SALARY INCOME

Meaning of Salary
Every payment made by an employer to his employee for service rendered would be chargeable to
tax as income from salaries. The term ‘salary’ for the purposes of Income-Tax Act will include
both monetary payments (e.g. basic salary, bonus, commission, allowances etc.). As well as non-
monetary facilities (e.g. housing accommodation, medical facility, interest free loans etc).
(1) Employer-employee Relationship:
Before an income can become chargeable under the head ‘salaries’, it is vital that there should exist
between the payer and the payee, the relationship of an employer and an employee.
(2) Full-time or part-time employment:
It does not matter whether the employee is a fulltime employee or a part-time one. Once the
relationship of employer and employee exists, the income is to be charged under the head “salaries”.
If, for example, an employee works with more than one employer, salaries received from all the
employers should be clubbed and brought to charge for the relevant previous years.
(3) Foregoing or sacrificing of salary:
Once salary accrues, the subsequent waiver by the employee does not absolve him from liability to
income-tax. Such waiver is only an application and hence chargeable.
(4) Surrender of salary:
However, if an employee surrenders his salary to the Central Government u/s 2 of the Voluntary
Surrender of Salaries (Exemption from Taxation) Act, 1961, the salary so surrendered would be
exempt while computing his taxable income.
(5) Salary paid tax-free:
This, in other words, means that the employer bears the burden of the tax on the salary of the
employee. In such a case, the income from salaries in the hands of the employee will consist of his
salary income and also the tax on this salary paid by the employer.This means both the salary and the
tax paid thereon will be taxable in the hands of the employee.
(6) Salary Taxed as FBT:
A person being an ‘Employer’ is liable to pay FBT. The tax base for the purposes of FBT is the value
of fringe benefits provided or deemed to have been provided by an employer to his employees during
the previous year. Fringe benefits are not included as perquisite in the salary. Employer has to pay
fringe benefit tax on the value of fringe benefits.
(7) Voluntary payments:
Whether the payment from an employer is based on a contract or not, it constitutes salary in the hands
of the employee. However, many employers give personal gifts and testimonials to the employees. For
example, employees who complete 20 years of service may be given a wrist watch. The question arises
whether the value of the watch can be taxed in the hands of the employee. Courts have taken the view
that such gifts are not taxable. However, in these cases it is important that such gifts must be given to
employees pursuant to a scheme applicable to employees in general. If gifts are given purely on a
selective basis they will become chargeable in the hands of the recipient. However, due to the levy of
Fringe Benefit Tax, these gifts will now be exempt in the hands of the recipient, but will be taxable in
the hands of the employer.
PROVISIONS RELATING TO COMPUTATION OF INCOME

The relevant provisions and rules for computation of income under the head “Salaries” are tabulated as
under:
Chargeability- Sec. 15
Deductions- Sec. 16
Definitions- Sec. 17
Exemptions- Sec. 10(5) to 10(14)

CHARGEABILITY OF SALARY

Subject to following further conditions—

1. Where salary paid in advance is included in total Income of a previous year, shall not be
included again, in the total Income of the previous year in which such salary becomes due.
[Explanation-1 to Sec. 15]
2. Any salary, bonus, commission or remuneration due or received by a partner of a firm from
the firm, shall not be regarded as salary under sec. 15 [Explanation-2 to sec. 15]
3. Salary earned in India is deemed to accrue or arise in India. [Sec. 9(1) (i)]
4. Salary payable for services rendered in India and salary payable for rest period or Leave
period, preceded or succeeded by service rendered in India, shall be regarded as income earned
in India. [Explanation to Sec. 9(1)(ii)]
5. Salary payable by Govt. to a Citizen of India for services rendered outside India shall be
regarded as Income deemed to accrue or arise in India. [Sec. 9(1)(ii)]

SALARY defined u/s 17 (1)-

Inclusive definition - means apart from general and popular meaning, also it includes those items
which otherwise may not be considered as salary.
“Salary” includes
a) wages;
b) any annuity or pension;
c) any gratuity;
d) any fees, commissions, perquisites or profits in lieu of or in addition to any salary or
wages;
e) any advance of salary;
f) any payment received by an employee in respect of any period of leave not availed of
by him;
g) the annual accretion to the balance at the credit of an employee participating in a
recognized provident fund, to the extent to which it is chargeable to tax under rule 6 of
Part A of the Fourth Schedule; and
h) 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 recognized provident fund, to the extent to which it is chargeable to tax under sub-
rule (4) thereof;
i) the contribution made by the Central Government or any other employer in the
previous year, to the account of an employee under a pension scheme referred to in
section 80CCD
TAX TREATMENT OF DIFFERENT FORMS OF SALARY INCOME

