Saving for higher education and marriage of up to 2 girl child.

(vi) National Saving Certificate- 5 year saving scheme of Post Office. Investment and maturity are tax free. But interest is chargeable to tax.

(vii) Senior Citizen Saving Scheme- Investment made by persons above the age of 60 years is eligible for deduction.

(viii) Tax Saving Fixed Deposit- Fixed Deposit specially designed for tax saving. Investment is eligible for deduction but interest is chargeable.

(ix) Principal Repayment of Home Loan- As you know the interest on home loan is eligible for exemption. In the same vein, the principal amount is eligible for deduction.

(x) ULIP/ ELSS- Market based investment eligible for deduction.

3. 80CCC- Investment in Annuity plan of LIC or any other insurer.

4. 80CCD- National Pension Scheme for all Indian citizens. You can claim deduction on your contribution (up to ₹1.5 lakh). Along with contribution from your employer ( maximum 10% of salary) and your additional contribution (₹50,000).

5. 80D- Medical Insurance for yourself, your family and parents are also eligible for deduction with certain limits.

Some more Deductions

• 80G- Donation to political parties, Government Relief Funds and others are eligible for deduction. But the deduction may be 100% or 50% of the donation as the case may be.
• 80U- You can claim a deduction of ₹75,000 on physical disability and ₹1,25,000 on severe disability.
• 80TTA and 80TTB- Interest income from bank and post office deposits may be claimed as deduction within the limits.
• 80CCG- ‘Rajiv Gandhi Equity Schemes for Investment in Equities’ is eligible for deduction. It is available @ 50% of invested amount or ₹25,000 whichever is less.
• 80E- Interest on Education Loan is eligible for deduction up to 8 years.
• 80EE- Additional deduction of ₹50,000 on interest on home loan for the first time buyers.

Exemption Vs Deduction; A Comparative Study

Some tax saving instruments give exemption, some provide deduction benefit. However, some instruments have both tax saving feature. Like, Insurance, Home Loan etc.

To compare both in the better way we follow a comparative study. So, let us see-

1. The exemption you receive on the particular source of income, not on the total income. While deduction can be claimed on the gross total income.
2. Generally, Exemption applies on incomes and allowances you receive. But you get the deduction on your expenses and investments.
3. Hence, you get an exemption when you earn something. And deduction you get when you spend something.
4. It may be, that you have not to do any effort to earn some income. You may receive it as a privilege. If this extra income is eligible for the exemption, then, you can get the exemption very easily. On the other hand, if you do not go for an investment manually, you can not avail the deduction benefit.