What are Tax-free income sources in India?

Taxes can be overwhelming, especially during tax season, which often comes with an additional sense of stress. However, with a little knowledge about the exemptions available under the Income Tax (IT) Act of 1961, you can significantly reduce your taxable income. This article will explore the top nine tax-free income sources in India that you can leverage when filing your income tax return to maximise savings. 

Nine tax-free income sources in India 

1. Agricultural income 

Agricultural income has been exempted in India since the implementation of the IT Act in 1961 under Section 10(1). The provision was intended to support farmer welfare and bolster agricultural growth in the country. 

Section 2(1A) defines agricultural income to include:

• Income from the manufacture, processing, or sale of agricultural produce such as fruits, vegetables, grains, spices, etc. 
• Rental income generated from agricultural land or building connected to the piece of land
• Capital gains arising on the sale of agricultural land

Although agricultural income is completely tax-free, if it exceeds Rs 5000 a year, it will be added to your gross total income to determine your applicable tax slab. This partial integration of agricultural income does not affect its tax-free status. However, you may have to pay tax at higher rates on your non-agricultural taxable income.  

2. Gifts 

Section 56 (2)(x) governs the taxability of gifts in India. Here is a list of some fully exempt gifts: 

• Gifts received from relatives as defined in the Income Tax Act
• Gifts from non-relatives up to Rs 50,000. If the amount exceeds 50,000, the entire value becomes taxable.
• Gifts received on the occasion of marriage 
• Gifts received by way of will or inheritance 
• Gifts received from a person in contemplation of death
• Gifts received from registered charitable trusts or institutions 
• Gifts received from recognised medical institutions or hospitals 
• Gifts received from educational institutions or universities 
• Gifts received from local authorities 
• Gift received from a trust solely created for the benefit of the recipient 

3. Scholarships and rewards 

Scholarships or awards received from government, private or other institutions for educational purposes are fully exempt under Section 10 (16), with no upper limit on the tax-free amount. 

Additionally, Section 10(17A) grants tax-exempt status to awards or rewards received from the central or state governments or other government authorities. For instance, the monetary rewards associated with awards such as the Bharat Ratna or the Arjuna Award are tax-free.  

4. Gratuity

Gratuity is the monetary reward given by an employer to an employee upon retirement or resignation in recognition of their long-term service. Gratuity received by government employees is entirely tax-free under Section 10(10). However, there is no tax-free gratuity for non-government employees; the taxability in their case depends on whether the organisation is covered under the Payment of Gratuity Act, with different tax treatments for covered and non-covered organisations. 

5. Leave encashment  

Leave encashment allows employees to receive monetary compensation from their employers for unused paid leave. According to Section 10 (10AA), leave encashment is fully exempt from tax for government employees if received after retirement or the end of employment. However, any leave encashment received during employment is fully taxable for both government and non-government employees. Moreover, for non-government employees, leave encashment received at the end of employment is partially exempt from tax, subject to certain limits and conditions. 

6. Receipts from a Hindu Undivided Family (HUF)/share of profit from a partnership firm 

Primarily formed to maximise tax savings, a HUF is treated as a separate legal entity distinct from its members for tax purposes. According to Section 10(2), if any income is taxed in the hands of the HUF and subsequently passed on to its members, such income is tax-free in the hands of the members. 

Similarly, a partnership firm is considered a separate legal entity. Under Section 10(2A), the share of profit received by a partner will not be taxed in their hands if the income has already been taxed at the partnership firm level.

7. Pension 

Pension is the regular income that an employee receives from their employer after retirement. It can be classified as uncommuted or commuted. An uncommuted pension is given in the form of regular monthly payments and is fully taxable as salary. On the other hand, a commuted pension refers to a lump sum payment given instead of periodic payments. 

A commuted pension is fully exempt only for government employees. For non-government employees, a commuted pension is partially exempt, subject to certain limits and conditions.  

8. Interest income 

Interest is the monetary reward earned from savings and investments. There are different types of interest, such as those on bank deposits, government schemes, and bonds. While most interest income is taxable, some types are fully exempt. Here is a list of tax-exempt interest income:

• Interest on the Sukanya Samriddhi Scheme 
• Interest on Gold Deposit Bonds 
• Interest on Local Authority Bonds
• Interest on Deposits by Bhopal Gas Tragedy Victims 
• Interest on Tax-free Infrastructure Bonds
• Interest on Bonds issued by local government or authorities 
• Interest on Tax-free Fixed Deposits
• Interest on Employee Provident Fund (EPF) and Public Provident Fund (PPF) up to Rs 2.5 lakh/year

9. Income from provident funds 

A provident fund is a retirement savings scheme for salaried individuals, with three main types: Statutory Provident Fund (SPF), Recognised Provident Fund (RPF), and Public Provident Fund (PPF). 

An SPF is for government employees, universities, educational institutions and railways. Income from the SPF received by government employees is fully exempt from tax under Section 10(11). For non-government employees, income from the RPF is fully tax-exempt only if the withdrawal is made after five continuous years of service.  The PPF falls under the Exempt-Exempt-Exempt category, making contributions, earned interest and withdrawals tax-free for everyone.