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

Exempt Income from Investments, Interest and Capital Receipts

Updated 10 October 2026 · Fact-checked

Exempt income from investments is income the Income-tax Act, 2025 leaves out of total income, such as specified interest, fund payouts and certain capital receipts. To solve a question, identify the receipt, check the exact condition in the provision, exclude it if met, and tax only the rest at the right rate.

Understand Exempt Income from Investments, Interest and Capital Receipts

Every receipt starts as taxable unless the Act says otherwise. Exempt income is income you do not add to total income, because a specific provision excludes it. The exemption usually depends on who receives it, what the instrument is and whether stated conditions are met.

For investments, the Act exempts certain interest, certain fund payouts and certain capital receipts. You will meet items such as provident fund and PPF interest, interest or maturity from specified government schemes, and payouts from approved funds. The exact section number and limits for each must be taken from the Act and the ICMAI study material. Learn each item as a pair: the receipt and its condition.

The main trap is that exemption is not general. A similar-looking receipt that fails the condition is taxable. For example, interest on a notified bond may be exempt in one case but taxable when the holder or the instrument differs.

The Act also contains special rate provisions for some non-residents. Under section 209, a non-resident's interest on specified bonds of an Indian company (issued under a notified scheme) or bonds of a public sector company sold by the Government, bought in foreign currency, is taxed at 10%. Dividends on specified Global Depository Receipts bought in foreign currency through an approved intermediary are also taxed at 10%. Long-term capital gains on transfer of those bonds or GDRs are taxed at 12.5%. These are concessional rates, not exemptions. Do not confuse the two.

Key rules to remember

Basic treatment of exempt income
Total income = Taxable income − Exempt income (excluded before computing)
Exempt receipts are left out of gross total income. Show them as 'exempt' with a reason, not as a deduction.
Section 209: interest on specified bonds (non-resident)
Tax = 10% × interest on specified bonds bought in foreign currency
Applies to bonds of an Indian company under a notified scheme, or public sector company bonds sold by the Government.
Section 209: dividend on specified GDRs (non-resident)
Tax = 10% × dividend on specified GDRs bought in foreign currency through an approved intermediary
GDR must meet one of the three conditions listed in the Table.
Section 209: long-term capital gains on such bonds or GDRs
Tax = 12.5% × long-term capital gains
Section 72(6) does not apply when computing these gains.
Section 209: remaining income
Tax on (Total income − income at serial numbers 1 to 3) at rates in force
Other income of the non-resident is taxed at normal rates.
Section 209: deductions
If GTI has only the interest or dividend: no deduction under sections 28 to 58, 60, 61, 93(1)(a) or (e), or Chapter VIII
If GTI includes other income too, reduce GTI by the special income and allow Chapter VIII deduction on the reduced GTI.
Section 209: return filing
No return under section 263(1) if total income is only bond interest and GDR dividend and TDS was deducted
Both conditions must be met.

How to solve Exempt Income from Investments, Interest and Capital Receipts questions

Use this order for any question on exempt investment income, whether it asks for total income or for the tax treatment of one receipt.

  1. 1List every receipt in the question: interest, dividend, maturity amount, fund payout, capital gain.
  2. 2For each, name the instrument and the recipient (resident individual, HUF, non-resident, company).
  3. 3Check the specific exemption and its conditions. If any condition fails, treat the receipt as taxable under the proper head.
  4. 4For a non-resident with specified bonds or GDRs, apply section 209: 10% on interest and GDR dividend, 12.5% on long-term capital gains.
  5. 5Exclude exempt receipts from gross total income and write 'exempt' with the reason.
  6. 6Compute tax on the balance. For section 209 cases, tax the special income at its rate and the rest at rates in force, with Chapter VIII deduction on the reduced GTI.
  7. 7State the final taxable figure and, if asked, the return-filing position.

Quickest way: Receipt, condition, rate in three checks

When to use it: Use for MCQs and short objective-style parts where you must decide exempt or taxable, or pick the right rate.

  1. Ask: is the receipt named in an exemption provision? If not named, assume taxable.
  2. Ask: does the question give the condition (notified, approved, foreign currency, non-resident)? A missing condition usually signals taxable.
  3. If a non-resident and specified bonds or GDRs appear, recall 10%, 10%, 12.5%, then rates in force for the rest.

