Income from Salary - Tax notes PDF

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INCOME FROM SALARY [Sections 15 to 17] Salient features: To understand the concept of ‘Salary’, following points would be worth considering:1) Relationship between payer and payee should be that of employer and employee or a master and servant. Following examples may highlight this point. Commission received by a director from a company would be termed as salary, if the director is an employee of that company (executive or managing director). However, if the director is not an employee of the company (non-executive director), such commission would be chargeable either under the head ‘profits and gains of business or profession’ or ‘income from other sources’. Salary received by a college lecturer is a salary, but remuneration received from University for setting or assessing papers cannot be called as salary as he is not an employee of the University. Salary received by a partner in a partnership firm is not taxable under the head salary, but is taxed under the head profits and gains of business or profession, because a partner cannot be termed as an employee of partnership firm. Salary and allowances received by MPs and MLAs from the Parliament or State Assembly cannot be termed as salary as the MPs and MLAs are not the employees of these houses. 2)

Salary received from former, present or prospective employer during the previous year is taxable under the head salaries.

3)

Salary income should be real and not fictitious. There should be an intention to pay and receive salary. The employee renders some services to the employer and as a reward or compensation of such services rendered the employer pays the remuneration.

4)

Salary is taxable on due basis. Salary in case of government employees falls due on 1 st day of the next month, while for private sector employees it falls due on the last day of the month. Accordingly, while computing taxable salary for government employees, salary for March to following February is considered while for private sector employees, salary is considered from April to March.

5)

If an employee foregoes any part of his salary voluntarily, it will be exempt as salary is taxable on due basis. [One day salary foregone for helping the family members of a deceased colleagues etc. will be added to taxable income even though not actually received]

6)

Employer cannot pay any tax-free salary to the employee. If employer pays any tax-free salary to the employee by taking the burden of tax on himself, such tax will also be added to the salary of the employee and such total salary will be taxable in the hands of the employee.

Basis of charge (Sec.15) Sec.15 provides for basis of charge for “income from salary”. According to Sec.15 salary consists of – a. Any salary due from an employer (or a former employer) to an employee in the previous year, whether actually paid or not; b. Any salary paid or allowed to him in the previous year by or on behalf of an employer (or former employer), though not due or before it became due; and c. Any arrears of salary paid or allowed to him in the previous year by or on behalf of an employee (or a former employer), if not charged to income-tax for any earlier previous year. Any payment received from an employer by an employee for the services rendered, would be termed as Salary. Such salary may be paid in different forms (cash or kind). Let us now try to understand the various forms of salary and their taxability.

T.Y.B.Com. – Income Tax Paper 1

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Computation of salary income is done in the following manner. Taxation of salary Amount 1. 2.

3. 4.

5. 6.

7.

Salary (including all allowances) Less : Allowances exempt u/s.10 a) Gratuity U/s.10(10) b) Leave Salary U/s.10(10AA) c) House Rent Allowance Sec.10(13A) d) Specified Allowances Sec.10(14) e) Leave Travel Allowance Sec.10(5) Balance (1-2) Add : Value of perquisite(s) and/or Profits in lieu of salary (Sec.17) a)Tax-free Perquisites (for all employees) b)Taxable Perquisites (for all employees) c)Taxable Perquisites (only for certain categories of employees) d)Profits in lieu of salary Total (3+4) Less : Deductions claimed u/s. 16 a) Standard deduction u/s.16(i) b) Entertainment Allowance u/s.16(ii) c) Tax on Employment u/s.16(iii) Income chargeable under the head Salaries (5-6)

Amount Rs................

Rs................. Rs................. Rs................. Rs................. Rs……….....

Rs………… Rs................

Note Ref. 1.1 1.1 1.1 1.2 1.3 1.4 1.5

Rs................. Rs................. Rs................. Rs.................

Rs................. Rs................. Rs.................

1.5.1 1.5.2 1.5.3 Rs................ Rs................

Rs................ Rs................