Basic salary and Dearness Pay are charged to tax U/S 15

1) Advance Salary Sec 17(1) (v) its taxable on receipt basis, in the AY relevant to PY n which it
received.
2) Arrears of Salary – Its taxable on receipt basis, if the same has been subject to the tax earlier
on due basis.
3) Leave Salary – at the time of Retirement

Assessee

Govt Employees - any amt received as Cash Others - Least of the following –
equivalent of leave salary in respect of the period
of earned leave at his credit at the time of a) The amt of Leave encashment actually received at the time of
retirement – wholly exempted from tax. retirement.
b) 10 months “Average Salary” (10 x Avg mts salary )
c) Cash equivalent of the leave salary in respect of the period of earned
leave standing to the credit of employee at the time of retirement or
superannuating i.e
[ { 30 days x No. of Years completed ) – No. of days leaves already
availed } x Last 10 months average salary / 30 days]
d) Such limit as the Central Govt by Notification shall specify - RS
300000/ - for retirement on or after 1.04.1998.

*salary for this purpose means: Basic Salary + Dearness Allowance (if terms of employment so
provide) Commission which is based on fixed percentage on Turnover.

Leave salary –

During the continuation of Employment:

If leave encashment is received during the continuity of employment, it is chargeable to tax, respective
of the fact whether the employee is in Govt service or private service. The employee can, however,
claim relief in terms of Section 89.
Leave salary to legal heirs of deceased employees is not taxable.

4) Salary to Partners

Salary pay to a partner by a Firm is an appropriation of profits. It is not chargeable under the
head of salary but is taxable under head Profit and Gain of Business & Profession. Likewise interest ,
bonus, commission or remuneration due to or received by partner is not taxable under the head of
salary.

5) Bonus –
It is taxable in the year of receipt if it has not been taxed earlier on due basis.While
contractual bonus is regarded as salary, gratuitous bonus is taxable as a perquisites.

6) Gratuity sec. 10(10) :

Gratuity means a Gift or present , often in return for favors or services.It is paid for long &
meritorious services rendered by an employee.
 Assessee

Govt Employees – the full amt is Other Employees

exempted from tax

Covered by payment of Gratuity Act 1972 Others

Least of the follows: Least of the follows :

a) Actual amt of gratuity received. a) Actual amt of gratuity received

b) 15 days salary (Note 1 )for each b) ½ months average salary (Note 2) for
completed yrs of services or part each completed year of service any
thereof in excess of 6 months fraction of year will be ignored
(15/26 x last months salary drawn x (1/2 x last 10 months average salary x
No of yrs of services) No. of Years Completed )
c) Rs 20,00,000/- c) Rs. 20,00,000 / -

(Here suppose yr of service is 10 yrs (Here 10yrs 7 months means 10 yrs i.e
7 months then take 11 yrs or 10 yrs 4 fraction ignored)
months then 10 yrs only)

Note 1 : Salary for the purpose of the aforesaid limits means salary last drawn by an employee and includes dearness
allowance but does not include any bonus, commission house rent allowance overtime wages and any other
allowances.

Note 2 : Salary Means Basic Salary + DA ( in terms of employment – so provide ) + Commission which is fixed on
turnover.

7) Pension Sec 17(1)(ii)

Pension is periodical payment received by an employee after his retirement and taxed as salary
on the other hand, the pensions earned and received abroad but later on remitted to India ,it is
exempted from tax. The main types of pension are as follows:
Pension

Uncommuted Pension Commuted pension (lumpsum payment)

(Periodical Payment)

Taxable salary in the hands of

both Govt & Non Govt
Employees
Govt Employees & defence Other Employees
Wholly Exempted

In case employee Gratuity received In case other Employee

Exempt Amt: Exempt Amt:
1/3x 100% commuted pension amt 1/2x 100% commuted pension
8) Annuity sec.17(1)(ii)
Annuity means an yearly allowance or income; the grant of an annual sum for term of year , for life or in perpetuity.
An annuity payable by a present employer is taxable even if it is received voluntarily without any contractual obligation of
employer (if from ex employer then taxable u/s 17(3)(ii) for profit in lieu of salary )

9) Retrenchment compensation sec 10 (10B)

Compensation received by workman under industrial dispute act 1947 or under any other act , rules , order , notification, at the the time
of retirement is exempt from tax to extent of lower of following
a) an amt is calculated in accordance with the provisions of sec 25F (b) of industrial disputes act 1947 or
b) Rs 500000
c) Amt received actually
10) Profit in lieu of Salary ( sec 17 (3) )
 Compensation for Loss of Employment or modification of the employment terms
 Payment from unrecognized Provident and superannuation fund
 Payment under key men insurance policy
 Payment before joining and after retirement
Salary received from United Nations organizations - not taxable.

