Tax Law Transition: Section 10(26) Moves to Schedule III, S.No. 19 of the Income Tax Act, 2025
A Professional Guide for Tax Practitioners and HR Teams in North-Eastern States and Scheduled Areas
For tax professionals and HR teams serving clients in India's North-Eastern states and scheduled areas, understanding the continuity of critical tax exemptions during the transition from the Income Tax Act, 1961 to the Income Tax Act, 2025 is essential. This article examines the preservation and relocation of the vital tax exemption previously available under Section 10(26), which will now be codified in Schedule III, Serial Number 19 of the new Income Tax Act, 2025 (effective from Assessment Year 2026-27).
Understanding Section 10(26): A Socio-Economic Policy Tool
Section 10(26) of the Income Tax Act, 1961 represents a critical socio-economic measure designed to promote economic empowerment and financial inclusion in India's specified tribal areas. This provision grants a significant tax exemption to individual members of Scheduled Tribes residing in designated regions.
Eligibility Criteria Under the Current Law
The exemption under Section 10(26) is subject to strict eligibility conditions:
1. Individual Assessee Requirement
The benefit is exclusively available to individuals. It does not extend to:
- Hindu Undivided Families (HUFs)
- Partnership firms
- Companies
- Association of Persons (AOPs)
- Body of Individuals (BOIs)
2. Scheduled Tribe Status
The assessee must be a member of a Scheduled Tribe as notified under:
- Article 342 of the Constitution of India
- The Constitution (Scheduled Tribes) Order, 1950 (as amended from time to time)
- Relevant state-specific notifications
3. Residence Requirement
The individual must be ordinarily residing in one of the specified areas, which include:
- North-Eastern States: Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland, and Tripura
- Union Territory: Ladakh
- Other Specified Areas: Certain districts and regions notified under the provision, including parts of West Bengal (Darjeeling district, including Kalimpong subdivision)
Scope of Exempt Income
The exemption under Section 10(26) covers two distinct categories of income:
Category A: Income Arising from Sources in the Specified Area
This includes all types of income that arise from sources located within the specified area:
- Salary income earned from employment within the specified area
- Business or professional income derived from operations conducted in the specified area
- Rental income from properties situated in the specified area
- Capital gains from transfer of assets located in the specified area
- Income from other sources that arise within the specified area
Category B: Dividend and Interest Income
This category enjoys broader exemption:
- Dividend income from any company (whether the company is located inside or outside the specified area)
- Interest on securities (irrespective of where the securities are issued or where the issuing entity is located)
This distinction is crucial: while most income must both arise from and be earned by a resident of the specified area, dividend and interest income is exempt based solely on the residential status of the recipient.
The Legislative Transition: Income Tax Act, 2025
The Government of India has undertaken a comprehensive overhaul of the income tax legislation through the enactment of the Income Tax Act, 2025. This modernization effort aims to:
- Simplify the tax code and improve readability
- Consolidate scattered provisions into logical groupings
- Reduce ambiguity and litigation
- Align the law with contemporary economic realities
Structural Reorganization of Exemptions
One of the key features of the 2025 Act is the reorganization of exemptions:
Previous Structure (1961 Act)
- All exemptions were listed as sub-clauses within the lengthy Section 10
- Over 40 different types of exemptions were crammed into a single section
- Cross-referencing and navigation was cumbersome
New Structure (2025 Act)
- Exemptions are systematically organized into separate Schedules
- Each Schedule addresses a specific category of exemptions
- Tabular format enhances clarity and ease of reference
- Schedule III specifically deals with exemptions related to socio-economic considerations
Location of the Tribal Area Exemption in the 2025 Act
The tax relief previously granted under Section 10(26) of the 1961 Act is fully preserved and will be codified in:
Schedule III of the Income Tax Act, 2025
Serial Number 19
This relocation confirms the government's commitment to maintaining this important social policy benefit, ensuring continuity of financial relief for eligible communities despite the comprehensive legislative overhaul.
Effective Date and Transition
- The Income Tax Act, 2025 will become effective from April 1, 2026 (Assessment Year 2026-27)
- For Financial Year 2025-26 (Assessment Year 2026-27) onwards, taxpayers and practitioners should reference Schedule III, S.No. 19
- All income earned during FY 2024-25 and earlier years will continue to be governed by Section 10(26) of the 1961 Act
Compliance Challenges: What Remains Unchanged
While the legislative framework is being modernized, the fundamental compliance challenges associated with claiming this exemption remain substantial. Tax authorities continue to rigorously scrutinize claims, and practitioners must be prepared to address these hurdles.