1.5.4

1.6 1.7 1.8

1.1 Meaning of salary: Section 17(1) defines ‘Salary’ as follows:Salary includes (i) wages; (ii) any annuity or pension; (iii) any gratuity; (iv) any fees, commission, perquisites or profits in lieu of or in addition to any salary or wages; (v) any advance of salary; (va) any payment received by an employee in respect of any period of leave not availed of by him; (vi) the annual accretion to the balance at the credit of employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under rule 6 of Part A of the Fourth Schedule; and (vii) the aggregate of all sums that are comprised in the transferred balance as referred to in sub-rule (2) of rule 11 of Part A of the Fourth Schedule of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under sub-rule (4) thereof. Salary means a reward or remuneration received by an individual in respect of services rendered by him under an express or implied contract of employment. For an income to be termed as ‘Salary’ there must exist an relationship of ‘employer’ and ‘employee’ between the payer and the payee. Every servant is an employee but an agent is not an employee. Different forms of salary given in the definition above and their taxability Wages: It is a form of salary paid to the workers normally on daily, hourly or monthly basis. Employees working in administrative departments or higher levels are paid salary (on monthly basis). This distinction is made from accounting point of view. This difference between wages and salary, from the accounting point of view is however, not recognised by Income Tax and salary includes wages. Annuity or Pension: Annuity is an yearly payment or allowance or grant of an annual sum for a specific period of annuity. The annuity may be received from the present employer, or ex-employer or even from a person other than employer.

T.Y.B.Com. – Income Tax Paper 1

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Annuity received is taxed as salary or as profit in lieu of salary, if received from the past employer. If it is received from a person other than employer, then it is treated as income from other sources. Normally, in private sector where the employer is not paying any pension after retirement an annuity may be paid. Pension is a periodical payment in consideration of past services of the retired employees. The pension is payable for the remaining life of the employee. In case of family pension, it is even paid to the surviving spouse of the deceased employee. Employees can commute (discount/get lump-sum payment in consideration of foregone part of the pension for a specific term) a part of the pension. Such commutation of pension is taxed as follows. 1) In case of Government employees such commuted value of pension is fully exempt from tax U/s. 10(10A). 2) In case of other employees the exemption restricted to the following limits: a) If the employee receives Gratuity also -1/3rd of pension which he is normally entitled to receive. b) In any other case - 1/2 of such pension. Gratuity [Sec.10(10)]: Gratuity received while in service is fully taxable. Gratuity received on the following occasions qualify for exemption, a) retirement, b) resignation, c) death, d) termination of employment or e) becoming incapable of employment. Any death-cum-retirement gratuity received under the following schemes shall be exempt. 1) Government Employees: The Gratuity received by employees of Central or State Governments or Local Authority is fully exempt. [Sec. 10(10)(I)] 2) In case of employees covered by Payment of Gratuity Act, 1972, the amount of exemption is the least of the following :a) Gratuity actually received; b) Amount specified (Rs.20,00,000); or c) 15 days’ salary based on salary last drawn for every completed year of service or part thereof in excess of 6 months. (15 days salary is calculated using the formula as Salary last drawn x 15/26 (26 working days in a months assumed) 3) In case of other employees, the amount of exemption is the least of the following : a) Gratuity actually received; b) Amount specified (Rs.20,00,000); or c) Half month’s salary (on the basis of average salary drawn for last 10 months) for each completed year of service (fraction to be ignored). Notes: 1) Gratuity received during employment is fully taxable. 2) If the gratuity is received by an employee from two or more employers, in the same previous year, the aggregate amount of gratuity would be subjected to exemption limits. 3) Salary for the purpose of calculating exemption limits is the salary last drawn by the employee. It includes dearness allowance, and commission based on percentage of turnover achieved but does not include any bonus, commission, H.R.A., overtime wages and any other allowances. 4) For employees working in seasonal establishments, 7 days’ salary shall be considered instead of 15 days’. For workers getting wages on piece rate basis, 15 days salary shall be computed on the basis of average of total wages (excluding overtime wages) received for a period of three months immediately preceding the termination of employment. Leave Salary [Sec.10(10AA)]: If leave encashment is received at the time of leaving the job or at the time of retirement, the same would be exempted subject to following conditions. 1) Government employees: In case of Central or State Government employees, any amount received as cash equivalent of leave salary in respect of period of earned leave at his credit at the time of his retirement, whether on super-annuation or otherwise, is exempt from tax. 2) Other employees : In case of non-Government employees (including local authority or public sector employees) leave salary is exempt to the extent of the least of the following : a) cash equivalent of leave salary in respect of the period of earned leave to the credit of employee at the time of his retirement. Such entitlement is restricted to 30 days for every year of actual service. The cash equivalent is calculated on the basis of ‘average salary’; or b) 10 months salary; or T.Y.B.Com. – Income Tax Paper 1

