Tax exemption
Tax exemption can be an income or an investment which is not taxable. These incomes or investments pertain to a specific head of income and can be claimed from those heads only. After deducting allowed exemptions from the specific income head, the different heads of income are totalled to arrive at the gross income.
For instance, under the ‘Income from salary’ head, you can claim an exemption for House Rent Allowance (HRA), Leave Travel Allowance (LTA) and Leave Encashment. After these exemptions are availed, the taxable portion of ‘Income from Salary’ would be obtained.
Tax exemptions can also be termed as tax free incomes. For eg, interest income of PPF, Maturity/Death benefit from life insurance policies. In short, incomes which are not taxable in the first place.
Tax Deduction
Now let us see what are Tax deductions. It also lets you lower your tax liability. Once you compute your gross total income, the Income Tax Act allows you to deduct some amount from your income. So that your income reduces and thereby reduces your tax liability.
This amount is based on certain investments or expenses you make in a financial year as per Income Tax Act called Deductions. Allowed deductions can be found in Chapter VIA of the Income Tax Act. This chapter contains sections 80C to 80U.
Common examples include life insurance premiums, health insurance premiums, ELSS investments, PPF investment, Repayment of principal component of home loan etc.
Moreover, there are certain other deductions available from a particular head, like standard deduction from salary income, Interest paid on home loan from “Income from house property” which help in lowering tax outgo.
Tax deductions are deducted from the gross total income or individual head to help save taxes.
Exemption Vs Deduction
Incidence
Tax exemption – The allowed exemptions are not included in your taxable income. They are deducted first to arrive at your gross total income.
Tax deduction – Deductions remain clubbed with your income. Once the gross total income is calculated, the deductions are deducted to arrive at Net taxable income. On this income, tax slabs are applied to calculate the tax amount.
Application
Tax exemption – Exemptions are applied at each head of income to get the taxable amount of that particular head.
Tax deduction – Deductions are applied to your gross total income.
Significance
Tax exemption – It consists of those items which are not taxable.
Tax deduction – Deductions are those items which are taxable but because of the provisions of the act, their taxability has been reduced.
A particular amount, which is reduced from an individual’s total tax liability, is called an income tax deduction.
A particular income, which is exempt from tax and thus, not included in one’s total tax liability is called an income tax exemption.
Tax deductions are covered between the scope of Section 80C to 80U of the Income Tax Act
Tax exemptions are generally covered under Section 10 of the Income Tax Act.
To be eligible for tax deductions, you have to meet certain predetermined criteria.
Any taxpayer in the country can qualify for income tax exemptions
Some examples of Income Tax deductions are: investments made in Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF), and National Pension Scheme (NPS).
Some examples of Income Tax Exemptions are:
House Rent Allowance, Leave Travel Allowance, Entertainment Allowance, Long Term Capital Gains on Equity Funds.
So, though exemptions and deductions have the same goal – reduction of your tax outgo, they are different. You should know the difference to file your taxes properly. Mistakes in tax filing can lead to penalties and unnecessary hassles. Though they sound technical the concept of exemptions and deductions is not complicated. Just a little understanding is all you need. So, the next time you file your taxes, know which items are exemptions, which are deductions and how they differ.
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