SALARY

The meaning of term salary for the purposes of income tax is much wider than what is normally

understood. 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 (example:-Basic salary, bonus etc.) as well as non-monetary

facilities (example housing accommodation, medical facilities etc.)

The following are the essential conditions for income to be treated as salary income:-

There must be relation of employer and employee between the payer of income and

receiver of income.

Salary may be from more than one employer.

Salary may be received from not just the present employer but also a prospective

employer and in some cases even from a former employer for example pension received

from a former employer.

Salary income must be real and not fictitious there must an intention to pay and receive

salary.

Forgoing of salary ie if an employee surrenders his salary to the central government,

then the salary so surrendered will not be treated as taxable income of the employee.

Salary paid tax free - Tax free salary means the salary on which income tax is borne not

by the employee but by the employer. Tax free salary is also taxable in the hands of the

employee.

BASIS OF CHARGE:

1. Section 15 of the Act deals with basis of charge. Salary is chargeable to tax either on

‘due’ basis or on ‘receipt’ basis whichever is earlier.

2. However, where any salary, paid in advance, is assessed in the year of payment, it

cannot be subsequently brought to tax in the year in which it becomes due.

3. If the salary paid in arrears has already been assessed on due basis, the same cannot be

taxed again when it is paid.

INCOMES FORMING PART OF SALARY:

Section 17(1) gives an inclusive definition of ‘Salary’

Salary includes-

i) Wages;

ii) any annuity or pension;

iii) any gratuity;

iv) any fees, commissions, perquisites or profits in lieu of or in addition to any salary or

wages;

v) any advance of salary;

vi) any payment received by an employee in respect of any period of leave not availed by

him;

vii) 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 (i.e. employer’s

contribution to RPF in excess of 12% of employee’s salary and interest credited in excess

of 9.5%);

viii) the aggregate of all sums that are comprised in the transferred balance of the employee

participating in a recognized P.F. to the extent to which it is chargeable to tax;

ix) the contribution made by the Central Government or any other employer in the previous

year, to the account of an employee under notified pension scheme referred in section

80CCD.l

Although above incomes are included in salary, but there are certain incomes mentioned

above, which are either tax free or fully exempt or exempt, upto a certain limit. The

aggregate of above incomes, after the exemption (s) available, if any, is known as ‘Gross

Salary’. From the gross salary, the following two deductions, are allowed under section

16:

i) Deduction for entertainment allowance[sec 16(ii)];and

ii) Deduction on account of any sum paid towards tax on employment [sec 16(iii)].

The amount arrived at, after allowing the above deductions, is the income under the

head ‘Salaries’

TREATMENT OF VARIOUS INCOMES TO BE INCLUDED IN GROSS SALARY:

A. Wages:

Conceptually there is no difference between salary and wages. Therefore, wages are

treated just like salary and are taxable on the same basis as salary.

B. Annuity:

It is an annual income received by the employee from his employer. It may be paid by

the employer as voluntarily or on account of contractual agreement. It is not taxable

until the right to receive the same arises. Under section 56, Income Tax Act, 1961 other

annuities come under a will or granted by a life insurance company or accruing as a

result of contract which comes as income under from other sources.

C. Leave Encashment:

Leave encashment is the salary received by an individual for leave period. It is a

chargeable income whether he is a government employee or not. Under section

10(10AA)(i) there is also a provision of exemption in case of leave encashment

depending upon whether he is a government employee or other employees.

D. Bonus :

Bonus is taxable on the due basis. Therefore, it will be included in the gross salary only

in the year in which the bonus is received. If the bonus is received in arrears, the

assessee can claim relief under section 89.

E. Salary in lieu of Notice period:

This is taxable in the previous year in which it is received.

F. Fee and Commission:

Any fee or commission paid/payable by employer to the employee shall be fully taxable

and thus would be included in Gross salary. Commission may be the fixed amount or a

percentage of turnover or net profit etc. But it will be taxable under the head of

‘Salaries’ only when it is paid/payable by employer to employee.

G. Overtime Payments:

Any payment made by the employer to the employee for working beyond the office

hours is taxable and therefore included in the Gross Salary.

