Income from Salary

Introduction

'Salary' is the first head of income. The income taxable under this head shall be calculated on the due basis or on the receipt basis, whichever occurs earlier. Taxable salary shall include taxable allowances, perquisites, retirement benefits, and profit in lieu of salary. Certain deductions are also allowed from salary income.​

Employer-Employee Relationship is a must

Taxability of an income under the head 'Salary' pre-requisites existence of employee and employer relationship. Before a payment can be taxed as salary, the relationship of employer and employee must be established. In the absence of an employer-employee relationship, the income shall be assessable either as business income or income from other sources.

Relationship of Principal and Agent

The relationship of the principal and agent may or may not be of an employer and employee. If the agent has to work under the direct control and supervision of the principal and he has no discretion of his own in the performance of his duties, he is deemed to be an employee and the remuneration payable to him in such a case is chargeable to tax under the head salaries. On the other hand, if the principal exercises only supervisory control in respect of work entrusted to the agent and the agent has wide discretion of his own in the execution of the policies of the principal, the presumption is that the agent is not an employee. The remuneration payable to the agent in such a case is liable to be taxed under the head 'Profits and gains of business or profession'.

Partner of firm

Salary paid to a partner by a firm is an appropriation of profits. Thus, the salary received by the partners from the firm is not deemed to be received from an employer. Such salary income constitutes the business income of the partner. Similarly, any interest, salary, bonus, commission, or remuneration due to, or received by the partner from such firm is chargeable to tax under the head 'Profits and gains from business or profession'.

Employment is distinct from Profession

If engagement for any work is incidental to the exercise of the profession, the gains arising from such engagement shall not be chargeable to tax under the head Salaries but the head 'Profits and gains from business or profession'.

Taxable on a due or receipt basis

An employee is liable to pay tax on salary income either on a 'due' basis or on a 'receipt' basis, whichever happens, earlier. Thus, if an advance salary has been received during the financial year, it shall be assessed to tax in the year of receipt itself. It shall not be subsequently charged to tax in the year in which it becomes due. ​

The employees are liable to pay tax on salary either on due basis or receipt basis, whichever happens earlier. Salary due from an employer or former employer to an employee in the previous year, even if it is not yet paid, is still chargeable to tax. The expression 'due' implies that there is an obligation on the part of the employer to pay that amount and a right has accrued to the employee to claim the same. Salary already taxed on receipt basis is not taxable again on due basis.

The salary income shall be computed in the following manner:

Section 17 provides an inclusive list of all those items which are covered in the definition of Salary. It includes wages, pension, gratuity, fees, advance salary, leave encashment, and so on. The salary shall also include all those components of salary which are not specifically defined in the inclusive list.

Inclusions in Salary

Salary shall include the following components:

1. Wages
2. Annuity or Pension
3. Gratuity
4. Fees, commission, perquisites, or profits in lieu of salary or in addition to salary or wages
5. Advance Salary
6. Payment received by an employee in respect of any period of leave not availed by him, i.e., leave salary encashment
7. Annual accretion to the balance in a Recognized Provident Fund, to the extent it is chargeable to tax
8. Transferred balance in a Recognized Provident Fund, to the extent it is chargeable to tax
9. Contribution made by the Central Government or any other employer to the account of an employee under a pension scheme referred to in Section 80CCD
10. Contribution made by the Central Government to the Agniveer Corpus Fund account of an individual enrolled under the Agnipath Scheme as referred to in Section 80CCH

If an employee is assessed on salary of more than 12 months for any previous year on account of receipt basis, he is entitled to claim relief under Section 89 from such salary.

Fees or Commission

If under the terms of the contract of employment, remuneration for the services rendered by the employee is determined at a fixed percentage of the turnover achieved by him, such remuneration or commission partakes the character of salary.

Any commission paid or allowed to an employee which is not based on the turnover achieved by him is still chargeable as salary, but it does not partake the character of basic salary.

Similarly, any fees or commission paid to an employee in addition to salary or in lieu of salary are taxable as salary. However, fees or commission payable to an employee by any person other than the employer shall be taxable as “Income from Other Sources”.

