ASSIGNMENT – CRIMINOLOGY

403

TAX TREATMENT OF SALARIES

DEPARTMENT OF LAW

TRINITY INSTITUTE OF PROFESSIONAL STUDIES

Submitted To: Submitted By:

Ms. Sonakshi kashyap Manas Tiwari

Assistant Professor 2018 – 2023

B.A. L.L.B 7th Semester

TIPS 1320603818
 TAX TREATMENT OF SALARIES

A. Employer-Employee Relationship

If you are in an employee-employer relationship, you belong to the salaried class of individuals.

The relationship of employer-employee is established where there is control over the method
of doing the work of other person. Control is said to exist if the payer can direct what has to be
done, when, how and by whom it has to be done, and the receiver is bound to follow all his
instructions. Where this relationship exists, there is a “contract of service”.

B. Salary and Its Components

Salary is defined as the remuneration that a person receives periodically for rendering services
based on an implied or express contract.

The salary for the purpose of calculation of income from salary includes:

• Wages;
• Pension;
• Annuity;
• Gratuity;
• Advance Salary paid;
• Fees, Commission, Perquisites, Profits in lieu of or in addition to Salary or Wages;
• Annual accretion to the balance of Recognized Provident Fund;
• Leave Encashment;
• Transferred balance in Recognized Provident Fund;
• Contribution by Central Govt. or any other employer to Employees Pension A/c as
referred in Sec. 80CCD.
However, not all income is termed as salary. If a professional is being paid for his/her expertise
in a professional capacity, it is termed as ‘Professional/Technical Fees’.

Similarly, a partner earning salary from his/her company is charged taxes under ‘Profits &
Gains from Profession or Business’.
Other examples include the salary paid to a Member of Parliament or a Member of Legislative
Assembly.

C. What are allowances? Are all allowances taxable?

Allowances are fixed amounts, apart from salary, which are paid by an employer for the
purpose of meeting some particular requirements of the employee. There are generally three
types of allowances for the purpose of income tax- taxable, fully exempted and partially
exempted.

i. Fully Taxable Allowances (for example)

• Dearness Allowance: The allowance is paid to the employees to cope with inflation.
• Entertainment Allowance: This is an allowance that is provided to the employees to
reimburse the expenses which are incurred on the hospitality.
• Overtime Allowance: Overtime allowance is the allowance which is paid to the
employees for working above the regular work hours.
• City Compensatory Allowance: This allowance is paid to those employees who move
to urban cities.
• Project Allowance: When an employer provides an allowance to the employees to
meet the project expenses.
• Tiffin/Meals Allowance: Employees may be provided with meal allowances in some
cases.
• Cash Allowance: Employer may also provide cash allowance in some cases like for
marriage or holiday purposes.

ii. Partly Taxable allowances:

• House Rent Allowance: It is the allowance that an employer pays to his employee for
accommodation.
• Special allowances like allowance for travel, uniform, research allowance etc.
• Special allowance to meet personal expenses like children’s education allowance,
children hostel allowance etc.
iii. Non Taxable allowances:

• Allowances that is paid to the Govt. servants abroad: When the government
employee of India are paid allowances when they are serving abroad.
• Sumptuary allowances: Sumptuary allowances which are paid to the judges of HC
and SC are not taxed.
• Allowance paid by UNO: Allowances which is received by the employees of UNO
are fully exempt from tax.
• Compensatory allowance paid to judges: When a judge receives a compensatory
allowance, it is also not taxable.

D. Perquisites

Perquisites are those payments which are received by an employee from the employer over
and above the salary.

i. Perquisites that are taxable for all the employees:

• Rent free accommodation

• Club fee payments
• Movable assets
• Concession in accommodation rent
• Interest-free loans
• Educational expenses
• Insurance premium paid on behalf of employees

ii. Perquisites that are taxable only to specified employees:

• Free gas, electricity etc. for domestic purpose

• Concessional transport facility
• Concessional educational expenses
• Payment made to gardener, sweeper and attendant.

iii. Perquisites that are exempt from tax:

• Medical benefits
• Health Insurance Premium
 • Leave travel concession
• Staff Welfare Scheme
• Car, laptop etc. for personal use.
Note: The above list of allowances and perquisites is not exhaustive.

E. Important points related to Salary

• Salary is taxed on ‘due basis’ or ‘receipt basis’, whichever is earlier.

