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Tax Explainer | June 2026
Not every rupee you receive is meant to be taxed. The Income-tax Act, 2025 sets aside an entire chapter, Chapter III, just for income that Parliament has decided should stay completely outside the tax net, not as a deduction that reduces your taxable income, but as income that is never counted as part of your total income in the first place. This is a meaningfully different and stronger form of relief than a deduction, and it is spread across seven separate Schedules attached to the Act. This article walks through Sections 11 and 12, and gives you a clear, practical map of what these Schedules actually cover, so you know where to look when you receive a sum of money and wonder whether tax even applies to it at all.
Sections 11 & 12
Chapter III of the Income-tax Act, 2025 contains just two operative sections, which work by pointing to seven detailed Schedules.
Schedules II-VIII
Each Schedule covers a different category of person or income, from individuals to non-residents to political parties.
Conditions Matter
Every single exemption in these Schedules is conditional; if the stated condition fails in any year, that income becomes fully taxable for that year.
Not a Deduction
Exempt income under this chapter is excluded before total income is even computed, unlike a deduction which reduces income after it is included.
Table of Contents
- How Chapter III Actually Works: Two Sections, Seven Schedules
- Why “Exempt” Almost Always Comes With a Condition Attached
- Schedule II: Common Exemptions for Individuals
- Schedule III: Exemptions Tied to Specific Eligible Persons
- Schedule IV: Non-Residents, Foreign Companies, and Diplomats
- Schedule V: Investment Funds and Business Trusts
- Schedule VI: International Financial Services Centre Entities
- Schedule VII: Persons Exempt From Tax Entirely
- Schedule VIII: Political Parties and Electoral Trusts
- Two Mistakes to Avoid When Relying on These Exemptions
- Frequently Asked Questions
Part IHow Chapter III Actually Works: Two Sections, Seven Schedules
Chapter III is unusually short for how much ground it covers. Section 11(1) simply states that in computing the total income of any person for a tax year, any income listed in Schedules II, III, IV, V and VI shall not be included, subject to the conditions specified in those Schedules. Section 11(3) does something similar but for entire categories of persons, rather than specific items of income, by saying that persons listed in Schedule VII are not chargeable to tax on their total income at all, again subject to conditions. Section 12 then carves out a separate, parallel rule specifically for political parties and electoral trusts, pointing to Schedule VIII.
The practical effect of this structure is that the real substance of Chapter III does not live in the Act’s main body at all, it lives in the Schedules. Each Schedule targets a different slice of the taxpayer universe. Schedule II applies broadly to any person. Schedule III applies to specific eligible persons named alongside each item, such as HUF members or Members of Parliament. Schedule IV is aimed at non-residents and foreign entities. Schedule V covers investment funds and business trusts. Schedule VI is for entities connected to an International Financial Services Centre. Schedule VII lists out specific bodies and funds that are exempt in their entirety. Schedule VIII is reserved for political parties and electoral trusts.
Why this matters for how you read the law: if you want to know whether a particular receipt is tax-free, the answer is almost never in Chapter III itself. You have to go to the relevant Schedule, find the specific row that matches your situation, and then check the conditions in that row carefully, since the exemption only applies if every condition is met.
Part IIWhy “Exempt” Almost Always Comes With a Condition Attached
Section 11(2) and Section 11(4) both make the same point in slightly different words: wherever the conditions specified for an exemption are not satisfied in a particular tax year, the income in question is charged to tax in that year under the normal provisions of the Act. This is true whether the exemption was for a specific item of income under Schedules II to VI, or for an entire category of person under Schedule VII. Section 12(2) applies the identical logic to Schedule VIII for political parties and electoral trusts.
This conditional design is what separates the Schedules in Chapter III from a flat, unconditional carve-out. None of these exemptions are automatic simply because the income falls into a named category. A research association’s income is only exempt if it applies its income to its stated objects and invests its funds in the modes permitted under Section 350. A political party’s income is only exempt if it maintains proper books of account, records every donation above Rs 20,000, gets its accounts audited, and files its return on time. Miss any one condition in a given year, and the exemption for that year is gone, even if it held perfectly in every earlier year.
Part IIISchedule II: Common Exemptions for Individuals
Schedule II is the broadest and most frequently relevant Schedule for an ordinary taxpayer, since it applies to any person rather than a narrowly defined category. It is not an exhaustive list of every exemption in the Act, since several well known exemptions, such as gratuity, leave encashment, and house rent allowance, are dealt with separately under the salary provisions in Chapter IV rather than here. What Schedule II covers instead is a set of standalone exempt receipts that do not naturally sit under any specific head of income. Some of the more commonly relevant entries include the following.
