Direct and Indirect Taxation · Income which does not form part of Total Income

Income Not Forming Part of Total Income: Section 14 Basics

Updated 10 October 2026 · Fact-checked

Exempt income is income that is earned but left out of total income under the Income-tax Act, 2025, mainly through Section 14 and the Schedules it refers to. To solve questions, classify each receipt, exclude the exempt items, and disallow expenditure incurred in relation to that exempt income from your deductions.

Understand Basics of Exempt Income under Income-tax Act, 2025

Every tax year you work out your total income by adding up income under the five heads and then applying set-off, carry forward and deductions. But not every rupee you receive goes into that calculation. Some receipts are not income at all (a loan taken, capital contributed). Others are income, but the law says they are not included in total income. These are called exempt income.

The key difference: a taxable item enters the computation and is taxed at the applicable rate. An exempt item is left out of total income, so no tax is charged on it. An exempt item is still income. It just never reaches the tax base. A capital receipt that is not income is different: it is outside the charge from the start.

Under the Income-tax Act, 2025, Section 14 is the gateway. It provides that the incomes listed in the Schedules it refers to do not form part of total income, subject to the conditions given in those Schedules. So when you see an exemption in a question, your job is to check the item, check its conditions (who earns it, in what form, up to what limit) and then exclude it only if every condition is met. Always apply the exemption to the right person. An exemption for an individual does not help a company.

There is one more rule you must know. If you could claim a deduction for expenses that were spent to earn tax-free income, you would be getting a double benefit: the income is untaxed and the cost reduces other taxable income. To stop this, the Act disallows expenditure incurred in relation to income that does not form part of total income (the rule that was Section 14A in the old 1961 Act). The expenditure is not allowed against taxable income, even if it is a normal business expense in nature.

Where the assessee's own allocation of expenses is not accepted as correct, the Assessing Officer can work out the disallowed amount by the method prescribed in the rules. In exam questions the split is almost always given, or the method is stated in the question. Use what the question gives you.

Key rules to remember

Exempt income rule: Total income = Taxable income under all heads − Income not forming part of total income; Exclude an item only if it is covered by Section 14 and the Schedules it refers to, and every condition for the specific item is met.
Disallowance of related expenditure: Expenditure incurred in relation to exempt income = NOT deductible; The expenditure is added back (or simply not claimed) in computing taxable income, whatever head it would otherwise fall under.
Adjusting book profit: Business income = Net profit as per P&L − Exempt income credited + Expenditure relating to exempt income debited + Other business adjustments; Do this in the profit-to-income reconciliation. Never deduct the exempt credit twice.
Allocation of common expenses: Disallowed share = Common expense × (Exempt activity base ÷ Total base); Use only if the question gives a base or method. Directly attributable expenses are disallowed in full.
Not income vs exempt income: Capital receipt (not income) → outside charge; Exempt income → income, but excluded from total income; Related-expense disallowance is about exempt income, not about every receipt that is outside the charge.

How to solve Basics of Exempt Income under Income-tax Act, 2025 questions

Use this order for any question on exempt income. It keeps you from missing the exemption, the conditions or the disallowance.

1List every receipt in the question separately with its nature (salary, business profit, agricultural income, loan, gift, and so on).
2Decide whether each receipt is income at all. A loan or capital introduced is not income, so drop it first.
3For items that are income, test whether an exemption applies under Section 14 and the Schedules. Check who earned it and check every condition and limit given.
4Move exempt items out of the computation. Keep taxable items under their proper heads.
5Identify expenditure that relates to the exempt income. Treat directly attributable expenses as fully disallowed. Apportion common expenses only if the question gives a base.
6Add back the disallowed expenditure to taxable income (or do not deduct it), and make sure the exempt income is not counted in taxable profit.
7Compute the total income and state clearly which items were excluded and why. In your answer, show the exempt income separately as a note.

Quickest way: Two-column sort and add-back check

When to use it: When the question gives a list of receipts and expenses and you have 8 to 10 minutes for a 14-mark answer.

Draw two columns: Taxable and Exempt/Not income. Put each receipt in one column in a single pass.
Mark each exempt item with the condition that makes it exempt. If a condition fails, move it back to Taxable.
Scan the expenses for any phrase such as 'incurred for', 'in connection with', 'relating to' exempt income. Tag them.
Start from the profit figure given. Subtract exempt credits and add back tagged expenses. Check the sign of each.
Write the final figure and add a one-line note on the exempt income excluded.

