EXEMPTION UNDER TAX LAW

Exemptions relating to tax depend upon the nature of income. Agricultural income, pension, allowances etc are in the list of exemption. Speaking about tax exemption, it can be said as a method to reduce the taxable income. To encourage certain economic activities, tax exemptions are offered. In addition, deduction of tax at source can be availed.

There are various sections regarding the Tax exemption available under Income Tax Act 1961:

Sec. 10 of the Income Tax Act, 1961 includes various items of income in different clauses which are excluded from the total income (known as exempted incomes). Such incomes shall not enter into the computation of taxable income. In addition to that, there are certain other incomes which are included in Gross total income which is wholly or partly allowed in the form of deductions as mentioned under Ch-VI-A of the Act in computation of total income.

EXEMPTED INCOME

There are various incomes that are exempted from tax along with certain necessary conditions required for eligibility.

Sec. 10(1) – Under this, agricultural income should not be included in the total income of the assessee. The reason behind this clause is that under the Constitution, the Central Govt. has no power to levy a tax on agricultural income.

Now the definition of agricultural income is covered under Section 2(1A) of the Act.

It covers not only the income of the cultivators but also the land holders who might have rented out the land. It may be received in cash or in kind and may arise in any one of the 3 ways –

• It can be a rent or revenue derived from land situated in India which is used for agricultural purposes only.

There are 3 conditions which need to be fulfilled –

• 1. Rent or revenue should be derived from land.
  2. Land should be situated in India (the entire income will be taxable if the agricultural land outside India).
  3. Land should be for agricultural purposes only.

The rent can either be received by the owner or by the original tenant from the sub-tenant.

The scope of ‘Revenue’ is much broader as it includes income other than rent like fees received for renewal for grant of land on lease would be revenue derived from land. 

• The income can be derived from such land by:

• • Agriculture – The term “Agriculture” has not been defined in the Act. However, cultivation of a field involving human skill and labour on the land can be broadly termed as agriculture. “Agriculture” means tilling of the land, sowing of the seeds and similar operations which involve basic operations and subsequent operations.
  • Process ordinarily employed by a cultivator or receiver of rent in kind to render the produce fit to be taken to the market – It includes thrashing, winnowing, cleaning, drying, crushing etc. For example, the process ordinarily employed by the cultivator to obtain the rice from paddy is to first remove the hay from the basic grain, and thereafter to remove the chaff from the grain. The grain has to be properly filtered to remove stones etc. and finally the rice has to be packed in gunny bags for sale in the market. After such a process, the rice can be taken to the market for sale. This process of making the rice ready for the market may involve manual operations or mechanical operations. All these operations constitute the process ordinarily employed to make the product fit for the market. The product must retain its original character in spite of the processing unless there is no market for selling it in that condition. However, if the marketing process is performed on a product which can be sold in its raw form, income derived therefrom is partly agricultural income and partly business income.
  • Sale of such agricultural produce in the market: Any income from the sale of any produce to the cultivator or receiver of rent-in-kind is agricultural income from the land situated in India and used for agricultural purposes. If the produce is subjected to any process other than process ordinarily employed to make the produce fit for market, the income arising on sale of such produce would be partly agricultural income and partly non-agricultural income. Similarly, if other agricultural produce like tea, cotton, tobacco, sugarcane etc. are subjected to manufacturing process and the manufactured product is sold, the profit on such sale will consist of agricultural income as well as business income. That portion of the profit will be exempted.

Apportionment of Income between business income and agricultural income

Under Rules 7, 7A, 7B & 8 of Income-tax Rules, 1962 mentions the basis of apportionment of income between agricultural income and business income.

• • Rule 7 mentions (Income from growing and manufacturing of any product) – Where income is partially agricultural income and partially income chargeable to income-tax as business income. The market value of any agricultural produce, which the assessee has raised or received by him as rent and utilized as raw material in such business or the sale receipts, are included in the accounts of the business & shall be deducted. No further deduction shall be made in respect of any expenditure incurred by the assessee as a cultivator or receiver of rent in kind.
  • Rule 7A mentions (Income from growing and manufacturing of rubber) – This rule is applicable when income derived from the sale of centrifuged latex or cenex or latex based crepes or brown crepes or technically specified block rubbers manufactured or processed from field latex or coagulum obtained from rubber plants grown by the seller in India. In such cases 35% profits on sale is taxable as business income under the head “profits and gains from business or profession”, and the balance 65% is agricultural income and is exempted.
  • Rule 7B – Income from growing and manufacturing of coffee 

1. 1. 1. Income derived from the sale of coffee grown and cured by the seller in India, 25% profits on sale is taxable as business income under the head “Profits and gains from business or profession”, and the balance 75% is agricultural income and is exempted.
      2. Income derived from the sale of coffee grown, cured, roasted and grounded by the seller in India, with or without mixing chicory or other flavoring ingredients, 40% profits on sale is taxable as business income under the head “Profits and gains from business or profession”, and the balance 60% is agricultural income and is exempted.