Agricultural income is exempt with no conditions attached at all, listed simply as “Nil” in the conditions column. Sums received under a life insurance policy, including bonus amounts, are exempt except when received on death, subject to conditions on the premium-to-sum-assured ratio for policies issued after specified dates. Payments from statutory and recognised provident funds are exempt, except that interest attributable to contributions made on or after April 1, 2021 that exceed Rs 5,00,000 a year, where the employer makes no matching contribution, or Rs 2,50,000 a year in other cases, is carved back into taxable income. Sums from a Sukanya Samriddhi Account are exempt with no conditions. Withdrawals from the National Pension System Trust on closure or opting out are exempt, but only up to 60% of the total amount payable at that time. Payments from the Agniveer Corpus Fund to an enrolled person or their nominee are exempt with no conditions. Approved superannuation fund payouts are exempt when made on death, retirement, incapacitation, or specified transfers. Scholarships granted to meet the cost of education are exempt, and awards and rewards are exempt when given in the public interest by a government or an approved body.
| Schedule II Entry | Key Condition to Watch |
|---|---|
| Agricultural income (Sl. No. 1) | None, fully exempt |
| Life insurance proceeds (Sl. No. 2) | Premium-to-sum-assured ratio limits apply for policies issued during specified periods |
| Provident fund interest (Sl. No. 3, 4) | Interest on contributions above Rs 2.5 lakh or Rs 5 lakh a year (post April 2021) becomes taxable |
| National Pension System withdrawal on exit (Sl. No. 6) | Exempt only up to 60% of the amount payable at closure or opting out |
| Scholarships (Sl. No. 9) | Must be granted specifically to meet education costs |
| Gold Deposit and Gold Monetisation Bond interest (Sl. No. 12) | None, fully exempt |
Part IVSchedule III: Exemptions Tied to Specific Eligible Persons
Schedule III is structured differently from Schedule II. Every row names a specific eligible person alongside the exempt income, meaning the exemption is only available to that category of person, not to taxpayers generally. This Schedule is long, covering everything from family arrangements to constitutional protections for specific regions, so this section highlights the entries most relevant to everyday readers rather than attempting to reproduce every row.
Family and Partnership Receipts
Any sum received by an individual member from a Hindu undivided family is exempt, as long as it has been paid out of the family’s income or the income of an impartible estate, and is not already covered by the clubbing provisions in Section 99(3) or (4). Similarly, any sum a partner receives as their share in the total income of a firm that is separately assessed as such is exempt, provided the amount matches the profit-sharing ratio in the partnership deed. The logic behind both exemptions is the same: the income has already been taxed once, in the hands of the HUF or the firm, so taxing it again in the hands of the individual member or partner would amount to double taxation.
Disaster Compensation
Any amount received from the Central Government, a State Government, or a local authority as compensation on account of a disaster is exempt for the individual or their legal heir, provided no deduction was already claimed earlier for the loss or damage caused by that disaster.
Allowances for Members of Parliament and State Legislatures
Daily allowances received by reason of membership of Parliament, any State Legislature, or related Committees are fully exempt, as are constituency allowances received by Members of Parliament or State Legislature members under the respective governing rules.
Leave Travel Concession
The value of travel concession or assistance received from an employer for travel within India, either while in service or after retirement or termination, is exempt, subject to prescribed conditions on the number of journeys and the amount exempt per head, and capped at the actual expenses incurred for the travel.
Gallantry Award Pensions
Pension received by an individual who served the Central or State Government and was awarded the Param Vir Chakra, Maha Vir Chakra, Vir Chakra, or a similar notified gallantry award is fully exempt, as is family pension received by their family members. Family pension received by the widow, children, or nominated heirs of a member of the armed forces who died in the course of operational duties is similarly exempt, subject to prescribed conditions.
Capital Gains on Compulsory Acquisition of Agricultural Land
Capital gains arising from the transfer of agricultural land are exempt for an individual or HUF where the land was used for agricultural purposes for the two years preceding the transfer, and the transfer was a compulsory acquisition or one where the consideration was determined or approved by the Central Government or the Reserve Bank of India, with the income having arisen from compensation received on or after April 1, 2004.
Sikkim and Scheduled Tribe Area Exemptions
Income accruing from sources in specified North-Eastern tribal areas, or by way of dividend or interest on securities, is exempt for members of a Scheduled Tribe residing in those areas. A parallel, broader exemption applies to income accruing from sources in the State of Sikkim, or by way of dividend or interest on securities, for an individual who is Sikkimese.