Common mistakes in Exempt Income from Investments, Interest and Capital Receipts

  • Treating the 10% section 209 rate as an exemption.

    Concessional and exempt both sound favourable.

    Fix: Exempt income is excluded from total income. Section 209 income is included and taxed at a special rate.

  • Applying section 209 to a resident or to bonds bought in rupees.

    Students remember the rates but skip the conditions.

    Fix: Check that the assessee is a non-resident and the bonds or GDRs were bought in foreign currency.

  • Claiming expense deductions against section 209 interest or dividend when it is the only income.

    Habit of deducting expenses from other sources income.

    Fix: Where GTI is only this income, no deduction under sections 28 to 58, 60, 61, 93(1)(a) or (e), or Chapter VIII is allowed.

  • Using 12.5% for all capital gains of the non-resident.

    Rate is memorised without its scope.

    Fix: 12.5% applies to long-term gains on the specified bonds or GDRs only. Other income goes at rates in force.

  • Assuming a return must always be filed, or never filed.

    Section 209(4) is half-remembered.

    Fix: No return is needed only if income is solely bond interest and GDR dividend and TDS has been deducted.

Worked examples

Example 1

Mr. Smith, a non-resident, bought specified bonds of an Indian company (issued under a notified scheme) in foreign currency. In the tax year he earned interest of ₹4,00,000 on them. He has no other income and TDS was deducted from the interest. Compute his tax (ignore cess) and state whether he must file a return.

Show the solution
  1. He is a non-resident and the bonds meet the section 209 conditions, so interest is taxed at 10%.
  2. Tax = 10% × ₹4,00,000 = ₹40,000.
  3. His GFI consists only of this interest, so no deduction under sections 28 to 58, 60, 61, 93(1)(a) or (e) or Chapter VIII is allowed.
  4. His total income is only this interest and TDS was deducted, so section 209(4) removes the need to file a return under section 263(1).

Answer: Tax is ₹40,000. No return under section 263(1) is required.

Example 2

A non-resident holds specified GDRs bought in foreign currency through an approved intermediary. In the tax year she gets dividend of ₹2,00,000 and long-term capital gains of ₹6,00,000 on transfer of the same GDRs. She also has other income of ₹3,00,000 taxable at rates in force, with no deduction. Assuming a flat 30% as the rate in force and ignoring cess, compute total tax.

Show the solution
  1. Dividend on specified GDRs: 10% × ₹2,00,000 = ₹20,000.
  2. Long-term capital gains on the GDRs: 12.5% × ₹6,00,000 = ₹75,000.
  3. Other income is taxed at rates in force: 30% × ₹3,00,000 = ₹90,000.
  4. Total tax = ₹20,000 + ₹75,000 + ₹90,000 = ₹1,85,000.

Answer: Total tax is ₹1,85,000 (before cess). The 30% rate is an assumption given for the question.

Exam tips

  • In MCQs, read for the words 'non-resident', 'foreign currency' and 'notified scheme'. They decide whether section 209 applies.
  • Memorise the three rates as a set: 10%, 10%, 12.5%, then rates in force.
  • In written answers, list each receipt with the word 'exempt' or 'taxable' and a one-line reason to earn step marks.
  • For other exempt items such as provident fund or PPF, learn the exact conditions from the Act and ICMAI material, because the question will test the condition.

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

Exempt Income from Investments, Interest and Capital Receipts in other exams

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

Exempt Income from Investments, Interest and Capital Receipts: frequently asked questions

Is income under section 209 exempt from tax?

No. It is taxable at special rates: 10% on specified bond interest and GDR dividend, and 12.5% on long-term capital gains from those bonds or GDRs. Only the stated conditions qualify.

Who can use section 209?

Only a non-resident assessee. The bonds or GDRs must be of the kinds described in the Table and purchased in foreign currency, with GDRs bought through an approved intermediary.

Can a non-resident claim Chapter VIII deductions on this income?

Not if the gross total income consists only of the bond interest or GDR dividend. If other income exists, GTI is reduced by the special income and Chapter VIII deduction is allowed on the reduced amount.

Does a non-resident have to file a return for this income?

Not if total income consists only of the specified bond interest and GDR dividend and tax deductible at source has been deducted. Otherwise a return is needed.