Challenge 1: The Dual Requirement Test
The most significant compliance challenge involves satisfying the dual requirement for most types of income (excluding dividend and interest):
Requirement A: Ordinary Residence in Specified Area
The assessee must establish that they are ordinarily residing in the specified area. This is not a mere formality but requires substantive evidence:
- Physical presence in the specified area for a substantial part of the year
- Maintenance of a dwelling place in the specified area
- Family and social ties rooted in the specified area
- Registration of address with government authorities (Aadhaar, voter ID, etc.)
Requirement B: Source of Income in Specified Area
Simultaneously, the income (other than dividend/interest) must arise from a source within the specified area:
- For salary: The employer's place of business and the location where services are rendered
- For business income: The location of business operations, not merely the registered office
- For rental income: The physical location of the property
- For professional income: Where professional services are actually performed
Challenge 2: The Remote Work Dilemma
The rise of remote work and digital employment has created new complexities:
Scenario 1: ST Member Working Remotely for Non-Local Employer
An individual residing in Shillong (Meghalaya) works remotely for a company based in Bangalore. Key questions:
- Where does the salary income "arise"?
- Is the source in Meghalaya (where work is performed) or Karnataka (where employer is located)?
- What documentation proves the work location?
Scenario 2: Digital Nomad ST Members
ST members who travel frequently while maintaining nominal residence in the specified area face heightened scrutiny regarding their "ordinary residence" claim.
Scenario 3: Hybrid Work Arrangements
Employees who split time between the specified area and metro cities must carefully track and allocate their income between exempt and taxable portions.
Challenge 3: Documentation Requirements
The foundation of any valid claim under this provision rests on comprehensive and irrefutable documentation:
Primary Documents (Mandatory)
- Scheduled Tribe Certificate
- Issued by the competent authority (usually the District Magistrate or designated revenue officer)
- Must be current and valid
- Should clearly state the tribe name and the applicant's membership
- Obtained in accordance with the relevant state/UT rules
- Proof of Ordinary Residence
- Aadhaar card showing address in the specified area
- Voter ID card registered in the specified area
- Ration card or domicile certificate
- Electricity bills, property tax receipts, or rental agreements
- Bank account statements showing local address
- Educational certificates of children showing local schools (if applicable)
Supporting Documents (Source-Specific)
For Salary Income:
- Employment contract specifying work location
- Posting orders or transfer orders
- Attendance records or biometric logs from office in specified area
- Form 16 showing employer's address
- Office location certificate from employer
For Business/Professional Income:
- Business registration certificates (GST, Shop & Establishment, etc.) showing address in specified area
- Lease agreements for business premises
- Invoices issued to clients showing business address
- Professional engagement letters specifying service delivery location
- Client testimonials or project completion certificates with location details
For Rental Income:
- Property ownership documents (sale deed, title deed)
- Property tax receipts from local municipal authority
- Rental agreements with tenants
- Address proof of the property
For Dividend and Interest:
- Portfolio statements showing securities held
- Form 16A/TDS certificates
- Bank statements showing dividend/interest credits
- (Note: For this category, only residence proof is needed, not source proof)
Challenge 4: Assessment and Reassessment Risk
Claims under this exemption attract heightened scrutiny:
- Notice under Section 143(2): Assessing Officers frequently issue scrutiny notices for returns claiming this exemption
- Detailed questionnaires: Expect extensive queries about residence and source
- Field verification: Revenue authorities may conduct physical verification of residence and business location
- Reassessment risk: Inadequate documentation can lead to reassessment proceedings years later
Strategic Guidance for Tax Professionals
As tax practitioners serving clients in specified areas across North-Eastern states and other notified regions, consider the following strategic approaches:
1. Proactive Documentation Strategy
- Maintain a comprehensive documentation checklist for each client claiming the exemption
- Update residence proof annually
- For salaried clients, obtain employer certificates at year-end confirming work location
- For business clients, maintain contemporaneous records of where business activities occur
- Create a dedicated file for each client with all exemption-related documents
2. Remote Work Documentation Protocol
For clients in remote work arrangements:
- Obtain detailed work-from-home letters from employers specifying the approved work location
- Maintain daily work logs showing work performed from the specified area
- Keep records of internet bills, co-working space invoices, or home office setup in the specified area
- Document any travel outside the specified area and adjust exemption claims accordingly
3. Transition Planning for 2025 Act
- Familiarize your team with the new Schedule III, S.No. 19 reference
- Update all return preparation software and templates for AY 2026-27 onwards
- Prepare client communication explaining the legislative change while assuring continuity of benefits
- Monitor any subordinate legislation or CBDT circulars clarifying the application of the new provision
4. Client Education and Expectation Management
- Educate clients about the dual requirement (residence + source) at the outset
- Set realistic expectations about documentation burden
- Advise clients to maintain clean, contemporaneous records rather than scrambling during assessment
- For ambiguous situations (e.g., partial year residence), recommend conservative approach or professional consultation
5. Litigation Preparedness
- Stay updated with relevant case law and tribunal decisions
- Build relationships with legal counsel experienced in tribal taxation matters
- Maintain precedent files of favorable rulings
- Consider advance ruling applications for complex fact patterns
Common Scenarios and Practical Solutions
Scenario 1: Salaried Employee Transferred Outside Specified Area Mid-Year
Facts: ST member ordinarily residing in Shillong transferred to Delhi on September 1, 2025.
