All you need to know about exemption and deduction

Income Tax is a statutory liability and a compliance burden for most of the individual taxpayers, which they usually wish to reduce to the extent possible. In this bid, many try to decode the complex tax provisions in their favour.

It is not easy for a normal person to understand the complex terminologies used in any statute and the meaning assigned to it in the law.

But when it is about cutting your tax bills and saving your hard earned money, it is imperative for you to understand two vital words, ‘Exemption’ and ‘Deduction’. These two words can help in reducing the tax burden significantly.

Exemption

The word ‘exempt’ means “free from an obligation to do something or liability to pay”. For taxation, exemption means that the particular income is free from tax at source itself and no tax is chargeable on such income, subject to fulfillment of prescribed conditions. For example, House Rent Allowance (HRA) and Leave Travel Allowance (LTA).

 Nature of benefit: It is more in the nature of relaxation provided from taxability of income at source itself. Like conveyance allowance received by a salaried individual is exempt from tax up to Rs 1,600 per month.

 Who can claim exemption: Exemption is available to all equally if they satisfy the related eligibility conditions and generally they do not have to do anything more to get the exemption.

 Section applicable: In general, all the income of the assessee are taxable unless those are specifically exempt under the Act. Most common exemptions are listed under Section 10 of the Income Tax Act. These include conveyance (transport) allowance, HRA, LTA, that are part of salary and help in reducing taxable salary to a large extent.

 Purpose served: Generally, the exemptions are allowed to boost or to prompt particular purpose in which exemption is provided. For example, Long Term Capital Gain exemption under Section 54 is intended at boosting the real estate development in the housing sector.

Deduction

The word ‘deduct’ means ‘to subtract or to take away from the total’. For taxation, the term deduction means that certain investments or expenses are deductible from the taxable income. It simply means that you first have to calculate the taxable income, after considering the applicable exemption and then you use this taxable income for certain investments or tax deductible expenses.

These investments or expenses of yours can be deducted from  Gross Taxable Income to arrive at Net Taxable Income. For example, deduction of up to Rs 1.50 lakh for investing in certain tax saving instruments like EPF, PPF, NSC, ELSS, insurance, etc., other deductions like medical insurance or expense and donations to certain charities.

 Nature of benefit: Deduction is a concession allowed by way of reduction from taxable income, based on certain investments or expenses or payment made by the taxpayer.

 Who can claim deduction: Deduction is available to only those who invested in specified investment options or incurred certain qualifying expenses. Deduction can’t exceed the taxable income of the individual, it means if you don’t have taxable income you cannot claim the deduction.

 Section applicable: Generally, the deductions relating to individuals are listed in Section 80C to 80U. Other than this, there are few other deductions which are available under particular head of income, like Professional tax deduction under Section 16 and Property tax deduction under Section 23, among others.

 Purpose served: To promote savings and investments of the general public and to make provision of welfare for the society in general. For example, Section 80DD allows a deduction for medical expenses of disabled dependents, which is intended at the welfare of disabled persons.

Once you thoroughly understand the various exemptions and deductions that you are eligible for, you can reduce your tax liabilities to a great extent. 

(The writer is Director at H&R Block India)