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Tax exemption

Tax exemption

Overview
Various tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Tax exemption may also refer to a personal allowance or specific monetary exemption which may be claimed by an individual to reduce taxable income
Taxable income
Taxable income refers to the base upon which an income tax system imposes tax. Generally, it includes some or all items of income and is reduced by expenses and other deductions. The amounts included as income, expenses, and other deductions vary by country or system. Many systems provide that...

 under some systems. Tax exempt status may provide a potential taxpayer complete relief from tax, tax at a reduced rate, or tax on only a portion of the items subject to tax.
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Encyclopedia
Various tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Tax exemption may also refer to a personal allowance or specific monetary exemption which may be claimed by an individual to reduce taxable income
Taxable income
Taxable income refers to the base upon which an income tax system imposes tax. Generally, it includes some or all items of income and is reduced by expenses and other deductions. The amounts included as income, expenses, and other deductions vary by country or system. Many systems provide that...

 under some systems. Tax exempt status may provide a potential taxpayer complete relief from tax, tax at a reduced rate, or tax on only a portion of the items subject to tax. Examples include exemption of charitable organizations from property taxes and income taxes, exemptions provided to veterans, and exemptions under cross-border or multi-jurisdictional principles. Tax exemption generally refers to a statutory exception to a general rule rather than the mere absence of taxation in particular circumstances (i.e., an exclusion). Tax exemption also generally refers to removal from taxation of a particular item or class rather than a reduction of taxable items by way of deduction of other items (i.e., a deduction). Tax exemptions may theoretically be granted at any governmental level that imposes taxation, though in some broader systems restraints are imposed on such exemptions by lower tier governmental units.

Specific monetary exemptions


Some jurisdictions allow for a specific monetary reduction of the tax base, which may be referred to as an exemption. For example, the U.S. Federal and many state tax systems allow a deduction of a specified dollar amount for each of several categories of "personal exemptions." Similar amounts may be called "personal allowances." Some systems may provide thresholds at which such exemptions or allowances are phased out or removed.

Exempt organizations


Some governments grant broad exclusions from all taxation for certain types of organization. The exclusions may be restricted to entities having various characteristics. The exclusions may be inherent in definitions or restrictions outside the tax law itself.

Approaches for Exemption


There are several different approaches used in granting exemption to organizations. Different approaches may be used within a jurisdiction or especially within sub-jurisdictions.

Some jurisdictions grant an overall exemption from taxation to organizations meeting certain definitions. The United Kingdom, for example, provides an exemption from rates (property taxes), and income taxes for entities governed by the Charities Law. This overall exemption may be somewhat limited by limited scope for taxation by the jurisdiction. Some jurisdictions may levy only a single type of tax, so a broad grant of exemption may have the effect of an exemption from only a particular tax.

Some jurisdictions provide for exemption only from certain taxes. The United States exempts certain organizations from Federal income taxes, but not from various excise or most employment taxes.

Charitable and Religious Organizations


Many tax systems provide complete exemption from tax for recognized charitable organizations. Such organizations may include religious organizations (churches, etc.), fraternal organizations (including social clubs), public charities (e.g., organizations serving homeless persons), or any of a broad variety of organizations considered to serve public purposes.

The U.S. system exempts from Federal and many state income taxes the income of organizations that have qualified for such exemption. Qualification requires that the organization be created and operated for one of a long list of tax exempt purposes, which includes more than 28 types of organizations and also requires, for most types of organizations, that the organization apply for tax exempt status with the Internal Revenue Service, or be a religious or apostolic organization. Note that the U.S. system does not distinguish between various kinds of tax exempt entities (such as educational versus charitable) for purposes of granting exemption, but does make such distinctions with respect to allowing a [tax deduction] for contributions.

The UK generally exempts public charities from business rates
Business rates
Business rates is the commonly used name of non-domestic rates, a tax on the occupation of non-domestic property. Rates are a property tax with ancient roots that was formerly used to fund local services that was formalised with the Poor Law 1572 and superseded by the Poor Law of 1601...

, corporation tax, income tax, and certain other taxes.

Governmental entities


Most systems exempt internal governmental units from all tax. For multi-tier jurisdictions, this exemption generally extends to lower tier units and across units. For example, state and local governments are not subject to Federal, state, or local income taxes in the U.S.

Pension Schemes


Most systems do not tax entities organized to conduct retirement investment and pension activities for employees of one or more employers or for the benefit of employees. In addition, many systems also provide tax exemption for personal pension scheme
Personal pension scheme
A Personal Pension Scheme , sometimes called a Personal Pension Plan , is a UK tax-privileged individual investment vehicle, with the primary purpose of building a capital sum to provide retirement benefits, although it may also be used to provide death benefits.These plans first became available...

s.