Solution:
- Salary for April–August 2025: Fully exempt (both residence and source in specified area)
- Salary for September 2025–March 2026: Taxable (source outside specified area)
- Obtain separate Form 16 or certificate from employer allocating salary between periods
- File return showing proportionate exemption claim
Scenario 2: Business Income with Mixed Operations
Facts: ST member runs a consultancy from Imphal but occasionally provides services to clients in Kolkata and Mumbai.
Solution:
- Maintain detailed project-wise records showing:
- Projects executed entirely from Imphal (work, meetings, deliverables all from Imphal): Fully exempt
- Projects requiring travel and work outside Manipur: Allocate income based on time/effort spent in vs. outside specified area
- Use conservative allocation methodology
- Document basis of allocation for audit defense
Scenario 3: Rental Income from Multiple Properties
Facts: ST member owns properties in both Aizawl (Mizoram) and Siliguri (West Bengal, outside specified area under Section 10(26)).
Solution:
- Rental income from Aizawl property: Exempt under Schedule III, S.No. 19
- Rental income from Siliguri property: Fully taxable
- Maintain separate rent agreements and bank accounts for clarity
- Clearly segregate in the income tax return
Scenario 4: Dividend and Interest Income
Facts: ST member residing in Itanagar receives dividend from TCS (Mumbai-based) and interest from SBI bonds.
Solution:
- Both dividend and interest: Fully exempt regardless of source location
- Only residential status in specified area needs to be proven
- Simpler documentation requirement compared to other income types
The Road Ahead: Preparing for Schedule III, S.No. 19
The transition from Section 10(26) to Schedule III, S.No. 19 is more than a mere renumbering exercise. It represents an opportunity for tax professionals to:
- Revisit and strengthen documentation protocols to ensure seamless compliance under the new legislative framework
- Engage with clients early to explain the transition and ensure no disruption in claiming legitimate exemptions
- Leverage the reorganized structure of the 2025 Act to provide clearer, more confident advice
- Monitor CBDT guidance as the new Act comes into force, particularly any clarificatory circulars on the application of Schedule III provisions
- Build expertise in the socio-economic exemptions that will be critical for clients in the North-Eastern region and other specified areas
Conclusion
The relocation of the tribal area income exemption from Section 10(26) to Schedule III, S.No. 19 of the Income Tax Act, 2025 preserves a vital socio-economic benefit while modernizing its legislative home. For tax professionals and HR teams in North-Eastern states and other specified areas, the substance of the exemption remains unchanged, but the transition offers an opportunity to strengthen compliance practices and documentation protocols.
The dual challenge of proving ordinary residence in the specified area and demonstrating that income arises from sources within that area remains the central compliance hurdle. In an era of remote work, digital businesses, and complex financial arrangements, this challenge is more acute than ever.
Success in navigating this exemption—whether under the 1961 Act or the 2025 Act—depends on:
- Meticulous documentation maintained contemporaneously, not retrospectively
- Clear understanding of the residence-source dual test
- Conservative approach in ambiguous situations
- Proactive communication with clients and tax authorities
As we prepare for the Income Tax Act, 2025 to take effect, let us ensure that the eligible members of Scheduled Tribes continue to receive the full benefit of this important exemption, now enshrined in Schedule III, Serial Number 19.
About the Author
CA Anant Lall Gupta is a Chartered Accountant based in Gangtok, specializing in tax compliance and advisory for individuals and businesses in the North-Eastern region and scheduled areas. With 4 years pre qualification of experience in navigating the unique tax provisions applicable to scheduled areas, He advises clients on optimizing legitimate tax benefits while maintaining robust compliance.
Disclaimer
This article is intended for general informational purposes only and does not constitute professional tax advice. The application of tax laws depends on specific facts and circumstances. Readers should consult with qualified tax professionals before making decisions based on this information. The author and publisher assume no liability for actions taken based on the content of this article.
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