Income from Salaries – Income tax Act

The following article deals with the Income from Salaries under the income tax act 1961. Section 15, 16 and 17 of the Income tax act, 1961 deal with the computation of income under the head Salaries. Any remuneration paid by an employer to his employee in consideration of his service is called Salary. It includes monetary value of those benefits and facilities provided by the employer which are taxable.To understand the computation of Income under the head Salaries, the following important concepts must be understood.

Income from Salaries - Income tax Act

Income from Salaries –  Important concepts

  • EMPLOYER AND EMPLOYEE RELATIONSHIP
  • BASIS OF CHARGE( SECTION 15)
  • TAX FREE SALARY
  • SALARY PAID BY FOREIGN GOVT./ENTERPRISES
  • ALLOWANCES

Employer and employee relationship

Income from Salaries - Income tax Act

Any Income can be taxed under the head “salaries” only if there is a relationship of an employer and employee between payer and payee. Any income would be deemed to be income from salary only if relation of employer and employee exist. Their relationship should be of master and servant. A master is a person who directs what is to be done and how it is to be done, and the servant is one who is required to conduct the work in manner prescribed by master.

Basis of charge [Section 15]

  1. Any salary due from an employer or a former employer to an assessee in the previous year , whether paid in that previous year or not.
  2. Any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due in that previous year or before it became due to him.
  3. Any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income tax in any earlier previous year.

Important Note:

  1. If any salary paid in advance is included in the total income of any person for any previous year, it shall not be included again in the total income of the person when the salary becomes due.
  2. Any salary, bonus, commission or remuneration due to or received by a partner of a firm from the firm shall not be regarded as salary for the purpose of this section. The same shall be taxable under the head Profits and gains of business and profession as per section 28 of Income Tax Act,1961.

PLACE OF ACCRUAL OF SALARY [sec. 9(1) (ii)]

The Golden Rule is that salary will be deemed to accrue or arise at a place where services are rendered.

Examples:

  • If any income taxable under head Salaries is earned in India, it is deemed to accrue or arise in India.

  •  If a person employed in India goes on leave outside the country and draws his salary for the leave period there, the leave salary shall be deemed to have been earned in India.
  •  If a person after having served in India , retires from service and settles outside India, then the pension drawn by him in the foreign country will be deemed to have been earned in India and will be treated as Indian Income.

EXCEPTION:

In case of a citizen of India who is a government employee and renders any service outside India, salary received by him would be treated as income deemed to accrue or arise in India although the services are rendered outside India. As per section 10(7), allowances and perquisites received by him in the foreign country from the Indian government are exempt from tax.

Income from Salaries - Income tax Act

TAX FREE SALARY

When the employee receives tax-free salary from his employer, it means employer himself pays the tax which is due on salary of such employee and for the purpose of computation of INCOME FROM SALARIES under Income Tax act 1961, such amount will be added to his salary.

SALARY PAID BY FOREIGN GOVERNMENT /ENTERPRISES

Salary paid by foreign Govt. /enterprises to its employees serving in India is taxable under head Salaries, unless it is specifically exempt under section 10

ALLOWANCES

Payments in cash made by the employer to his employees usually at regular intervals, other than salary are known as allowances. In other words, it is defined as a fixed quantity of money given regularly in addition to salary for meeting specific requirements of the employees. From Income Tax point of view, there are 3 types of allowances which are as under:-

  • TAXABLE ALLOWANCES
  • ALLOWANCES EXEMPT UPTO SPECIFIED LIMITS
  • FULLY EXEMPT ALLOWANCES

TAXABLE ALLOWANCES

TAXABLE ALLOWANCES are those allowances which are fully taxable under Income tax act, 1961.While computing taxable salary whole amount is added into the salary. Following are the allowances which are fully taxable:

  • Dearness Allowance and dearness pay
  • Fixed medical allowance
  • Tiffin allowance
  • Servant allowance
  • Non practicing allowance
  • Hill allowance
  • Warden/ Proctor allowance
  • Deputation allowance
  • Overtime allowance

– Other allowances like City Compensatory allowance, Telephone allowance, Holiday allowance, Special qualification allowance, etc.

All the above allowances can be understood by their names but yet there are some allowances, which I think needs explanation. So there explanation is given below:

Dearness Allowance

This allowance is given to employees on account of high prices. Sometimes Dearness Allowance is given as Dearness pay. Normally we think that these 2 words are synonyms, but in actual they have different treatment. Dearness Allowance is an allowance granted to the employees to compensate for the cost of inflation. However, when certain portion of the Dearness Allowance is converted into Dearness Pay, then the applicable allowance would get calculated on (Basic Pay + Dearness Pay).