H. Gratuity:

Gratuity is a payment made by the employer to an employee in appreciation of the past

services rendered by the employee. Gratuity can either be received by the employee

himself at the time of his retirement or the legal heir on the event of the death of the

employee.

Gratuity received by an employee on his retirement is taxable under the head

‘Salaries’ whereas gratuity received by legal heir of the deceased employee shall be

taxable under the head ‘Income from other sources’. However, in both the above cases,

according to section 10(10) gratuity is exempt upto a certain limit. Therefore, in case

gratuity is received by employee, salary would include only that part of the gratuity

which is not exempt under section 10(10).

I. Pension:

It is a payment made by the employer after the retirement/death of the employee as a

reward for past service.

Pension is normally paid as a periodical payment on monthly basis but certain

employers may also allow an employee to forgo a portion of pension. This is known as

commutation of pension. The pension may be fully or partly commuted i.e. in lieu of the

pension, a lumpsum payment is made to the employee. The treatment of these 2 kinds

are:

a. Uncommuted pension is fully taxable in the hands of all the employees.

b. Commuted pension is fully exempted in case of the Government employees or

employees of local authorities or statutory corporation under section 10(10A)(i). But

in case of the other employees it is exempt upto an extent >[u/s 10(10A)(ii)].

J. Allowance:

Allowance is a fixed monetary amount paid by the employer to the employee

(over and above basic salary) for meeting certain expenses, whether personal or

for the performance of his duties. These allowances are generally taxable and are to be

included in gross salary unless specific exemption is provided in respect of such

allowance. For the purpose of tax treatment, we divide these allowances into 3

categories:

I. Fully taxable cash allowances

II. Partially exempt cash allowances

III. Fully exempt cash allowances

I. FULLY TAXABLE ALLOWANCES

This category includes all the allowances, which are fully taxable. So, if an

allowance is not partially exempt or fully exempt, it gets included in this category.

The main allowances under this category are enumerated below:

(i) Dearness Allowance and Dearness Pay: As is clear by its name, this allowance is

paid to compensate the employee against the rise in price level in the economy.

Although it is a compensatory allowance against high prices, the whole of it is

taxable. When a part of Dearness Allowance is converted into Dearness Pay, it

becomes part of basic salary for the grant of retirement benefits and is assumed

to be given under the terms ofemployment.

(ii) City Compensatory Allowance: This allowance is paid to employees who are

posted in big cities. The purpose is to compensate the high cost of living in cities

like Delhi, Mumbai etc. However, it is fully taxable.

(iii) Tiffin / Lunch Allowance: It is fully taxable. It is given for lunch to the employees.

(iv) Non practicing Allowance: This is normally given to those professionals (like

medical doctors, chartered accountants etc.) who are in government service and

are banned from doing private practice. It is to compensate them for this ban. It

is fully taxable.

(v) Warden or Proctor Allowance: These allowances are given in educational

institutions for working as a Warden of the hostel or as a Proctor in the

institution. They are fully taxable.

(vi) Deputation Allowance: When an employee is sent from his permanent place of

service to some place or institute on deputation for a temporary period, he is

given this allowance. It is fully taxable.

(vii) Overtime Allowance: When an employee works for extra hours over and above

his normal hours of duty, he is given overtime allowance as extra wages. It is

fully taxable.

(viii) Fixed Medical Allowance: Medical allowance is fully taxable even if some

expenditure has actually been incurred for medical treatment of employee or

family.

(ix) Servant Allowance: It is fully taxable whether or not servants have been

employed by the employee.

(x) Other allowances: There may be several other allowances like family allowance,

project allowance, marriage allowance, education allowance, and holiday

allowance etc. which are not covered under specifically exempt category, so are

fully taxable.

II. PARTIALLY EXEMPT ALLOWANCES

This category includes allowances which are exempt upto certain limit. For certain

allowances, exemption is dependent on amount of allowance spent for the purpose for

which it was received and for other allowances, there is a fixed limit of exemption.