Charitable, Research, and Professional Bodies
Schedule III also exempts the income of approved research associations, certain professional regulatory associations and institutions, and institutions engaged in the production or marketing of khadi and village industry products, each subject to detailed conditions around how the income is applied and how the approval is maintained. Given how detailed the compliance requirements are for these categories, an organisation relying on this exemption should treat it as a separate, dedicated compliance exercise rather than a one-time qualification.
Part VSchedule IV: Non-Residents, Foreign Companies, and Diplomats
Schedule IV is aimed squarely at non-residents, foreign companies, and similar persons, and exists largely to prevent double taxation and to honour international diplomatic norms. Interest earned by a person resident outside India, or someone permitted by the Reserve Bank of India to maintain a Non-Resident External account, on money held in such an account is exempt. Remuneration received by diplomatic and consular officials and their staff, who are not Indian citizens, is exempt on a reciprocal basis, meaning India extends the exemption only where the foreign country grants a similar exemption to Indian officials there.
Employees of a foreign enterprise that does not carry on business in India are exempt on remuneration for services rendered during a stay in India not exceeding ninety days in aggregate in a tax year, provided the cost is not deducted from the employer’s taxable income in India. A similar ninety-day rule applies to salary received by a non-resident, non-citizen individual for services rendered in connection with employment on a foreign ship.
Part VISchedule V: Investment Funds and Business Trusts
Schedule V deals with the tax treatment of pooled investment vehicles, principally investment funds (such as certain categories of alternative investment funds) and business trusts (such as REITs and InvITs). The underlying principle here is what is often called pass-through taxation: rather than taxing the fund or trust and then taxing the investor again on the same income, the law exempts the income at one level so it is taxed only once, generally in the hands of the unit holder.
Specifically, income of an investment fund, other than income chargeable under “Profits and gains of business or profession,” is exempt in the fund’s own hands, while a unit holder is correspondingly exempt on the proportion of income from the fund that is of the same business-income nature, since that portion is taxed directly at the fund level instead. Business trusts are exempt on interest and dividend income received from a special purpose vehicle, and a real estate investment trust is exempt on income from renting, leasing, or letting out real estate assets it owns directly. Distributed income paid out to unit holders of a business trust carries a corresponding exemption, except to the extent it represents interest, dividend, or rental income of the kinds already described.
Part VIISchedule VI: International Financial Services Centre Entities
Schedule VI is a more specialised Schedule, built to support India’s International Financial Services Centre, principally GIFT City in Gujarat. It exempts specified funds on income from the transfer of certain capital assets and securities traded on a recognised stock exchange located in an International Financial Services Centre, on income from securities issued by non-residents, and on income from securitisation trusts, generally subject to the income being attributable to units held by non-residents or to an offshore banking unit’s investment division, and to the relevant consideration being paid in convertible foreign exchange. It also exempts non-residents on income from specified derivative contracts and instruments entered into with an offshore banking unit in such a centre.
Part VIIISchedule VII: Persons Exempt From Tax Entirely
Schedule VII is structurally different from the Schedules discussed so far. Rather than exempting a specific item of income for a category of person, it exempts certain bodies and funds from tax on their total income altogether, under Section 11(3). The list includes regimental and non-public welfare funds of the armed forces, certain notified employee welfare funds, pension funds set up by LIC or other insurers under approved schemes, State-level Khadi and Village Industries Boards, bodies administering public religious or charitable trusts and endowments such as temples, gurudwaras, wakfs, and churches, and a number of specifically named institutions including the SAARC Fund for Regional Projects, the Insurance Regulatory and Development Authority, the Central Electricity Regulatory Commission, Prasar Bharati, and the Prime Minister’s National Relief Fund and Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund.
An important nuance: the exemption in Schedule VII Sl. No. 5, for bodies administering religious or charitable trusts, applies to the administering body itself, not automatically to the trusts, endowments, or societies it administers. Those underlying trusts must separately qualify for exemption on their own terms under the charitable and religious trust provisions elsewhere in the Act.
Part IXSchedule VIII: Political Parties and Electoral Trusts
Schedule VIII, read with Section 12, is the most heavily conditioned exemption in this entire chapter. A political party registered under Section 29A of the Representation of the People Act, 1951 can exempt its income from house property, other sources, capital gains, and voluntary contributions, but only if it satisfies a demanding set of compliance conditions together: maintaining books of account adequate for the Assessing Officer to deduce its income, recording the name and address of every contributor for donations above Rs 20,000 other than by electoral bond, getting its accounts audited, never accepting a donation above Rs 2,000 in cash, filing the treasurer’s contribution report under election law, and filing its income tax return on time.
