A technology that enables one network to send its data via another network’s connections. Tunneling works by encapsulating a network protocol within packets carried by the second network. i.e. one network protocol (the delivery protocol) encapsulates a different payload protocol. By using tunneling one can carry a payload over an incompatible delivery-network, or provide a secure path through an untrusted network.
For example, Microsoft’s PPTP technology enables organizations to use the Internet to transmit data across a VPN. It does this by embedding its own network protocol within the TCP/IP packets carried by the Internet.
Tunneling is also called encapsulation.
Source: wikipedia, webopedia