Educational institutions


Some jurisdictions provide separate total or partial tax exemptions for educational institutions. These exemptions may be limited to certain functions or income.

Other not for profit entities


Some jurisdictions provide tax exemption for other particular types of organizations not meeting any of the above categories.

Reciprocal exemptions


Some jurisdictions allow tax exemption for organizations exempt from tax in certain other jurisdictions. For example, most U.S. states allow tax exemption for organizations recognized for Federal tax purposes as tax exempt.

Sales tax


Most states and localities imposing sales and use taxes in the United States exempt resellers from sales taxes on goods held for sale and ultimately sold. In addition, most such states and localities exempt from sales taxes goods used directly in the production of other goods (i.e., raw materials).
See also Sales taxes in the United States
Sales taxes in the United States
There is no federal sales or use tax in the United States. 45 states and the District of Columbia impose sales and use taxes on the retail sale, lease and rental of many goods, as well as some services. Many cities, counties, transit authorities and special purpose districts impose additional local...

, tax-free shopping
Tax-free shopping
-Introduction:Tax-Free Shopping allows shoppers to reclaim the VAT /GST they have paid on their shopping in foreign countries. Promoting the tax rebate and making it easier for tourists to claim it back, has helped to attract travellers to many countries...

, tax holiday
Tax holiday
A tax holiday is a temporary reduction or elimination of a tax. Programs may be referred to as tax abatements, tax subsidies, tax holidays, or tax reduction programs. Governments usually create tax holidays as incentives for business investment...

.

Exempt individuals


Certain classes of persons may be granted a full or partial tax exemption within a system. Common exemptions are for veterans or clergymen. The exemption granted may depend on multiple criteria, including criteria otherwise unrelated to the particular tax. For example, a property tax exemption may be provided to certain classes of veterans earning less than a particular income level. Definitions of exempt individuals tend to be complex.

Exempt income


Most income tax systems exclude certain classes of income from the taxable income base. Such exclusions may be referred to as exclusions or exemptions. Systems vary highly. Among the more commonly excluded items are:
  • Income earned outside the taxing jurisdiction. Such exclusions may be limited in amount.
  • Interest income earned from subsidiary jurisdictions.
  • Income consisting of compensation for loss.
  • The value of property inherited or acquired by gift.


Some tax systems specifically exclude from income items that the system is trying to encourage. Such exclusions or exemptions can be quite specific or very general.

Among the types of income that may be include are classes of income earned in specific areas, such as special economic zones, enterprise zones, etc. These exemptions may be limited to specific industries. As an example, India provides SEZs where exporters of goods or providers of services to foreign customers may be exempt from income taxes and customs duties.

Exempt property


Certain types of property are commonly granted exemption from property or transaction (such as sales or value added) taxes. These exemptions vary highly from jurisdiction to jurisdiction, and definitions of what property qualifies for exemption can be voluminous.

Among the more commonly granted exemptions are:
  • Property used in manufacture of other goods (which goods may ultimately be taxable)
  • Property used by a tax exempt or other parties for a charitable or other not for profit purpose
  • Property considered a necessity of life, often exempted from sales taxes in the United States
    Sales taxes in the United States
    There is no federal sales or use tax in the United States. 45 states and the District of Columbia impose sales and use taxes on the retail sale, lease and rental of many goods, as well as some services. Many cities, counties, transit authorities and special purpose districts impose additional local...

  • Personal residence of the taxpayer, often subject to specific monetary limitations

Conditions imposed on exemptions


Exemption from tax often requires that certain conditions to be met.

Multi-tier jurisdictions


Many countries that impose tax have subdivisions or subsidiary jurisdictions that also impose tax. This feature is not unique to federal systems, like the U.S., Switzerland and Australia, but rather is a common feature of national systems. The top tier system may impose restrictions on both the ability of the lower tier system to levy tax as well as how certain aspects of such lower tier system work, including the granting of tax exemptions. The restrictions may be imposed directly on the lower jurisdiction's power to levy tax or indirectly by regulating tax effects of the exemption at the upper tier.

Cross-border agreements


Jurisdictions may enter into agreements with other jurisdictions that provide for reciprocal tax exemption. Such provisions are common in an income [tax treaty]. These reciprocal tax exemptions typically call for each contracting jurisdiction to exempt certain income of a resident of the other contracting jurisdiction.

Multi-jurisdictional agreements for tax exemption also exist. 20 of the U.S. states have entered into the Multistate Tax Compact that provides, among other things, that each member must grant a full credit for sales and use taxes paid to other states or subdivisions. The European Union members are all parties to the EU multi-country VAT harmonisation rules.

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