Compensation received at time of voluntary retirement and separation sec 10 (10C)

It is exempt from tax if following conditions are satisfied

a) Its received at the time of voluntary retirement and termination or in case PSU (public sector units) at the time of
voluntary separation
b) It is received by an employee following undertaking i) an
authority established under central , state, or provincial act
ii) local authority, university, an Indian institute of technology , State & Central Govt
c) It is received in accordance with scheme of voluntary retirement
d) Maximum amt of exemption is Rs 5,00,000
e) Where exemption has been allowed to an employee u/s 10 (10C) for any AY.

Allowances
Definition:
“Fixed quantity of money or other substance given regularly in addition of salary for purpose of meeting some
particular requirement connected with the service rendered by employee or as a compensation for unusual conditions of that
service.”
It is fixed, predetermined and given irrespective of actual expenditure.

There are three types of allowances:

1) Fully taxable allowances
2) Partly taxable allowances
3) Fully exempted allowances

1) Fully taxable allowances

a) City compensatory allowance

b) Dearness allowance
c) Rural allowance
d) Proctorship allowance
e) Warden ship allowance
f) Project allowance
g) Deputation allowance
h) Overtime allowance
i) Tiffin allowance
j) Interim allowance
k) Fixed medical allowance
l) Servant allowance

2) Fully exempted allowance

a) Allowance to govt employee outside india
b) Allowance to high court judges
c) Allowance received from UNO
 d) Compensatory allowance received by a judge
e) Sumptuary allowance given to high court judge

3) Partly taxable allowances

a) House Rent Allowance (sec 10(13A)) and Rule 2A

Exemption in respect of HRA is available to the extent of following :

a) an amount equal to
50% of Salary (i.e ½) - if where residential house is situated at Mumbai, Kolkata Delhi, Chennai
and 40% of Salary (i.e 2/5)- if where residential house is situated at
any other place
b) Actual HRA Received
c) Rent paid - 10% of Salary

however , no deduction for HRA shall be allowed if the assessee owns the house occupied and
he has incurred no actual expenditure for the payment of rent.

Salary = Basic Salary DA (if terms of employment so provide) + Commission ( which is fixed on
Turnover )

b) Entertainment Allowance (sec 16 (ii))

Entertainment Allowance is first included in salary income under the head ‘Salaries ‘ and thereafter a
deduction is given u/s 16 (ii).

c) Special allowance prescribed as exempt u/s 10(14)

1) When exemption depends upon actual expenditure by employee – the following allowances are
exempt to the extent the amt is utilized for specified purpose for which allowance received (Unspent
amt is fully taxable )

Name of allowance Nature of Allowance

1)Travelling any allowance granted to meet the cost of travel on tours or on transfer
Allowance or
Transfer allowance
2) conveyance To meet the expenditure on conveyance in performance of duty of an office
allowance ( expenditure covering the journey between office and residence is not treated as
expenditure in performance of duties of the office and consequently such
expenditure is not exempt from tax
3)Daily allowance To meet the ordinary daily charges incurred by an employee on account of
absence from his normal place of duty
4)Helper allowance To meet the expenditure on helper where such helper is engaged for the
performance official duty
5)Research For encouraging the academic research and other professional pursuits
Allowance
6)Uniform To meet expenditure on purchase or maintenance of uniform for wear during
allowance office hours

2 ) when exemption doesn’t depends upon expenditure

Name of allowance Nature of allowance Exemption as

specified rule 2bb
Special It include any special compensatory allowance in the Amt exempt from
compensatory (Hills nature of hills areas or high altitude allowance or RS 300 pm to Rs 7000
areas allowance) uncongenial climate allowance and snow bounced pm
allowance
Boarder area It includes any special compensatory allowance in the Amt of exemption
allowance nature of border area allowance or remote locality varies from Rs 200
allowance or difficult area or disturbed area allowance pm to Rs 1300 pm
Tribal / Schedule This is given in MP, UP, Tamil Nadu, Karnataka , Rs.200 p.m.
Area allowance Orissa , Tripura, Assam , west Bengal , Bihar ,
 Allowances for It is given to Employee who working in any Transport The Amt of
Transport Employee System to meet his personal expenditure during his Exemption is Least of
duty performed in the course of running of such the following:
transport from one place to another provided that such a. 70% of such
employee ia not in receipt of daily allowance. allowance:
or
b. Rs. 10000
p.m.