Bonus

Bonus paid or payable by the employer is taxable in the year of receipt if it has not been taxed earlier on a due basis. If the bonus is received in arrears, the assessee can claim relief under Section 89.

Employer’s Contribution under a Pension Scheme

Any contribution made by the Government or by other employers to the account of an employee under a pension scheme as referred to in Section 80CCD shall be included in the salary income of the employee.

However, the lower of such contribution or 14% of salary (where the contribution is made by the Central Government or State Government) or 10%* of salary (in other cases) shall be allowed as a deduction from the Gross Total Income. Salary for this purpose includes dearness allowance if the terms of employment so provide, but excludes all other allowances and perquisites.

* 14% where the total income of the employee is chargeable to tax under Section 115BAC(1A), i.e., the new tax regime.

Employer’s Contribution under the Agnipath Scheme

Any contribution made by the Central Government to the account of an employee under the Agnipath Scheme as referred to in Section 80CCH shall be included in the salary income of the employee. However, the entire amount so contributed by the Central Government shall be allowed as a deduction from the Gross Total Income.

Deductions from Salary to be Ignored

Salary is chargeable to tax on a gross basis without deduction for any component except the following:

• Standard Deduction
• Professional Tax
• Entertainment Allowance

Allowances are additional components of salary that are regularly given to the employees to meet the expenditure for particular purposes. Allowances are generally fixed irrespective of actual expenditure and are taxable. Under the Act, it is taxable under section 15 on a "due" or "accrual" basis, irrespective of whether it is paid in addition to or in lieu of salary. However, some exemptions are allowed by the Income-tax Act.

Types of Allowances

In accordance with the term of employment or condition of the workplace or statutory requirement, every employer may provide various allowances to the employees. The purpose of these allowances is to compensate the employee for working in an uncongenial or challenging workplace or to compensate the employees for the high cost of living.

An allowance is assumed to be taxable under the head 'Salary' unless it is specifically exempted from tax, fully or partly, under the Act. The treatment of popular allowances shall be in accordance with the following provision.

Fully Taxable Allowances

Partially Taxable Allowances

Note: House Rent Allowance

The exemption for House Rent Allowance (HRA) shall be allowed only if residential accommodation occupied by the employee is not owned by him and he actually pays rent in respect of such accommodation.

'Salary' for this purpose shall be the aggregate of basic salary, dearness allowance (if it forms part of salary for retirement benefits) and commission.

The exemption is allowed only for the period during which the rented house is occupied by the employee. If rental expenditure is less than 10% of salary, no exemption shall be allowed.

Perquisite means emoluments made available to an employee for his personal benefits or use which is in addition to regular salary or wages. The perquisite may be in cash or in-kind or in money or money's worth, and also amenities that are not convertible into money.

A perquisite is taxable as salary only when the employer provides it during the continuance of employment. Any perquisite allowed by a person other than the employer is taxable as income from 'other sources'.

What is included in Perquisites?

(a)  Rent-free accommodation or accommodation at concessional rent

(b)  Use of motor car

(c)  Facility of Gardener, Watchmen, Sweeper, or any other servant

(d)  Facility of Gas, Electricity, or Water

(e)  Free or concessional education facility

(f)  Transport Facility

(g)  Monetary Perquisites, i.e., an obligation of employee met by the employer

(h)  Insurance Facilities

(i)  Sweat Equity Shares or ESOPs

(j)  Contribution to retirement funds in excess of Rs. 7,50,000

(k)  Annual accretion on excess contribution to retirement funds

(l)  Loan at nil or concessional rate of interest

(m)  Holiday Facility

(n)  Free Food and Refreshments

(o)  Gift

(p)  Credit Card Facilities

(q)  Club Facilities

(r)  Use or transfer of employer's moveable assets

(s) Medical Facilities

(t)  Leave Travel Concession

(u)  Mobile or Telephone facility

(v)  Any other benefit or amenity

Taxability of Perquisites

For the purpose of taxability, the perquisites can be classified into the following categories:

(a)  Perquisites taxable in the hands of all employees

(b)  Perquisites taxable in the hands of specified employees

(c)  Tax-free Perquisites

(a)  Perquisites taxable in the hands of all employees

 

When an employer makes available the following benefits or amenities to its employees, the value of such benefits shall be taxable in the hands of all employees:

(b)  Perquisites taxable in the hands of specified employees

Certain benefits or amenities provided to the employees are taxable only in the hands of specified employees. For the purpose of this provision, the following employees shall be treated as specified employees:

(a)  Director of a Company

(b)  Employees with a substantial interest in the Company

(c)  Employees with a salary exceeding such amount as may be prescribed.