• • Rule 8 mentions Income from growing and manufacturing of tea – This rule applies only in cases where the assessee himself grows tea leaves and manufactures tea in India. In such cases 40% profits on sale is taxable as business income under the head “Profits and gains from business or profession”, and the balance 60% is agricultural income and is exempted.

• Income from farm building:

Income from the farm building which is owned and occupied by the receiver of the rent or revenue of any such land or occupied by the cultivator or the receiver of rent in kind, of any land with respect to which, or the produce of which, any process discussed above is carried on, would be agricultural income. The income arising from the use of such farm building for any purpose (including letting for residential purpose or for the purpose of business or profession) would not be agricultural income. Further, the income from such farm building would be agricultural income only if the following conditions are satisfied: 

1. • The building should be on or in the immediate vicinity of the land; and
   • The receiver of the rent or revenue or the cultivator or the receiver of rent in kind should be a dwelling house or as a storehouse.
   • The land should either be assessed to land revenue in India or be subject to a local rate assessed and collected by the officers of the Government as such or;
   • Where the land is not so assessed to land revenue in India or is not subject to local rate:-

• • • It should not be situated in any area as comprised within the jurisdiction of a municipality or a cantonment board and which has a population not less than 10,000 or
    • It should not be situated in any area within such distance, measured aerially, in relation to the range of population

Sec. 10(2) – It mentions the amounts received by a member from the income of the HUF.

• • Income earned by the HUF is accessible in its own hands.
  • It provides that members of a HUF do not have to pay tax in respect of any amounts received by them from the family in order to prevent double taxation of one and the same income.

The exemption applies only in respect of a payment made by the HUF to its member

• • Out of the income of the family or
  • Out of the income of the importable estate belonging to the family.

Sec. 10(2A) – It mentions the share income of a partner. It exempts from tax a partner’s share in the total income of the firm. In other words, the partner’s share in the total income of the firm determined in accordance with the profit-sharing ratio will be exempt from tax.

Sec. 10(4)(ii)– It mentions about the interest on moneys standing to the credit of individual in his NRE A/c – Any income by way of interest on moneys standing to his credit in a Non-resident (External) Account (NRE A/c) in any bank in India in accordance Foreign Exchange Management Act, 1999 (FEMA, 1999), and the rules made there under, would be exempt, provided such individual; 

• • Is a person resident outside India, as defined in FEMA, 1999, or 
  • Is a person who has been permitted by the Reserve Bank of India to maintain such an account. 

Sec. 10(6) – It mentions about the remuneration received by individuals, who are not citizens of India – Individual assessees who are not citizens of India are entitled to certain exemptions:

Section 10(6)(ii) –  The remuneration received by a person for services as an official of an embassy, high commission, legation, commission, consulate or the trade representation of a foreign State or as a member of the staff of any of these officials is exempt. 

Conditions:

1. 1. The remuneration received by our corresponding Government officials or members of the staff resident in such foreign countries should be exempt.
   2. The above-mentioned members of the staff should be the subjects of the respective countries represented and should not be engaged in any other business or profession or employment in India.

Section 10(6)(vi) – Remuneration received by a foreign national as an employee of a foreign enterprise for service rendered by him during his stay in India is also exempt from tax.

Conditions:

1. 1. The foreign enterprise is not engaged in any business or trade;
   2. The employee’s stay in India does not exceed 90 days during the previous year;
   3. The remuneration is not liable to be deducted from the employer’s income chargeable to tax under the Act.

Sec. 10(6)(viii) – Salary income received by or due to a non-citizen of India who is also non-resident for services rendered in connection with his employment on a foreign ship is exempt where his total stay in India does not exceed 90 days during the previous year.

Sec. 10(6)(xi) – Any remuneration received by employees of foreign Government from their respective Government during their stay in India, is exempt from tax, if such remuneration is received in connection with their training in any establishment or office of or in any undertaking owned by –

1. 1. Government; or
   2. any company wholly owned by the Central or any State Government(s) or jointly by the Central and one or more State Governments;
   3. any company which is subsidiary of a company referred to in (b) above; or
   4. any statutory corporation; or
   5. any society registered under the Societies Registration Act, 1860 or any other similar law, which is wholly financed by the Central Government or any State Government(s) or jointly by the Central and one or more State Governments.