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c) d) Notes:

Rs.3,00,000 (for employees retiring after 01.04.1998) Leave encashment actually received. 1)

2) 3)

Salary for this purpose, means a) basic salary, b) dearness allowance if the terms of employment so provide and c) commission based upon fixed percentage of turnover achieved by the employee. Average Salary is to be calculated on the basis of average salary drawn during 10 months immediately preceding the retirement. Where, cash equivalent of unutilised earned leave is received by an employee from two or more employers in the same year, the exempted amount is to be calculated for all such encashments.

Provident Fund: Provident fund is a retirement benefit scheme. Under the provident fund scheme, a stipulated amount is deducted from the salary of an employee as his contribution towards the fund. The employer also puts his own contribution. This money is invested in the gilt-edged securities. Interest earned is also credited to the fund account. The accumulated balance is paid to the employee at the time of his retirement. There are three types of provident funds namely; a) Statutory Provident Fund; b) Recognised Provident Fund; c) Unrecognised Provident Fund Besides, there is one more scheme called as Public Provident Fund. However, the same is not restricted only to the salaried class. Anybody can open a P.P.F. A/c with any nationalised banks. Now even private sector banks are also allowed to operate PPF Accounts. The same is discussed under the chapter on ‘rebates and relief’. a) Statutory Provident Fund: This fund is maintained by Government and semi-government organisations, local authorities, railways, universities and recognised educational institutions. b) Recognised Provident Fund: A provident fund scheme to which the Employee’s Provident Fund and Miscellaneous Provisions Act, 1952 apply is called as a Recognised Provident Fund. Any establishment employing 20 or more employees is covered by the Act. Establishments where the number is less can also join the scheme voluntarily. An establishment can either join a scheme set up by Government or can have their own scheme. If the establishment frames its own scheme, then it will have to create a ‘Trust’ for the same. Such scheme requires an approved of the P.F. Commissioner to become a Recognised Provident Fund. c) Unrecognised Provident Fund: In case, if the scheme mentioned above is not approved by the P.F. Commissioner, the same is called as Unrecognised. Tax treatment of the contributions to various provident fund schemes can be understood as follows:Particulars Statutory Recognised Provident Fund Unrecognised Provident Fund Provident Fund Exempt from tax Exempt from tax Exempt upto 12% of salary. Employer’s Excess contribution over contribution to 12% of salary is taxable provident fund Available Available Not available Deduction U/s.80C on employee’s contribution Exempt from tax. Exempt from tax if rate of Interest credited Exempt from tax interest does not exceed on Provident 9.5%. Excess of interest over Fund 9.5% is taxable. Exempt upto employee’s Exempt from tax. Exempt provided certain Lump-sum contribution. Interest on conditions are fulfilled. payment at the employee’s contribution is When not exempt RPF will time of taxable as income from other be treated as URPF right retirement etc. sources. Employer’s contribution from its inception. and interest thereon is taxable under salary.