Benefits taxable in the hands of Specified Employees

• Supply of Gas, Electricity, or Water
• Free Education
• Free Domestic Servants
• Transportation Facility
• Car or any other automotive conveyance
   

(c)   Tax-free Perquisites (fully or partially)

When an employer makes available the following benefits or amenities to its employees, the value of such benefits shall not be chargeable to tax in the hands of an employee:

Profits in lieu of salary provides an exclusive list of salary components which are deemed as payments to the employees in lieu of salary. It includes compensation paid for termination of employment, payment from the provident fund, payment under the keyman insurance policy, etc. All components which are part of the profit in lieu of salary are taxable in the hands of employee.

The profit in lieu of salary shall include the following components.

Compensation for loss of employment [Section 17(3)(i)]

Any compensation due to or received by an employee from his employer or former employer at or in connection with the termination of his employment or modification of terms of employment is taxable as profit in lieu of salary. It is taxable on due basis or receipt basis, whichever occurs first. If an employee loses employment due to retrenchment, he is entitled to claim an exemption under Section 10(10B) from the amount of compensation.

Section 56(2)(xi) contains a similar provision that any compensation or other payment due to or received by any person in connection with the termination of his employment or modification of terms of employment is taxable under the head Other Sources. Thus, both the provisions are similar except following:

1. Section 17(3)(i) covers 'compensation' only, section 56(2)(xi) covers 'any other payment' as well; and
2. Section 17(3)(i) covers payments from 'employer or former employer', and section 56(2)(xi) covers payments from 'any person'.

Hence, payment would be taxed under section 17(3)(i) or section 56(2)(xi) depending on the payer and 'type of payment'.

Voluntary retirement compensation [Section 17(3)(i)]

Where an employee of specified institution receives compensation for voluntary retirement, it shall be taxable as profit in lieu of salary. The employee is entitled to claim an exemption under Section 10(10C) from the amount of compensation.

Contribution to Unrecognized PF [Section 17(3)(ii)]

If any payment from an unrecognized provident fund becomes due and payable to an employee, such receipts to the extent of the employer's contribution and interest thereon are liable to be taxed as profits in lieu of salary. Interest on the employee's contribution from the unrecognized provident fund is chargeable to tax as income from other sources and not as profits in lieu of salary.

Payment under Keyman Insurance Policy [Section 17(3)(ii)]

Keyman insurance policy is taken by an employer on the life of a key employee whose services contribute substantially to the success of the business. The object of keyman insurance is to indemnify the employer from the loss of earnings resulting from the death of a valuable employee. The amount of policy is paid either on the maturity of the policy or the death of the keyman, whichever is earlier.

Where an employer assigns a keyman insurance policy to such employee at the time of his retirement as a reward for his services, the surrender value of such policy (including the sum allocated by way of bonus on such policy) at the time of retirement is taxable in the hands of such employee as profits in lieu of salary. No exemption is available to the employee in this respect.

Sum received before or after employment [Section 17(3)(iii)]

Any amount due to or received, whether in lump sum or otherwise, by an assessee from any person before joining any employment with that person or after cessation of his employment with that person shall be treated as profits in lieu of salary.​

Income-tax Act allows three deductions from the salary income, i.e., Standard Deduction, Deduction for Entertainment Allowance, and Deduction for Professional Tax. Standard Deduction is allowed to every employee whose income is taxable under the head salary. While the other two deductions are allowed subject to certain conditions.

Standard Deduction

This deduction is available to all employees drawing salary income, including retired employees drawing pension income. The Standard Deduction is absolute and unconditional. The employee does not require to furnish any supporting evidence to claim this deduction. The deduction is the same for all employees with a ceiling of Rs. 50,000, irrespective of the salary drawn.