Section 10(10BC) – It mentions about the compensation received on account of disaster

1. 1. This clause exempts any amount received or receivable as compensation by an individual or his legal heir on account of any disaster.
   2. Such compensation should be granted by the Central Government or a State Government or a local authority.
   3. Exemption would not be available in respect of compensation for alleviating any damage or loss, which has already been allowed as deduction under the Act.
   4. “Disaster” means a catastrophe, mishap, calamity or grave occurrence in any area, arising from natural or manmade causes, or by accident or negligence. It should have the effect of causing – (1) substantial loss of life or human suffering; or (2) damage to, and destruction of, property; or (3) damage to, or degradation of, environment. It should be of such a nature or magnitude as to be beyond the coping capacity of the community of the affected area.

Sec. 10(11A) mentions about the payment from Sukanya Samriddhi Account – any payment from an account opened in accordance with the Sukanya Samriddhi Account Rules, 2014, made under the Government Savings Bank Act, 1873, shall not be included in the total income of the assessee. The interest accruing on deposits in, and withdrawals from any account under the said scheme would be exempt.

Sec. 10(16) provides educational scholarships – The value of scholarship granted to meet the cost of education would be exempt from tax in the hands of the recipient irrespective of the amount or source of scholarship.

Sec. 10(17) provides payments to MPs & MLAs – The following incomes of Members of Parliament or State Legislatures will be exempt:

1. 1. Daily Allowance – Daily allowance received by any Member of Parliament or of any State Legislatures or any Committee thereof.
   2. Constituency Allowance of MPs – In the case of a Member of Parliament, any allowance received under Members of Parliament (Constituency Allowance) Rules, 1986; and
   3. Constituency allowance of MLAs – Any constituency allowance received by any person by reason of his membership of any State Legislature under any Act or rules made by that State Legislature.

Sec. 10(17A) provides awards for literary, scientific and artistic works and other awards by the Government – Any award instituted in the public interest by the Central/State Government or by any other body approved by the Central will enjoy exemption under this clause.

Sec. 10(18) provides pension received by recipient of gallantry awards – Any income by way of pension received by an individual is exempt from income-tax if –

1. 1. The individual was an employee of the Central or State Government and has been awarded “Param Vir Chakra” or “Maha Vir Chakra” or “Vir Chakra” or such other gallantry award notified by the Central Government on this behalf.

In case of the death of such an individual, income by way of family pension received by any member of the family shall also be exempt under this clause.

Sec. 10(26AAA) provides specified income of a Sikkimese Individual – The following income, which accrues or arises to a Sikkimese individual, would be exempt from income-tax –

1. 1. Income from any source in the State of Sikkim; or
   2. Income by way of dividend or interest on securities.

However, this exemption will not be available to a Sikkimese woman who, on or after 1st April, 2008, marries a non-Sikkimese individual.

TAX HOLIDAY FOR UNITS ESTABLISHED IN SPECIAL ECONOMIC ZONES [SECTION 10AA]

A deduction of profits and gains which are derived by an assessee being an entrepreneur from the export of articles or things or providing any service, shall be allowed from the total income of the assessee.

1. Assessee who are eligible for exemption – Exemption is available to all categories of assessees who derive any profits or gains from an undertaking, being a unit, engaged in the manufacturing or production of articles or things or provision of any service. 

Such assessee should be an entrepreneur (section 2(j) of the SEZ Act, 2005) i.e., a person who has been granted a letter of approval by the Development Commissioner under section 15(9) of the said Act.

Essential conditions to claim exemption

• • It has begun to manufacture or produce articles or things or provide any service in any SEZ during the previous year relevant to A.Y.2006- 07 or any subsequent assessment year but not later than A.Y.2020-21.
  • The assessee should furnish in the prescribed form, before the date specified in section 44AB i.e., one month prior to the due date for furnishing return of income, the report of a chartered accountant certifying that the deduction has been correctly claimed.

The unit of an entrepreneur, which begins to manufacture or produce any article or thing or provide any service in a SEZ on or after 1.4.2005, shall be allowed a deduction of:

1. 100% of the profits and gains derived from the export, of such articles or things or from services for a period of 5 consecutive assessment years beginning with the assessment year relevant to the previous year in which the unit begins to manufacture or produce such articles or things or provide services, and
2. 50% of such profits and gains for further 5 assessment years.
3. not exceeding 50% of the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is to be allowed and credited to a reserve account (to be called the “Special Economic Zone Re-investment Reserve Account”) to be created and utilized in the manner laid down under section 10 AA(2) for next 5 consecutive years.