Children Education Given for children’s education. Exempt up to Rs. 100

Allowances p.m. per child
(maximum two
Children)

Hostel Expenditure Given to meet the hostel Expenditure on employee’s Exempt up to Rs. 300
Allowance children. p.m. per child
(maximum two
Children)

Transport allowance It has given to an employee to meet his expenditure for Minimum of the
the purpose of commuting between the place of his following shall be
residence & the place of his duty. exempted:
a. Actual amount
received; or
b. Rs.3,200 p.m
(Assessee is blind /
deaf and dumb /
orthopaedically
handicapped.)

Underground Given to an employee who is working in uncongenial, Exempt up to Rs. 800

Allowance unnatural climate in underground mines. p.m.

Island duty This special allowance is granted to the members of Exempt up to Rs. 3250
allowance armed forces in the nature of Island duty allowance in p.m.
Andaman & Nicobar, Lakshadweep Group of Island.

Perquisites:
 Valuation of perquisite in respect of Motor Car

Car is Car Car is used Car is used wholly for Car is used partly for Official &
owned by expenses wholly for Private purposes private purpose
are met by Official
purposes

Employer Employer No value is Actual expenditure incurred Cubic capacity Rate

provided (note 1) by Employer [ i.e. Exceed 1.6 litres, -Rs. 2400p.m
expenditure on running & Does not exceed - Rs.1800 p.m.
maintenance including 1.6 litres
salary of driver + normal Drivers salary - Rs.900 p.m.
wear & tear at rate of 10% (Chauffeur)
of actual cost to employer)
or hire charges if car is Nothing is deductible in respect
taken on hire] of any amt recovered from
Less: amt recovered from employee.
employee if any.

Employee Not a perquisite, Actual expenditure incurred Cubic capacity Rate

hence not taxable. by Employer [ i.e. Exceed 1.6 litres - Rs. 900p.m
expenditure on running & Does not exceed -Rs.600 p.m.
maintenance including 1.6 litres
salary of driver + normal Driver’s salary -Rs.900 p.m.
wear & tear at rate of 10% (Chauffeur)
of actual cost to employer)
or hire charges if car is Nothing is deductible in respect
taken on hire] of any amt recovered from
Less: amt recovered from employee
employee if any.

Employee Employee Not a perquisite, Not a perquisite, hence not Not a perquisite, hence not
hence not taxable. taxable. taxable.

Employer No value is Actual expenditure incurred Actual expenditure incurred by

provided (note 1) by the employer. the employer.
Less: Amt recovered from Less: Amt used for Official
employee. Purpose
(Cubic capacity Rate
Exceed 1.6 litres, - Rs. 2400p.m
Does not exceed - Rs.1800 p.m.
1.6 litres
Drivers salary -Rs.900 p.m.
(Chauffeur)
Less: Amt recovered from
employee.

Note 1: conditions to be satisfied if Car is used for official purposed:

1) The Employer has maintained complete details of journey undertaken for official purpose which
may include date of journey, destination, mileage, & amt of expenditure incurred thereon.
2) The Employer gives a certificate to the effect that the expenditure is wholly for performance of
official duties.
 Conveyance facility to Judges: Conveyance facility provided to High Court Judges & Supreme
court Judges is not chargeable to tax.

Car Facility between Office & residence: The use of Motor Car by Employee for the purposes of
going from his residence to the place where duties of employment are to be performed or from such
place back to his residence, is not taxable.

Employees Provident Funds: (Profit in lieu of salary)

P.F. is a retirement Benefit scheme. Under this a stipulated sum is deducted from the salary of the
employee as his contribution towards the fund. The Employer also contributes simultaneously an
equal amount out of it pocket to the fund. These contributions are invested in gilt-edged securities.
Interest earned thereon is also credited to the P.F. The accumulated sum is paid to the Employee at
the time of his retirement or resignation. In the case of death of an employee, the accumulated
balance is paid to his legal heirs. Govt. provides deductions u/s 80C.
 Types of Provident Funds:
1) Statutory Provident Fund
2) Recognised Provident Fund
3) Unrecognised Provident Fund
4) Public Provident Fund
 Tax treatment:

S.P.F. R.P.F U.R.P.F. P.P.F

Employers Exampt i.e Not treated as Exampt i.e not Employer does
contribution to not treated as “income” up to treated as not contribute.
P.F. “Income” 12% of “Income”
salary .excess 12%
of salary is taxable.
(Note: 1)
Deductions u/s Available Available Not Available Available
80C on
employees
contribution
Interest Exampt i.e Excess of Interest Exampt i.e not Exempt from
credited to not treated as over Notified rate treated as tax
provident fund “Income” is taxable. “Income”
(Note: 2)
Lumpsum Exempt from Exempt from Note 4 Exempt from
payment at the tax tax(in some case, tax
time of Note 3)
retirement or
termination of
service.