For instance normally Dearness Allowance is calculated as a % of Basic Pay.

In cases where there is Dearness Pay, then the Dearness Allowance would get calculated on (Basic Pay + Dearness Pay). To that extent the employee would get increased amount in absolute terms.

Such DP is also taken into account at the time of arriving at the pension benefits etc

Non Practicing Allowance

It is generally given to those medical doctors who are in government service and they are banned from doing private practice. This allowance is given to them to compensate this ban.

Deputation allowance

When an employee is sent from his permanent place of service to some other place or institution or organization on deputation for a temporary period, this allowance is given to them.

City Compensatory Allowance

This allowance is paid to employees who are posted in big cities. The idea is to compensate the high cost of living in cities like Delhi, Mumbai, Bangalore, and other metropolitan cities. However, it is a fully taxable allowance. i.e. the amount of this allowance will be taxed with the salary received.

ALLOWANCES EXEMPT UPTO SPECIFIED LIMITS

  1. HOUSE RENT ALLOWANCE
  2. ENTERTAINMENT ALLOWANCE
  3. SPECIAL ALLOWANCES FOR MEETING CERTAIN EXPENDITURES

EXPLANATION OF ABOVE ALLOWANCES

HOUSE RENT ALLOWANCE

Income from Salaries - Income tax Act

HRA is given to meet the cost of a rented house taken by the employee for his stay. The Income Tax Act allows for deduction in respect of the HRA paid to employees. The exemption on HRA is covered under Section 10(13A) of the Income Tax Act and Rule 2A of Income Tax Rules. HRA is exempt to the extent of the minimum of following 3 amounts.

– Actual Amount Received,

– Excess of Rent paid by the assessee over 10 % of salary due to him for the relevant period,

– 50% of the salary if residential house is situated at Mumbai ,Kolkata, Delhi, Chennai .

– 40% of the salary if residential house is situated at city other than above metropolitan cities.

ENTERTAINMENT ALLOWANCE

Income from Salaries - Income tax Act

It is an allowance given by an employer to his employee. It is first included in income from salary under section 15 and then deduction is allowed to a govt. employee under sec 16(ii). Least of the following amounts shall be deducted:-

Amount Actual received,
1/5 of salary , where salary = Basic Salary
Rs. 5000

SPECIAL ALLOWANCES FOR MEETING CERTAIN EXPENDITURES

There are two types of special allowances under this category:-

  • Special allowances for performance of official duties – These allowances are exempt to the extent of actual amount received or the amount spent for the purpose of official duties, whichever is less. E.g. Travelling allowance, Daily allowance, Helper allowance , etc.
  • Allowances to meet personal expenses:-

There are many allowances covered under this category, but here I am explaining the provisions of few allowances which are as follows:-

Children Education Allowance – Exempt upto actual amount received per child or Rs.100 p.m. per child upto a maximum of 2 children, whichever is less.

Hostel Expenditure Allowance – Exempt upto actual amount received per child or Rs.300 p.m. per child upto a maximum of 2 children, whichever is less.

Tribal Area Allowance – Exempt upto actual amount received or Rs. 200 per month, whichever is less.

Transport Allowance – It is exempt upto Rs.800 p.m. but in case of blind or orthopedically handicapped, it is exempt upto Rs. 1600 p.m.

Allowance allowed to transport employees working in any transport system –It covers Fixed Allowance given by employer to his employee working in any transport system, to meet his personal expenditure during his performance of duty and amount of exemption shall be 70% of such allowance or rs.10,000 p.m. whichever is less.

FULLY EXEMPTED ALLOWANCES:- There are certain allowances which are fully exempt under Income Tax Act,1961 :-

1.Foreign Allowance – This allowance is usually paid by the government to an Indian citizen outside India for rendering services in abroad. It is not taxable atall. There may be several types of foreign allowances e.g. Overseas allowance, Children Education allowance,etc. Important point: This Exemption is available only to government employees and they must be citizen of India.

2. Sumptuary allowances – These allowances are given to High Court/ supreme Court Judges and are fully exempt from tax.

3. Allowance From UNO – Allowances paid by UN organizations to its employees are fully exempt.

4. Per Diem Allowance – It means Per Day Allowance. If per Diem Allowance is paid for the use of hotel, boarding and lodging facilities to an employee, any surplus accruing to him from such allowance are exempt from tax.

Final Words

The Taxation of income received from salaries is not just a concept to learn only but practically it puts a lot of challenges in front of tax return preparers so as to ensure that correct provisions are applied while computing the net salary income. Income from salary seems to be a very small portion but it contains lot of provisions, the study of which is must before practically applying it.

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