Tax-free on the other hand implies income that is not taxable in the hands of investors i.e. simply put the income from such tax-free source is not included in the total income for the purpose of computation of total tax liability.
As, people generally have confusion in this respect and sometimes when intending to save on tax, inadvertently end up buying tax-free investment instruments or count on such stream of income i.e. tax free their purpose is left unsolved. So, here we attempt to clarify the difference between the two.
Some of the sections of the Indian Income Tax Act allows individuals to save on tax liability by investing in some particular investment products. For instance- The well known Section- 80C allows tax rebate of a maximum amount of Rs. 1Lac if investments are made in insurance products, PPF, PF, fixed deposits for a minimum term of 5 years, bonds, stamp duty paid on property and bonds among other investment products that are included in the Sec 80C net.
So, the question now comes up, how investment into such asset classes, reduces or saves tax of the taxpayer? Actually, the amount of allowed deduction in each such provision, as Rs. 1Lac in case of Section 80C is deducted from the gross income of the taxpayer. So, if the gross total income of the taxpayer is Rs. 5Lac and he makes an investment of Rs. 50,000 in assets covered u/s 80C, then his gross total income will decrease by the amount of investment of Rs. 50,000. So, he will now be liable to pay income tax on Rs. 4.5 lac instead of the otherwise Rs. 5lac as per his tax bracket that saves tax reasonably for the taxpayer.
As stated above, some of the expenses even qualify for tax-saving option. For eg: expenses incurred on principal repayment of home loan; interest on education loan; health insurance premium; tuition fee paid for children.
On the other hand, tax-free investment instruments attract no tax on the investment made or on the interest earned i.e investment in such instruments is exempt from tax. Also, with no income tax being charged on the returns on the tax-free investment no other rebate in the form of deduction for the amount invested is provided. Tax-free bonds are exempt from tax payments.