An electoral trust, separately, can exempt voluntary contributions it receives, but only if it distributes at least 95% of the aggregate donations received during the year, together with any surplus carried forward from earlier years, to registered political parties, and otherwise functions in accordance with rules framed by the Central Government.
Part XTwo Mistakes to Avoid When Relying on These Exemptions
The first common mistake is assuming an exemption is permanent once it has applied in a past year. As Section 11(2) and 11(4) make clear, every one of these exemptions is tested afresh, year by year. A research association that fails to invest its funds in the specified modes in one particular year, or a political party that accepts a single cash donation above Rs 2,000, can lose the exemption for that year even though it qualified comfortably in every prior year.
The second common mistake is treating these Schedules as a substitute for the deductions you might already be claiming elsewhere in the Act. Items like gratuity, leave encashment, house rent allowance, and standard deduction are governed by their own dedicated provisions under the salary computation rules, not by Chapter III. Confusing the two can lead to either claiming the same relief twice under the wrong heading, or missing a relief entirely because you were looking in the wrong part of the Act.
The Bottom Line
Chapter III is really a signpost rather than a rulebook. Sections 11 and 12 tell you that exempt income exists and where to find it, but the actual eligibility, scope, and conditions for every single exemption live inside Schedules II through VIII. Before assuming any receipt is tax-free, identify which Schedule it might fall under, locate the specific row that matches your situation, and read every condition attached to that row carefully.
The conditional nature of these exemptions is the single most important thing to remember. An exemption that held last year can disappear this year if even one condition is not met, so anyone relying on a Schedule III, VI, VII, or VIII exemption in particular should treat ongoing compliance as a continuing obligation, not a box that was ticked once and can be forgotten.
Frequently Asked Questions
An exemption under Chapter III means the income is never included in your total income in the first place, under Section 11(1) or 11(3). A deduction, by contrast, first includes the income in your total income and then reduces your tax liability or taxable income through a separate provision. The practical effect can sometimes look similar, but exempt income generally does not factor into surcharge thresholds, certain disclosure requirements, or other computations that are based on gross or total income, whereas income that is included and then deducted may still count for some of those purposes depending on the specific provision involved.
Agricultural income itself is listed in Schedule II with no conditions attached, so it is not included in your total income and is not directly taxed. However, it is not entirely irrelevant to your tax bill either. Section 405(2) of the Act provides that where the annual Finance Act specifies that net agricultural income should be taken into account for computing advance tax for a class of assessees, that net agricultural income is factored in for rate purposes in the manner the Finance Act prescribes for that year. So while the agricultural income itself stays exempt, the rate applied to your other income can still be influenced by it, depending on what the relevant year’s Finance Act provides.
Under Schedule VIII, audited accounts are one of several conditions a political party must satisfy together to retain its exemption on income from house property, other sources, capital gains, and voluntary contributions. Section 12(2) states that wherever the conditions in Schedule VIII are not satisfied in any tax year, the income is charged to tax under the Act for that year. So a failure to get accounts audited in a given year would put the exemption for that specific year at risk, even if every other condition, such as the cash donation limit and contributor record-keeping, was fully met.
No, these are two different things. The HUF, as a separate assessable unit, computes and pays tax on its own income in the normal way. The Schedule III exemption (Sl. No. 1) applies one level down, to an individual member who receives a sum from the HUF, provided that sum is paid out of the family’s already-taxed income or the income of an impartible estate, and is not already covered by the clubbing provisions under Section 99(3) or (4). The purpose is to prevent the same income from being taxed once in the HUF’s hands and again in the member’s hands.
Not completely. Schedule V exempts a unit holder’s distributed income from a business trust, but this exemption specifically excludes the portion of that distribution which represents interest or dividend income received by the trust from a special purpose vehicle, or rental income from real estate owned directly by a real estate investment trust. Those specific components are designed to be taxed in the hands of the unit holder rather than exempted twice, since the business trust itself is already exempt on receiving them at its own level under the earlier entries in the same Schedule.
Disclaimer: This article is for informational and educational purposes only and is current as of June 21, 2026. All legislative information is sourced from Chapter III (Sections 11 and 12) of the Income-tax Act, 2025, along with Schedules II, III, IV, V, VI, VII and VIII referenced therein. This article highlights illustrative and commonly relevant entries from each Schedule rather than reproducing every item, since several of these Schedules contain a large number of detailed rows. Readers should consult the full text of the relevant Schedule and a qualified chartered accountant or tax professional before relying on any specific exemption discussed here. This article does not constitute tax or legal advice. Fiscalzenith.com accepts no liability for decisions made in reliance on this article.