Notes:
1) Salary for this purpose means Basic Salary, Dearness Allowance or pay, if term of
employment so provide, & commission which determined at the fixed % of turnover
achieved by an Employee.
2) Interest credited to R.P.F. is exempt from tax if rate of interest does not exceed the
notified date given below:

Date of credit of Interest Notified rate()

Between June 18,1985 & March 31, 1986 10.5
Between April 1,1986 & March 31,2001 12
Between April 1, 2001 & August 31, 2010 9.5
On or after Sept 1, 2010 8.5

3) The accumulated balance will be exempt from total income in following cases:
a) If he has rendered continuous service with his Employer for a period of 5 years or
more.
b) If the employee is not able to fulfill the conditions of such continuous service due to
his ill-health or any other which beyond control of the employee.
 4) Payment received in respect of Employee’s own contribution is exempt from tax. Interest
on Employees contribution is taxable under the head “Income from Other Sources” But
Employers contribution & Interest thereon is taxable under “Salaries”.

Approved Superannuation Fund:

 It means superannuation fund which has been & continues to be approved by the Commissioner
in accordance with the rules contained in Part B of the fourth Schedule.
 The tax treatment of contribution to & payment from the fund is as under:
 Employer contribution is exempt from tax. However From A.Y.
2010-2011 onwards, employer’s contribution will be chargeable
to tax in the hands of an employee to the extent it exceed Rs. 1
lakh per annum.
 Employees contribution qualifies for deduction u/s 80C
 Interest on accumulated balalnce is exempt from tax.
 Sec.10(13) provides exemption in respect of payment from fund-
a) To the legal heirs on the death of beneficiary
b) To an employee in lieu of or in commutation of an annuity
on his retirement at or after the specified age or on his
becoming incapacitated prior to such retirement;
c) By way of refund of contribution on death of the
beneficiary ; or

Approved Gratuity Fund:

 It means a gratuity fund which has been & continues to be approved by the
Commissioner of Income tax in accordance with the rule contained in Part
C of the Fourth Schedule.
 Tax treatment:
 Employer’s contribution is exempt from tax.
 Actual payment received by the employee is exempt from tax
within limits specified in Sec.10(10).

What is Transferred Balance when unrecognized provident fund is recognized?

Ans : An organization maintains unrecognized provident fund. The organization has obtained recognition
to its provident fund with existing balance during the previous year. The amount transferred from the
unrecognized provident to recognized provident fund is ‘transferred balance’.

How much of the “transferred balance” is taxable?

Ans:
Recognised provident fund Unrecognised provident fund
Employer Contribution The amt in excess of 12% of employees Not taxable in year of contribution
salary is taxable in the year of making
of contribution.
Credit of interest in provident fund Amt in excess of 9.5% p.a.is taxable. Not taxable in year in which amt is
W.e.f. Sept 1, 2010 rate is 8.5%. credited.

DEDUCTIONS FROM SALARY- [Sec. 16]

The following deductions are allowed under section 16:
 Standard Deduction-[Sec.16 (i)] not applicable.
 Entertainment allowance- [Sec.16(ii)]
 Tax on employment / profession tax - [Sec. 16(iii)]
Entertainment Allowance – [Sec. 16 (ii)]
W.e.f. Assessment Year 2002-03 deduction in respect of entertainment allowances is only allowed
Government employee. Such allowances admissible to non-Government employees has been
withdrawn from Assessment Year 2002-03.
The deduction available will be least of:
(i) Actual entertainment allowance received during the Previous Year; or
 (ii) 20% of salary (salary means only basic pay exclusive on any allowance or perquisites); or
(iii) Rs. 5,000.
Tax on employment or Professional Tax– [Sec. 16 (iii)]
It is levied by a State under article 276 of the Constitution is allowed as deduction.

Following points should be kept in mind:

1) Tax on employment or Professional Tax will be allowed as deduction only on payment basis in
the year in which it is actually paid.
2) There is no monetary ceiling under the Income tax act (under article 276 of the Constitution, a state Govt cannot
impose more than Rs. 2500 p.a. as professional tax).
3) If the professional tax is paid by the employer on behalf of the employee, it is first included in the salary of the
employee as a ‘perquisite’ and then the same amount is allowed as deduction u/s 16(iii).