• Income from salary taxable during the year consists of following:

1. Salary due from employer (including former employer) to taxpayer during the previous year,
whether paid or not;

2. Salary paid by employer (including former employer) to taxpayer during the previous year
before it became due;

• Arrear of salary paid by the employer (including former employer) to taxpayer during
the previous year, if not charged to tax in any earlier year;

F. Place of accrual of salary:

1. Salary accrues where the services are rendered even if it is paid outside India;
2. Salary paid by the Foreign Government to his employee serving in India is taxable
under the head Salaries;
3. Leave salary paid abroad in respect of leave earned in India shall be deemed to accrue
or arise in India.

G. What is CTC?

CTC is one of the generic term when a person talks about salary. CTC stands for Cost To
Company. It is the amount that the company in spending on hiring and sustaining an employee.

CTC includes the salary as well as the other benefits provided to an employee which can be
meal coupons, office space rent, Provident Fund, Medical Insurance, House Rent
Allowance(HRA) and any other element that cost to the company.
It may be noted that CTC varies from the actual income from salary that a person receives as
CTC also includes variables over and above the actual salary that a person is receiving.

What will be the taxability in case you receive arrears or salary in advance? The next section
of the article deals with the taxability of salary belonging to different periods.

H. Advance Salary and Its Taxability

Advance salary received by an employee is taxed in the year of receipt. However, an employee
can claim relief under section 89 in respect of advance salary.

Similarly, Bonus received by an employee is charged to tax in the year of receipt.

I. Arrears of Salary and Its Taxability

Arrears of salary received by an employee are taxed in the year of receipt if the same were not
taxed earlier on due basis. However, an employee can claim relief under section 89 in respect
of arrears of salary.

J. Tax treatment of salary received by an Indian citizen deputed outside

India

Salary received by an Indian citizen deputed outside India by the Government is treated as
income deemed to be accrued or arisen in India and will be taxed in India. However, in such a
case allowance and perquisites will be exempt from tax.

K. Tax treatment of salary foregone by the employee

Salary is charged to tax on due or receipt basis whichever is earlier, hence, salary foregone by
the employee is charged to tax on due basis, even though it is not received by him. In other
words, salary foregone after its accrual is charged to tax, even though it is not received by the
employee. However, if salary is surrendered to the Central Government under section 2 of the
Voluntary Surrender of Salary (Exemption from Taxation) Act, 1961, then such surrendered
salary is not charged to tax.

L. Detailed Discussion on Various Components of Salary

1. Dearness Allowance

The concept of Dearness Allowance or DA was introduced after World War II and was initially
known as ‘Dear Food Allowance’. However, it was later linked to the Consumer Price Index.

A number of committees in the Central Government have been revising and restructuring the
percentage of Dearness Allowance.

The DA component takes care of the change in the cost of living depending upon the location
of the employee. Specially, for government sector employees, job transfers are an essential
feature and hence DA becomes even more significant in order to hedge the inflation cost of
living difference as well as inflation. The DA component is different for different employees
based on their location. This means DA is different for employees in the urban sector, semi-
urban sector or the rural sector.

The Income Tax Act mandates that tax liability for Dearness allowance will have to be
declared in the filed returns.

Industrial Dearness Allowance

• Industrial dearness allowance or IDA is the allowance applicable to employees of the

public sector enterprises.
• IDA for government sector enterprises is revised quarterly based on the movement of
the Consumer Price Index (CPI) in order to compensate for the rising inflation in the
country.

Variable Dearness Allowance

VAD or Variable dearness allowance is the allowance that comes as a result of revision every
six months for central government employees.

There are three components that make up VAD. First is the consumer price index, second, the
base index and third is the variable DA amount fixed by the government of India.
Rarely Known Fact about Dearness Allowance:

It is practice to merge the DA with the basic salary once the DA percentage breaches the 50%
mark. This is supposed to be a great salary booster for employees since all other components
of the salary are calculated as a percentage of the basic salary.

2. Pension

Pension is a regular payment made by the state to people after their official retirement, to
widows, and disabled people. It is a deferred wages of people’s services in the past. The
minimum pensionable service varies from service to service. Since Apr 2004, a new ‘National
Pension Scheme,’ a contributory system is evolved as an universal pension scheme. This is
not applicable to the Armed Forces.

Q. Is pension income considered as salary?

Ans. Yes; However pension received from the United Nation is exempt.

Q. Is Family pension considered as salary?

Ans. No, It is taxable under ‘other sources’.

Q. If someone receives pension through a bank who will issue Form-16 or pension
statement – the bank or former employer?

Ans. The bank.

Commuted Pension

Commutation means inter-change. Many pensioners convert their future right to receive
pension into a lumpsum amount receivable immediately. For example, suppose a person is
entitled to receive a pension of say Rs. 2000 p.m. for the rest of his life. He may commute
1/4th i.e., 25% of this amount and get a lumpsum of say Rs. 30,000. After commutation, his
pension will now be the balance of 75% of Rs. 2,000p.m. = Rs. 1,500 p.m.

