The Income Tax Act, 1961 contains a detailed framework that determines how income is taxed in India. While most receipts are taxable unless specifically exempted, the Act also provides several categories of income that do not form part of total income under Sections 10 to 13B. These exemptions are essential for promoting economic welfare, encouraging investments, supporting charitable activities, providing relief to certain categories of taxpayers, and ensuring equitable taxation.
Understanding exempt income is crucial for accurate tax planning, compliance, and examination preparation. Courts have consistently held that exemptions must be interpreted strictly, as they constitute exceptions to the rule of taxability. In Novopan India Ltd. v. CCE (1994), the Supreme Court observed that exemption notifications should be construed narrowly, and taxpayers must strictly satisfy the conditions to avail the exemption. Similarly, in CIT v. Gwalior Rayon Silk Manufacturing Co. (1992), the Court highlighted that exemptions operate only when the statutory language expressly provides them.
Exempt income plays a foundational role in the computation of total income, as any income falling within these sections is excluded at the very first stage, ensuring that the taxpayer is not assessed for such receipts.
Overview of Section 10 Exemptions
Section 10 of the Income Tax Act lists multiple forms of income that do not form part of total income. These include agricultural income, allowances, share of profit from partnership firms, exempt incomes for charitable or political institutions, and specific categories of capital gains. Most exemptions aim to support social objectives and reduce the tax burden on individuals engaged in certain activities.
Tip: Always remember that Section 10 exemptions are applied before computing the gross total income.
Agricultural Income – Section 10(1)
Agricultural income is fully exempt from tax because of constitutional principles. Article 246 read with Entry 46 of the State List allows only state governments to tax agricultural income. Therefore, Parliament cannot levy tax on such income.
The Supreme Court in CIT v. Raja Benoy Kumar Sahas Roy (1957) held that agricultural income includes basic operations like tilling, sowing, and harvesting, as well as subsequent operations integrally connected with the agricultural process.
However, agricultural income may indirectly affect tax liability through the partial integration method in the case of individuals and HUFs when their non-agricultural income exceeds the threshold.
Payments Received by Members of HUF – Section 10(2)
Any amount received by a member from the Hindu Undivided Family is exempt, as the family is already assessed on its income. This prevents double taxation.
Partner’s Share in Firm – Section 10(2A)
A partner’s share of profit from a firm assessed as a partnership firm under the Act is exempt in the hands of the partner. The Supreme Court in CIT v. R.M. Chidambaram Pillai clarified that a firm is a separate taxable entity; therefore, partners are not taxed again on profits.
Leave Travel Concession – Section 10(5)
Employees can claim exemption for travel expenses incurred during leave, subject to restrictions on destinations (India only), travel mode, and eligible family members.
Tip: LTA exemption is available only on actual travel; encashment without travel is not exempt.
Allowances to Government Employees
Various allowances granted to government employees are exempt, such as:
- Foreign allowance under Section 10(7).
- Allowances to High Court and Supreme Court judges under Section 10(10A).
These exemptions support public offices that require special conditions of service.
Exemptions Related to Retirement Benefits
Gratuity – Section 10(10)
Gratuity received by government employees is fully exempt. For non-government employees, it is exempt to the extent specified under the Gratuity Act or the limits notified by the government. In Bharat Earth Movers v. CIT, the Supreme Court held that gratuity provisions recognized by law promote social welfare and must be viewed beneficially.
Pension – Section 10(10A)
Commuted pension received by government employees is fully exempt. For non-government employees, only a portion of commuted pension is exempt.
Leave Encashment – Section 10(10AA)
Leave encashment during service is fully taxable; however, encashment at retirement is exempt up to specified limits.
Voluntary Retirement Compensation – Section 10(10C)
Amounts received under Voluntary Retirement Schemes (VRS) are exempt up to ₹5,00,000 if the scheme complies with Rule 2BA.
Exemptions Related to Capital Gains
Long-Term Capital Gains from Equity – Section 10(38)
Before its withdrawal in 2018, LTCG on equity shares subject to STT was exempt. Although replaced by Section 112A (taxing LTCG above ₹1 lakh at 10%), cases decided during the earlier regime still apply for interpretational guidance.
Capital Gains of Charitable Trusts
Capital gains applied for charitable purposes are exempt under Sections 11 and 12.
Tip: Charitable trusts must ensure proper application of funds to maintain exemption status.
Income from Charitable and Religious Trusts
Sections 11, 12, 12A, and 13 exempt income received by trusts established for charitable or religious purposes, provided conditions such as registration, application of income, and compliance with audit requirements are met.
The Supreme Court in Addl. CIT v. Surat Art Silk Cloth Manufacturers Association (1980) held that the dominant purpose test determines whether an institution’s income qualifies as charitable.
Exemptions to Educational and Medical Institutions
Under Sections 10(23C)(iiiab), (iiiad), and (vi), income of educational institutions and hospitals existing solely for educational or philanthropic purposes is exempt. The exemption applies if they are wholly or substantially financed by the Government or meet prescribed thresholds.
Exemptions for Political Parties – Section 13A
Political parties receive exemption for income from voluntary contributions, membership fees, and certain other receipts, provided they maintain audited accounts and comply with disclosure requirements. This provision promotes transparency and accountability in political funding.
Dividends and Business Exemptions
Dividend Income – Section 10(34)
Earlier, dividend income was exempt because companies paid Dividend Distribution Tax (DDT). After the abolition of DDT in 2020, dividends became taxable again in the hands of shareholders. However, historical cases like Apollo Tyres v. CIT guide interpretation relating to exempt dividend regimes.
Income from Units of Mutual Funds – Section 10(35)
Certain income from mutual fund units remains exempt, promoting investment in markets.
Exemption for Units in SEZ – Section 10AA
Units operating in Special Economic Zones enjoy profit-based exemptions for a prescribed period to encourage export-oriented growth.
Scholarships and Awards – Section 10(16) and 10(17A)
Scholarships granted to meet educational expenses are fully exempt. Awards instituted by the government or approved bodies are also exempt, promoting academic and social excellence.
Tip: Stipends given to students for research may qualify as scholarships if they support education, as held in Lok Sabha Secretariat v. CIT.
Income Exempt Under Sections 10B, 10BA
Export-oriented units in manufacturing or IT enjoy exemptions to promote international competitiveness. Courts have emphasized strict compliance with conditions, as seen in CIT v. Yokogawa India Ltd., where the Supreme Court clarified the treatment of deductions for Section 10A/10B units.
Conclusion
Income not forming part of total income represents one of the most significant components of Indian tax law, ensuring fairness, promoting development, and supporting vulnerable or priority sectors. While the list of exemptions is extensive, each exemption carries specific conditions and judicial interpretation. Law students must thoroughly understand the statutory framework, judicial principles, and policy rationale behind these exemptions, as they form the foundation for tax planning, litigation, and advisory work.
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Appropriation of Payments under the Indian Contract Act, 1872