T.Y.B.Com. – Income Tax Paper 1

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Allowances and their taxability: Allowance can be defined as a fixed amount either in the form of money or otherwise, given regularly in addition to salary for the purpose of meeting a particular requirement connected with the services rendered by the employee or as a compensation for unusual / peculiar conditions of that service. Following are some ‘allowances’ paid to employees. Dearness Allowance: Dearness allowance is paid for increased cost of living due to inflation. While deciding the pay scales of the employees, salaries are fixed in slabs according to the grades. Such salary slabs cannot be changed frequently. However, keeping in mind the increasing cost of living, salary needs to be increased. Therefore, normally, employers give fixed basic salary with annual increments plus dearness allowance decided from time to time on the basis of Inflation Index. This will facilitate an employee to maintain his standard of living. Such dearness allowance received is a part of salary and is fully taxable. City Compensatory Allowance: Cost of living in big cities is often more than in smaller towns or villages. To meet such high cost of living, employees are normally paid with a compensatory allowance depending upon the size of the city to which he is posted. So when an employee is transferred from a smaller town to a bigger city, his increased cost is taken care of. Such allowance is fully taxable. House Rent Allowance: House Rent Allowance is paid for meeting the cost of hiring an accommodation. Taxability of such allowance is discussed later in para. 1.2. Entertainment Allowance: During the course of performing their duties, if the employees have to entertain their customers and clients, a separate allowance is paid to meet such expenditure. Such allowance is to be included in the salary first and then a deduction is allowed U/s.16(ii). Taxability of entertainment allowance is discussed later in para. 1.7. Foreign Allowance: This allowance is paid by the Government to the employees posted outside India. This allowance is fully exempt and not included in the total income. However, in case of other employers, foreign allowance given to the employees for meeting the expenditure overseas is exempt to the extent it is actually spent. Travelling Allowance: When employees have to travel outstation, for performing their duties, any allowance paid for such travel is exempt to the extent it is spent by the employee. However, any unspent balance would be taxable. Conveyance Allowance: Sometimes, employees have to travel outside the premises of the employer to meet customers or to complete their outside duties etc. Any allowance paid for such conveyance is exempt to the extent it is spent by the employee. Special Allowances [Section 10(14)(i) and (ii)]: Special allowances are given due to peculiar nature of employment, place of employment, or even disciplines followed etc. Taxability of such allowances is discussed later in para 1.3. Fixed Medical Allowance: Any fixed medical allowance is fully taxable. However, medical facilities provided by the employer form part of perquisites and are discussed later. Tiffin Allowance: An allowance may be paid for meeting the expenses on food. This allowance is fully taxable. Servant Allowance: An allowance may be paid for meeting the expenses on household servants. This is fully taxable. Sumptuary Allowance: This is an allowance granted to High Court under Section 22C of the High Court Judges (Conditions of Service) Act, 1954 and Supreme Court Judges under Section 23B of the Supreme Court Judges (Conditions of Service) Act, 1958. This is fully exempt from tax. T.Y.B.Com. – Income Tax Paper 1

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Any allowance paid to High Court Judges under Section 22A(2) of High Court Judges (Conditions of Service) Act, 1954 is fully exempt from tax. Exemptions U/s.10: We have already seen the taxability and the extent of exemption of Gratuity and Leave salary in the preceding paragraphs. The taxability of other allowances is as follows. 1.2: House Rent Allowance [Sec.10(13A) and Rule 2A]: Employees may be given House Rent Allowance to meet the cost of hiring accommodation. H.R.A. is partly taxable and partly exempt from tax as discussed below. H.R.A. is to be included in the salary first and then least of the following amounts is exempt from tax:a) an amount equal to 50% of salary, if residential house is situated in Metros i.e. Mumbai, Delhi, Kolkata or Chennai, and 40% of salary, where residential house is situated at any other place (like Pune); b) House Rent Allowance received by the employee in respect of the period for which rental accommodation is occupied by the employee during the previous year; c) the excess of rent paid over 10% of salary. Notes : 1) ‘Salary’ for the purpose of this clause means basic salary plus dearness allowance, if the terms of employment so provide, and commission based on fixed percentage of turnover achieved by an employee as per the terms of employment of the employee. 2) Salary is to be calculated on due basis. i.e. if an employee received any arrears of salary or in advance the same is to be excluded for the purposes of valuation. 3) The basis for calculation is the location of accommodation and not the place of employment. 4) The exemption can be calculated on annual basis if a) the salary of an employee, b) the HRA received, c) the rent paid by him and d) the place taken on rent, remain same throughout the year. However, if there is any change in any of the above, separate calcul...