A scholarship/fellowship payment received by a candidate for a degree is generally not taxable income to the student if it is used for "qualified expenses." Qualified expenses are defined by the Internal Revenue Service (IRS) and include tuition and required fees, and/or for books, supplies, and equipment required of all students in the course. These payments do not need to be reported to the IRS by the student or the university.
A scholarship/fellowship used for expenses other than qualified expenses is taxable income. Taxable scholarships are generally referred to as stipends and are payments for which no services are rendered or required. Examples of stipends are payments that can be used for living and incidental expenses such as room and board, travel, non-required books and personal computers, etc. The granting department is responsible for correctly determining the amount, which should be classified as a stipend, but such determination is always subject to review and reclassification by the Tax Department. All stipends are paid through University Payables except for certain athletic living stipends, which are paid through Student Account Services.
A stipend paid to a non-resident alien with an F-1, J-1, M-1, or Q-1 visa is subject to U. S. income tax withholding at a rate of 14% unless tax treaty relief is available. Currently, state taxes are not required to be withheld by the University even though the payments may be taxable in the state. This, however, is subject to changes in state legislation. A taxable scholarship/fellowship is not subject to FICA withholding since the payment is not for services.
Students from countries that have a tax treaty with the U.S. that includes a scholarship article may claim exemption or a reduction of the 14% withholding if the payment meets the requirements of the treaty. The student must, however, complete the required forms at the university's Tax Department.
The university reports stipend payments and the amount of federal tax withheld, if any, on Form 1042-S to the student and to the IRS. Students are responsible for reporting these payments and remitting any tax due with their personal income tax return at the end of the year on Forms 1040NR or 1040NR-EZ and the corresponding state forms.
There are a numerous scholarships available to students for studies. The Universities, Colleges, Schools offer scholarship to meritorious students on the basis of their last performance. Some NGOs also award scholarships to needy and poor students to pursue their studies. Some Old Boys Associations also award certain scholarships. The Central/State Government also award different types of scholarships on the basis of past achievements, financial status with quota for reserved, backward & the disabled.
The scholarships are generally meant for meeting the cost of current education but sometimes it is awarded as an incentive to achievement in academics, sports and co-curricular activities. Some scholarships are awarded for excellent performance, like topping in the school/college or scoring highest marks in a particular subject. The scholarships are sometimes utilised for purposes other than education or the scholarship awarded is utilised after a certain interval of time.
In simple terms, ‘scholarship’ means a grant which has been achieved on the basis of the academic or other achievement to support a student’s education. Thus, it needs to be ascertained whether the amount received as Scholarship is liable to be taxed under the provisions of the Income Tax Act. It is pertinent that any kind of scholarship granted to a student to meet the cost of education is exempt under Section 10(16) of the Income Tax Act. Section 10(16) of the Income Tax Act reads as under:
Incomes not included in total income.
10. In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included—
(16) scholarships granted to meet the cost of education;
Thus, if any student gets a monthly scholarship or a lump sum scholarship or a stipend and the same is utilised to meet the cost of education then the same is not taxable under the Income Tax Act.
The benevolent Provisions of section 10(16) exempt any scholarship granted to meet the cost of education. Thus, any scholarship received by the deserving students to meet the cost of education is exempted from income tax in terms of section 10(16) of the Income Tax Act. The only condition of exemption is that the scholarship amount should be used to meet the education expenses.The entire amount of scholarship granted to meet the cost of education is exempt and there is no upper limit prescribed for exemption under the Income Tax Act.
The following scholarships/Stipend are exempt u/s 10(16) of the Income Tax
1. Any amount received by the employee from the employer towards the scholarship of his child is eligible for exemption under section 10(16).
2. Any amount received by the employee from the employer to aid his own studies and research is eligible for exemption under section 10(16).
3. Research fellowships in all fields
An important question arose before the ITAT in the case of Income-Tax Officer vs Dr. V. Ramalinghaswami 1983 6 ITD 491 Delhi wherein the question arose was whether the exemption granted in educational fee of wards of teachers studying in the same school exempt u/s 10(16) of IT Act.The ITAT held that the said scholarship clearly fell under section 10(16) and is exempt from levy of Income Tax.
A stipend received for meeting the cost of education is also treated as a scholarship within the meaning of Section 10(16) of the Income Tax Act.
It would be trite to refer to the case of Ratnakar Rao vs ACIT 128 ITR 527 wherein it was held by the Karnataka High Court that the stipend paid by the Hospital for securing training, study & research in a branch of medicine is in the nature of Scholarship and falls under the ambit of Section 10(16) of the Income Tax Act and is therefore not Taxable.
It is relevant that in the case of CIT vs VK Balchandran 147 ITR 4 the Madras High Court held that grant-in-aid received by the assessee for advance Research in a foreign University falls within the meaning of Section 10(16) of the Income Tax Act and is not taxable. The Court clarified that if the payment is in the nature of remuneration for services rendered, it shall be exigible to Income Tax.
The Revenue should not deny the benefit of the benevolent Provisions of the Income Tax where the provision is clear like the aforesaid Section 10(16).