(i) House Rent Allowance (H.R.A.): An allowance granted to a person by his

employer to meet expenditure incurred on payment of rent in respect of

residential accommodation occupied by him is exempt from tax to the extent of

least of the following three amounts:

a) House Rent Allowance actually received by the assessee

b) Excess of rent paid by the assessee over 10% of salary due to him

c) An amount equal to 50% of salary due to assessee (If accommodation

is situated in Mumbai, Kolkata, Delhi, Chennai) ‘Or’ an amount equal to 40%

of salary (if accommodation is situated in any other place).

Salary for this purpose includes Basic Salary, Dearness Allowance (if it forms

part of salary for the purpose of retirement benefits), Commission based on fixed

percentage of turnover achieved by the employee.

The exemption of HRA depends upon the following factors:

(1) Basic Salary

(2) Rent paid

(3) Place of residence

(4) HRA received

If an employee is living in his own house and receiving HRA, it will be fully

taxable.

(ii) Entertainment Allowance: This allowance is first included in gross salary under

allowances and then deduction is given to only central and state government

employees under Section 16 (ii).

(iii) Special Allowances for meeting official expenditure: Certain allowances are

given to the employees to meet expenses incurred exclusively in performance of

official duties and hence are exempt to the extent actually incurred for the

purpose for which it is given. These include travelling allowance, daily allowance,

conveyance allowance, helper allowance, research allowance and uniform

allowance.

(iv) Special Allowances to meet personal expenses: There are certain allowances

given to the employees for specific personal purposes and the amount of

exemption is fixed i.e. not dependent on actual expenditure incurred in this

regard. These allowances include:

a. Children Education Allowance

b. Children Hostel Allowance

c) Transport Allowance

d) Out of station allowance

III. FULLY EXEMPT ALLOWANCES

(i) Foreign allowance: This allowance is usually paid by the government to its

employees being Indian citizen posted out of India for rendering services abroad. It

is fully exempt from tax.

(ii) Allowance to High Court and Supreme Court Judges of whatever nature are exempt

from tax.

(iii) Allowances from UNO organisation to its employees are fully exempt from tax.

K. Perquisites:

A perquisite is any casual emolument, fee or profit attached to an office or position in

addition to the salary or wages. In other words, perquisites are the benefits in addition

to normal salary to which the employee has a right by virtue of his employment.

Types of perquisites: Perquisites may be divided into three broad categories:

(1) Perquisites taxable in the case of all employees

(2) Perquisites exempt from tax in the case of all employees

(3) Perquisites taxable only in the hands of specified employees.

(1) Perquisites taxable in the case of all employees:

The following perquisites are chargeable to tax in all cases.

(i) Value of rent-free accommodation provided to the assessee by his employer

[Section 17(2)(i)]; Exception : Rent-free official residence provided to a Judge of a

High Court or to a Judge of the Supreme Court is not taxable. Similarly, rent-free

furnished house provided to an Officer of Parliament, is not taxable.

(ii) Value of concession in rent in respect of accommodation provided to the assessee

by his employer [Section 17(2)(ii)]

(iii) Amount paid by an employer in respect of any obligation which otherwise would

have been payable by the employee [Section 17(2)(iv)].

(iv) Amount payable by an employer directly or indirectly to effect an assurance on the

life of the assessee or to effect a contract for an annuity, other than payment made

to RPF or approved superannuation fund or deposit-linked insurance fund

established under the Coal Mines Provident Fund or Employees’ Provident Fund Act.

However, there are schemes like group annuity scheme, employees state insurance

scheme and fidelity insurance scheme, under which insurance premium is paid by

employer on behalf of the employees. Such payments are not regarded as perquisite

in view of the fact that the employees have only an expectancy of the benefit in such

schemes.

(v) The value of any other fringe benefit or amenity (excluding the fringe benefits

chargeable to tax under Chapter XII-H) as may be prescribed. Thus, only those

benefits not falling within the meaning of ‘fringe benefit’ as defined under section

115WB would be treated as ‘perquisites’ under section 17. Those benefits falling

within the meaning of ‘fringe benefit’ as defined under section 115WB will be taxed

in the hands of the employer in addition to income-tax.

