We tell you the difference between allowance, deductions & exemptions

Have you ever been confused by different financial terminologies, I believe, many times? But don’t worry, when it comes to understanding income tax jargons and laws, you are not the only one who gets bewildered by these. Considering this fact, there are few specific terms under income tax act, which always confuse many taxpayers and these are Exemption, deductions and allowances.

All these are nothing but different options for reducing your tax outgo and can be availed as allowed under income tax act. Let us understand these terms in detail: -

Income tax exemption, deduction and allowance, similar yet different terms. Similar because all are related to different benefits as available to a taxpayer but different because of the applicability and availability of these items to the Taxpayer. So it becomes necessary for you to understand these terms to optimally utilise these items to minimize your tax liability.

All these terms be it ‘Allowances’, ‘tax deduction’ and ‘tax exemption’ refers to lowering of taxable income; these are various tax reliefs and tax breaks as provided by the government to a taxpayer.

Tax Allowance:

The dictionary meaning of allowance is ‘the amount of something that is permitted, especially within a set of regulations or for a specified purpose’ i.e. for example allowance is a payment made by an employer to an employee for a specific purpose. The earned income is expected to be utilized for the specific purpose for which it is given. For ex. House Rent Allowance should be utilized to meet the Rent Expenses.

Below is the suggestive list of allowances for understanding purpose:

• Dearness Allowance
• Performance Allowance
• Conveyance Allowance
• Laundry Allowance
• House Rent Allowance
• Transportation Allowance etc.     

Tax Exemptions:

Tax Exemption means a part of your income which will not be taxable. These are available in two types, Partial Exemption and total exemption. Some incomes are fully exempt such as dividend earned from equity shares and some are exempt to an extent only, like transport allowance which is exempt only up to Rs 1600/- per month or less. 

Other Examples of ‘Exemption’:

a) House rent allowance

b) Leave travel allowance

c) Leave encashment

Tax exemptions may include complete relief from taxes or tax only on a portion of your income and to encourage investments, the government generally offers tax exempt entities to invest in. Such entities are exempted from a single or multiple taxation laws. For example, investments in the Sukanya Samriddhi Scheme are fully tax exempt. Money deposited under this scheme will be exempted from tax at the time of investment, accumulation of interest and payout of returns i.e. following the EEE regime i.e. exempt, exempt, exempt. 

Tax Deductions

In case of tax deductions, your income tax liabilities decrease by a specified amount for spending money in specified avenues. You invest in various schemes to reduce your taxable income, for example, you can get tax deduction by paying life insurance premiums or towards payments of your home loan principal amount . Tax deductions are offered by government to tempt taxpayers to participate in programs carrying societal benefits.

Deduction is termed as reduction from something. Tax Deduction is basically the deduction allowed in income tax on application of income in prescribed instruments. These all are available at the discretion of the taxpayer. The more you invest, the more deduction you will get as per the limits prescribed under the income tax act.

Few examples of Deductions:

a) Section 80C – Payments to investments as mentioned in the section.

b) Section 80D – Payments for medical insurance premium.

c) Section 80E – Payments to repayment of interest on education loan.

d) Section 80G – Payments to charitable institutions as donations.

Rishabh Parakh is a Chartered Accountant and the Chief Gardener & Founder Director of Money Plant Consulting, a leading Tax & Investment Planning Advisory Service Provider. He also runs a personal finance blog called “Mango Investor” aka AAM Niveshak at www.mangoinvestor.com.