Common mistakes in Basics of Exempt Income under Income-tax Act, 2025

Treating every receipt that is not taxed as 'exempt income'.
Students use 'exempt' and 'not taxable' as the same thing.
Fix: First ask whether the receipt is income at all. A loan or capital receipt is simply not income. Only items listed under Section 14 and its Schedules are exempt income.
Claiming an exemption without checking its conditions.
Students memorise the list of exempt items but not the limits or the person who can claim.
Fix: For each item write the condition next to it in your answer. If the question does not satisfy the condition, tax the item.
Allowing expenses related to exempt income as a business deduction.
The expense looks normal (interest, demat charges, administration), so it is claimed automatically.
Fix: Ask what the expense was spent for. If it was spent to earn exempt income, add it back in the computation.
Leaving exempt income inside the net profit and taxing it.
Students start from the profit and forget that it already includes the exempt credit.
Fix: Always reconcile from the profit as per the P&L: deduct exempt income credited, then add back related expenditure.
Disallowing the whole common expense when the question asks for apportionment.
Students are in a hurry and treat all overheads as relating to exempt income.
Fix: Disallow only the directly attributable amount in full. Apportion common expenses on the base given in the question.
Ignoring that the exemption is person-specific.
Students read a rule for individuals and apply it to a firm or company in the question.
Fix: Check the type of assessee in the question before you apply any exemption.

Worked examples

Example 1

Mr. Arvind Nair, a resident individual, has the following for the tax year 2026-27: salary taxable under the head Salaries ₹6,00,000; business profit (computed, taxable) ₹3,00,000; agricultural income, assumed exempt ₹1,50,000; loan received from a bank ₹2,00,000. Find the income to be included in total income before any deduction, and classify each item. Ignore any effect of exempt income on the rate of tax.

Show the solution

Loan from the bank ₹2,00,000: it is a borrowing, a capital receipt, so it is not income at all. Exclude it.
Agricultural income ₹1,50,000: it is income, but we are told it is exempt, so it does not form part of total income. Exclude it and show it as a note.
Salary ₹6,00,000: taxable under the head Salaries. Include it.
Business profit ₹3,00,000: taxable under the head Profits and gains of business or profession. Include it.
Total income before deductions = ₹6,00,000 + ₹3,00,000 = ₹9,00,000.

Answer: Income included in total income (before deductions) = ₹9,00,000. The loan is not income; the agricultural income of ₹1,50,000 is exempt and excluded.

Example 2

M/s Kaveri Traders, a resident firm, shows a net profit of ₹10,00,000 in its profit and loss account. The credits include ₹3,00,000 of income that is exempt (assume it is covered by Section 14 and its Schedules and all conditions are met). The debits include interest of ₹40,000 on a loan taken specifically to invest in the asset that yields the exempt income, and ₹10,000 of charges directly paid to hold those investments. No other adjustment is needed. Compute the income under the head Profits and gains of business or profession.

Show the solution

Start with the net profit as per the P&L: ₹10,00,000.
Deduct the exempt income credited, since it does not form part of total income: ₹10,00,000 − ₹3,00,000 = ₹7,00,000.
Identify expenditure in relation to the exempt income: interest ₹40,000 (specific loan) and holding charges ₹10,000. Both are directly attributable, so total ₹50,000.
These expenses were debited in the P&L but are not deductible against taxable income, so add them back: ₹7,00,000 + ₹50,000 = ₹7,50,000.
Business income = ₹7,50,000. The exempt income of ₹3,00,000 is reported separately as exempt.

Answer: Income from business = ₹7,50,000. Exempt income of ₹3,00,000 is excluded, and expenditure of ₹50,000 relating to it is disallowed.

Exam tips

In theory questions, answer in this order: define exempt income, name Section 14 as the gateway, give one example, then state the related-expenditure disallowance. This earns step marks.
In MCQs, watch for the trap between 'not income' (a capital receipt such as a loan) and 'exempt income'. The two answer options often differ only on this point.
In numerical questions, always show the reconciliation from the book profit. Writing 'less: exempt income credited' and 'add: expenditure relating to exempt income' as separate lines picks up marks even if the final figure is off.
Read the question for the words 'directly', 'specific loan' and 'common expenses'. They tell you whether to disallow in full or apportion.
State the assumption when a question says an item is exempt but gives no section. Write 'assumed to be covered by Section 14 and its Schedules, conditions satisfied' and move on.

Practice questions from Income which does not form part of Total Income

Basics of Exempt Income under Income-tax Act, 2025 in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Basics of Exempt Income under Income-tax Act, 2025: frequently asked questions

What is the difference between exempt income and taxable income?

Taxable income is included in total income and charged to tax. Exempt income is income that the Act says does not form part of total income, so it is not taxed. Expenses spent to earn exempt income cannot be claimed against taxable income.

What does Section 14 of the Income-tax Act, 2025 do?

Section 14 is the provision under which the incomes listed in the Schedules it refers to do not form part of total income. You must still check the conditions of each specific item before you exclude it.

Are expenses related to exempt income deductible?

No. Expenditure incurred in relation to income that does not form part of total income is disallowed. Directly attributable expenses are disallowed in full, and common expenses are apportioned using the method given in the question or the rules.

Is a loan received an exempt income?

No. A loan is a capital receipt and is not income at all, so the question of exemption does not arise. Exempt income is a type of income that is specifically excluded from total income.