Note: A higher amount of standard deduction of Rs. 75,000 shall be available to employee if the income-tax is computed under section 115BAC(1A)(ii), i.e. new tax regime.

Entertainment Allowance

Entertainment allowance received by an employee is a taxable allowance. If such entertainment allowance is received by a Government employee, the deduction is allowed to him while computing the taxable income under the head salary.

No deduction is allowed under this provision to a taxpayer who is not an employee of any Central or State Government.

The amount of deduction allowable to the Govt. employee for the Entertainment Allowance shall be lower of the following:

• Actual amount of entertainment allowance received during the previous year
• 20% of salary exclusive of any allowance, benefit, or other perquisite
• Rs. 5,000

Professional tax

Professional tax paid by the employee, by way of deduction from his salary, is allowed as a deduction from the taxable salary income. Even if paid in advance, the professional tax paid during the year is deductible from the salary income.

If the employer pays the professional tax out of his own pocket, without deducting it from the employee's salary, then it shall be first included in the employee's income as perquisite. After that, a deduction on such professional tax is allowed from gross salary.​

Certain employees are completely or partially exempted from payment of tax on their salary income. These exemptions are generally given to foreign citizens subject to certain conditions:

- Salary of teachers from SAARC Member States

- Salary received from UNO [Circular No. 293, dated 10-02-1981]

- Salary to non-resident seafarer [Circular No. 13/2017, dated 11-04-2017]

- Salary of diplomatic personnel [Section 10(6)(ii)]

- Salary of foreign employees [Section 10(6)(vi)]

- Salary received by a ship's crew [Section 10(6)(viii)]

- Remuneration of a foreign trainee

- ​Payment made gratuitously to legal heirs of employees [Circular No. 573, dated 21-08-1990 and Circular No. 776, dated 08-06-1999]​

Relief from Salary

Salary is charged to tax either on a receipt basis or on an accrual basis, whichever is earlier. Therefore, if an employee receives arrears of salary relating to earlier years or receives an advance salary, which shall fall due in succeeding previous years, his tax liability during the previous year of receipt of such additional salary increases. The relief in this regard is provided to neutralize the increased tax burden by placing the taxpayer in the same situation as he would have been if such salary has been taxed on an accrual basis instead of being taxed on a receipt basis.

Relief under Section 89​ is allowed to an employee if he is liable to pay tax in respect of the following during the financial year:

1. ​Salary received in arrears or in advance
2. Arrears of family pension
3. Premature withdrawal from PF account
4. Gratuity
5. Commuted value of pension
6. Compensation on termination of employment

The employee should claim relief in the return of income for the year in which the lump sum payment is received. For this purpose, the employee will have to furnish Form No. 10E before filing of the Income-tax return.

Relief from taxation of income from foreign retirement benefit account

Where a non-resident individual has become a resident in India, the income in his foreign retirement benefits account is chargeable to tax in India on an accrual basis. However, some countries tax such an amount at the time of withdrawal or redemption. Due to a mismatch in the year of taxability of such income in retirement funds, the taxpayer (generally NRI who have permanently returned to India) faces practical difficulties in availing the foreign tax credit in respect of tax paid outside India on such income. To remove this difficulty, relief is provided under Section 89A with effect from the assessment year 2022-23.

An individual can claim relief under Section 89A if he fulfils the following conditions:

1. He should be a resident in India in the year in which relief is claimed;
2. He has opened a specified retirement benefits account in a notified country;
3. He should be a non-resident in India and a resident in that country while opening such a specified account; and
4. The income from the specified retirement benefits account is not taxable on an accrual basis but is taxed by such country at the time of withdrawal or redemption.
   
   Rule 21AAA provides an option to the resident individual to include income from the specified retirement benefits account in his total income in the assessment year in which such income is taxed at the time of withdrawal (or redemption) in the notified country.
   
   It should be noted that the individual has the option to pay tax on such income in the year of accrual or defer it to the year in which it is taxed in the respective country on withdrawal. Further, such an option can be exercised only for the income accrued on or after 01-04-2021 in the specified account.
   
   The specified person can exercise the option by filing Form No. 10-EE electronically on or before the due date for furnishing of return of income. Once this option is exercised, it will apply to all subsequent previous years and cannot be withdrawn.