Conditions to be satisfied for claiming deduction for further 5 years (after 10 years) [Section 10AA(2)] –

It provides that the deduction under (3)(iii) above shall be allowed only if the following conditions are fulfilled, namely:-

• The amount credited to the Special Economic Zone Re-investment Reserve Account is utilised-
  • for the purposes of acquiring machinery or plant which is first put to use before the expiry of a period of three years following the previous year in which the reserve was created; and
  • until the acquisition of the machinery or plant as aforesaid, for the purposes of the business of the undertaking.

However, it should not be utilized for

• • Distribution by way of dividends or profits; or
  • for remittance outside India as profits; or
  • for the creation of any asset outside India;

Consequences of non-utilisation of reserve [Section 10AA(3)] –

Where any amount credited to the Special Economic Zone Re-investment Reserve Account –

1. has been utilised for any purpose other than those referred to in subsection (2), the amount so utilized shall be deemed to be the profits in the year in which the amount was so utilised and charged to tax accordingly; or
2. has not been utilised before the expiry of the said period of 3 years, the amount not so utilised, shall be deemed to be the profits in the year immediately and be charged to tax accordingly.

Computation of profits and gains from exports of such undertakings – The profits derived from export of articles or things or services (including computer software) shall be the amount which bears to the profits of the business of the undertaking.

Restriction on other tax benefits

1. The business loss under section 72(1) or loss under the head “Capital Gains” under section 74(1), relates to the business of the undertaking, being the Unit shall be allowed to be carried forward or set off.
2. The assessee should furnish a report from a Chartered Accountant in the prescribed form along with the return of income certifying that the deduction is correct.
3. During the period of deduction, depreciation is deemed to have been allowed on the assets. Written Down Value shall accordingly be reduced.
4. No deduction under section 80-IA and 80-IB1 shall be allowed in relation to the profits and gains of the undertaking.
5. Where any goods or services held for the purposes of eligible business are transferred to any other business carried on by the assessee, or
6. Where any goods held for any other business are transferred to the eligible business and, in either case, if the consideration for such transfer as recorded in the accounts of the eligible business does not correspond to the market value thereof, then the profits eligible for deduction shall be computed by adopting market value of such goods or services on the date of transfer.

In case of exceptional difficulty in this regard, the profits shall be computed by the Assessing Officer on a reasonable basis as he may deem fit.

Similarly, where due to the close connection between the assessee and the other person or for any other reason, it appears to the Assessing Officer that the profits of Deduction under section sections 80-IA and 80-IB are dealt with at Final Level eligible business is increased to more than the ordinary profits, the Assessing Officer shall compute the amount of profits of such eligible business on a reasonable basis for allowing the deduction.

1. Where a deduction under this section is claimed and allowed in relation to any specified business eligible for investment-linked deduction under section 35AD, no deduction shall be allowed under section 35AD in relation to such specified business for the same or any other assessment year.

Deduction allowable in case of amalgamation and demerger

In the event of any possibilities, being the unit which is entitled to deduction under this section, being transferred, before the expiry of the period clearly mentioned in this section, to another undertaking, being the unit in a scheme of amalgamation or demerger-

1. No deduction shall be admissible to the amalgamating or the demerged Unit for the previous year in which the amalgamation or the demerger takes place; and
2. The provisions of this section would apply to the amalgamated or resulting Unit, as they would have applied to the amalgamating or the demerged Unit had the amalgamation or demerger had not taken place.

RESTRICTIONS ON ALLOWABILITY OF EXPENDITURE [SECTION 14A]

Section 14A(1) – Expenditure incurred in relation to any exempt income is not allowed as a deduction while computing income under any of the five heads of income.

Section 14A(2) – The Assessing Officer is empowered to determine the amount of expenditure incurred in relation to such income which does not form part of total income in accordance with such method as may be prescribed.

Such method should be adopted by the Assessing Officer in the following cases –

• if he is not satisfied with the correctness of the claim of the assessee, having regard to the accounts of the assessee. or
• where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of total income

Rule 8D lays down the method for determining the amount of expenditure in relation to income not includible in total income.

If the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with –

1. the correctness of the claim of expenditure by the assessee; or
2. the claim made by the assessee that no expenditure has been incurred in relation to exempt income for such previous year, he shall determine the amount of expenditure in relation to such income in the manner provided hereunder –

The expenditure in relation to income not forming part of total income shall be the aggregate of the following:

1. the amount of expenditure directly relating to income which does not form part of total income;
2. an amount equal to 1% of the annual average of the monthly averages of the opening and closing balances of the value of investment, income from which does not form part of total income. However, the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.