3. Gratuity

Gratuity is a part of salary that is received by an employee from his/her employer in gratitude
for the services offered by the employee in the company. Gratuity is a defined benefit plan and
is one of the many retirement benefits offered by the employer to the employee upon leaving
his job.

One can know your gratuity amount in advance. The amount of gratuity depends upon the
tenure of service and last drawn salary. Every employer is bound to give gratuity amount to its
employees if it employs more than 10 people. The gratuity is given after leaving the job of you
have completed continuous service of 5 years.

An employer may offer gratuity out of his own funds or may approach a life insurer in order to
purchase a group gratuity plan. In case the employer chooses a life insurer, he has to pay annual
contributions as decided by the insurer. The employee is also free to make contributions to his
gratuity fund. The gratuity will be paid by the insurer based upon the terms of the group gratuity
scheme.

4. Pay Commission

Pay Commission is set up by Government of India, and gives its recommendations regarding
changes in salary structure of its employees. Since India’s Independence, seven pay
commissions have been set up on a regular basis to review and make recommendations on the
work and pay structure of all civil and military divisions of the Government of India.

M. How is TDS calculated?

Calculate TDS from Salary

The government allows tax exemption under Section 80C and 80D. This allows an individual
to seek for exemption on tax based on various types of investment he/she is making for that
particular financial year.

Deductions under Section 80C, 80CCC, 80CCD and 80D

• 80C: Premium to be paid for life insurance and/or investments to be made in ELSS
funds, PPF, NPS and/or school tuition fees for children, etc
• 80CCC: Premium to be paid for annuity plan
• 80CCD: Additional contributions made to NPS
• 80D: Premium to be paid for medical insurance
Deductions under other sections like 80E, 80G, 80TTA

• 80E: Interest to be paid on education loan

• 80G: Donations to be made to specified organisations
• 80TTA: Interest income earned from savings bank account
TDS Deductions

The following process is involved in the deduction of TDS:

• Calculating total earning – The employer is required to calculate the total earning of the
employee.
• Calculating total amount eligible for the exemption – The employer is accountable for
calculating the total amount that is considered for tax exemption. The employee needs
to declare the type of amount that is eligible for exemption.
• Obtaining declaration and investment proof – The employer is required to collect
investment and proofs from employees
• Depositing TDS deductions – The employer will require depositing the collected TDS
to the central government.

N. How is TDS calculated on salary?

Now comes the most important part of the article i.e. how TDS is computed on salary. It is
simply taking out your net taxable income, calculating Tax thereon and taking out the amount
of deduction on monthly basis (Average)

While the basic salary is fully taxable according to respective tax bracket, some exemptions
are available for payments made as allowances and perks. You can calculate TDS on your
income by following the below steps.

• Calculate gross monthly income as a sum of basic income, allowances and perquisites.
• Calculate available exemptions under Section 10 of the Income Tax Act (ITA).
Exemptions are applicable on allowances such as medical, HRA, travel.
• Reduce exemptions according to step (2) for the gross monthly income calculated in
step (1).
• As TDS is calculated on yearly income, multiply the corresponding figure from above
calculation by 12. This is your yearly taxable income from salary.
 • If you have any other income source such as income from house rent or have incurred
losses from paying housing loan interests, add/subtract this amount from the figure in
step (4).
• Next, calculate your investments for the year which fall under Chapter VI-A of ITA,
and deduct this amount from the gross income calculated in step (5). An example of
this would be exemption of up to Rs.1.5 lakh under Section 80C, which includes
investment avenues such as PPF, life insurance premiums, mutual funds, home loan
repayment, ELSS, NSC, Sukanya Samriddhi account and so on.
• Now, reduce the maximum allowable income tax exemptions on a salary. Currently,
income up to Rs.2.5 lakhs is fully exempt from paying taxes, while income from Rs.2.5
lakhs to Rs.5 lakhs is taxed at 5%, and Rs.5 lakhs to Rs.10 lakhs income bracket is
taxed at 20%. All income above this amount is taxed at 30%.
• Do note that senior citizen have different tax slabs and receive higher exemptions than
those discussed above.

O. Recent Amendment for Salaried Class

As per an amendment in the Budget 2018, tax exemption on medical reimbursement amounting
to Rs. 15,000 and transport allowance amounting to Rs. 19,200 in a financial year have been
replaced with a standard deduction of Rs. 40,000 (For FY 2018-19) and Rs. 50,000 (For FY
2019-20).

CONCLUSION

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.