(2) Perquisites exempt from tax in all cases:

(i) Telephone provided by an employer to an employee at his residence;

(ii) Goods sold by an employer to his employees at concessional rates;

(iii) Transport facility provided by an employer engaged in the business of carrying of

passengers or goods to his employees either free of charge or at concessional rate;

(iv) Privilege passes and privilege ticket orders granted by Indian Railways to its

employees;

(v) Perquisites allowed outside India by the Government to a citizen of India for

rendering services outside India;

(vi) Sum payable by an employer to a RPF or an approved superannuation fund or

deposit linked insurance fund established under the Coal Mines Provident Fund or

the Employees’ Provident Fund Act;

(vii) Employer’s contribution to staff group insurance scheme;

(viii) Leave travel concession;

(ix) Payment of annual premium by employer on personal accident policy effected by

him on the life of the employee;

(x) Refreshment provided to all employees during working hours in office premises;

(xi) Subsidized lunch or dinner provided to an employee;

(xii) Recreational facilities, including club facilities, extended to employees in general

i.e., not

restricted to a few select employees;

(xiii) Amount spent by the employer on training of employees or amount paid for

refresher management course including expenses on boarding and lodging;

(xiv) Medical facilities subject to certain prescribed limits;

(xv) Rent-free official residence provided to a Judge of a High Court or the Supreme

Court;

(xvi) Rent-free furnished residence including maintenance provided to an Officer of

Parliament,

Union Minister and a Leader of Opposition in Parliament;

(xvii) Conveyance facility provided to High Court Judges under section 22B of the High

Court Judges (Conditions of Service) Act, 1954 and Supreme Court Judges under

section 23A of the Supreme Court Judges (Conditions of Service) Act, 1958.

(xviii) Motor car facility.

However, some of the perquisites mentioned above are taxable as fringe benefits in the hands

of the employer (Refer to definition of fringe benefits as per section 2(23B)

(3) Perquisites taxable only in the hands of specified employees [Section 17(2)(iii)]:

The value of any benefit or amenity granted or provided free of cost or at concessional rate

which have not been included in 1 & 2 above will be taxable in the hands of specified

employees:

Specified employees are:

(i) Director employee: An employee of a company who is also a director is a specified

employee. It is immaterial whether he is a full-time director or part-time director. It

also does not matter whether he is a nominee of the management, workers,

financial institutions or the Government. It is also not material whether or not he is a

director throughout the previous year.

(ii) An employee who has substantial interest in the company: An employee of a

company who has substantial interest in that company is a specified employee. A

person has a substantial interest in a company if he is a beneficial owner of equity

shares carrying 20% or more of the voting power in the company. Beneficial and

legal ownership: In order to determine whether a person has a substantial interest

in a company, it is rather the beneficial ownership of equity shares carrying 20% or

more of the voting power that is relevant rather than the legal ownership.

(iii) Employee drawing in excess of Rs.50,000: An employee other than an employee

described in (i) & (ii) above, whose income chargeable under the head ‘salaries’

exceeds Rs.50,000 is a specified employee. The above salary is to be considered

exclusive of the value of all benefits or amenities not provided by way of monetary

payments. In other words, for computing the limit of Rs.50,000, the following items

have to be excluded or deducted:

(a) all non-monetary benefits;

(b) monetary benefits which are exempt u/s 10. This is because the exemptions

provided u/s 10 are excluded completely from salaries.

(c) Deduction for entertainment allowance [u/s 16(ii)] and deduction toward

professional tax [u/s 16(iii)] are also to be excluded.

If an employee is employed with more than one employer, the aggregate of the salary

received from all employers is to be taken into account in determining the above ceiling limit of

Rs.50,000, i.e. Salary for this purpose

= Basic Salary + D.A. + Commission, whether payable monthly or turnover based + Bonus +

Fees + Any other taxable payment + Any taxable allowances + Any other monetary

benefits – Deductions under section 16]

BIBLIOGRAPHY

Every presentation needs the help of many sources, which helps to give us an idea to do the work perfectly, efficiently and clearly. To overcome the presentation of our project we have taken the help of many books, magazines and few websites. They are mentioned below:

Books like:

Taxation, Professional Competence Course Bharat’s Publications; Systematic Approach To Income Tax Service Tax And VAT, Dr.

Girish Ahuja and Ravi Gupta