Income Tax Law & Practice

Unit 2

Dr. Pooja Sharma

Assistant Professor
DME Management School
p.sharma@dme.ac.in

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 Unit 2
HeadsofIncome-Salary(Part1)
2.1
HeadsofIncome-Salary(part2)
2.2

2.3 House Property ( Part 1)

2.4 House Property ( Part 2)

2.5 Profits and Gains fromBusiness and Profession ( Part 1)

2.6 Profitsand GainsfromBusinessand Profession ( Part 2)

2.7 Capital Gains ( Part 1)

2.8 Capital Gains ( Part 2)

2.9 Income from Other Sources (Part1)

2.10 Income from Other Sources ( part 2)

 2.1
Heads of Income-
Salary
(perquisites, allowances, and
retirement benefits)

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 Suggested Readings

Author: Ahuja, Girish and Gupta, Ravi

Title of the Book: Systematic Approach to Income Tax,
Bharat Law House
Chapter’s Name: Salaries

Author: Singhania, V.K. and Singhania, Monica,

Title of the Book: Student’s Guide to Income Tax
Chapter’s Name: Income under the head Salaries

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 BASIC CONCEPTS
that we will discuss in this Chapter
are as follows:

 BASIS OF CHARGE
 TAX TREATMENT OF
 DIFFERENT TYPES OF SALARIES
 RETIREMENT BENEFITS
 ALLOWANCES
 PERQUISITIES
 DEDUCTIONS

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 FIRST Keep in mind the following norms to
understand the meaning of salary under the
Act……

 Relationship between Payer and Payee:- Amount received by an

individual shall be treated as “salary” only if the relationship between
payer and payee is that of employer and employee or master
and servant

 Employer can be Central/State Govt., public Authority, local authority,

individual, firm, Association of persons, Company, corporation.
Employer can be operating in India or abroad.

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 Member of parliament or state legislature is not treated as
employee of the govt.

 Their remuneration is not taxable as salary; its taxable as income from

other sources.

 If a person receives salary from more than one source due to change of
employment or being in employment with two firms then both are
taxable as “salaries”.

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 Even if an employee foregoes his salary that does not mean salary is not
taxable, even if an employee waives his salary does not exempt his tax
liability.

 Even if an employer pays salary perquisite or allowance as a gift to an

employee, yet it would be taxable.
 BONUS is taxable on a RECEIPT basis.

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 BASIS OF CHARGE
• Salary is taxable on RECEIPT OR DUE basis whichever is earlier as
per section 15. Arrears of salary is taxable in the year of receipt if not
taxed on due basis. Advance of salary is taxable on receipt basis as
receipt occurs first in advance salary.

• Example: if salary of 2020-21 is received in advance in say 2019-20,

then it will be included in the total income of 2019-20 as salary is
taxable on due or receipt basis whichever is earlier and here receipt is
earlier so incidence of tax is according to receipt.
.
• If an individual receives salary from more than one source/employer
during the same P/Y, All is taxable

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SALARY under section 17(1) includes –

 Wages or basic salary

 Any annuity or pension received from employer

 Any Gratuity

 Any fees, commission, perquisite or profit in lieu of salary or in addition to salary

 Any Advance Salary

 Leave Salary

 Amount transferred to Recognised Provident Fund to the extent is taxable.

 Any other payment made or benefit extended due to the employer-employee

relationship, is also taxable.
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 Place of accrual of salary
Salary is said to accrue or deemed to accrue or arise at the place where the services
is rendered under general circumstances.

But this rule has certain conditions and exceptions as well:

 If the service is rendered in India then salary is deemed to accrue or arise in India;
if service is rendered outside India, then salary income is not deemed to be
earned in India but….

 if salary is received by an Indian citizen from GOI, for rendering service outside
India- it is deemed to accrue in India.
 However perquisites and incentives received by the citizen of India from GOI for
same purpose is exempt from tax.

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 Taxability of different components
included in Gross salary
Different Receipts
Basic Salary
Dearness Allowance
Advance salary
Arrears of salary
Leave Encashment while in service
Salary in lieu of notice
Bonus
Monthly pension (uncommuted
pension)
Pension under NPS(National Pension
Scheme)
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Tax treatment
Taxable
Taxable
Taxable in the year of Receipt
Taxable on due basis and if not
taxed in the year of due then taxed
on receipt basis;
Taxable
Taxable
Taxable on Receipt basis if not
taxed on due basis
Taxable
At the time of receipt of pension, it
is taxable. Tax consequences taken
in detail later
 Remuneration for extra duties Fully taxable

Compensation received under VRS Exempt in some cases discussed later

Profits in lieu of salary Taxable

Salary from UNO Not chargeable to tax

Annuity from employer Taxable as salary

Leave encashment at the time of retirement Exempt in the hands of the Govt.
or at the time of leaving the job Employee. In case of non govt employee,
exempt in only certain cases

Gratuity Exempt in the hands of the Govt.

Employee. In case of non govt employee,
exempt in only certain cases

Lumpsum payment of pension Exempt in the hands of the Govt.

(commuted pension) Employee. In case of non govt employee,
exempt in only certain cases
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Retirement benefits

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 Benefit 1
Leave Encashment
• The leaves accumulated or standing to the credit of the employee, if not
availed and not lapsed, then the accumulated leaves can be either
encashed at the time of retirement or leaving the job-

• This encashment is called leave salary or simply stating Encashment of

leaves by surrendering leave standing to one’s credit is known as “LEAVE
SALARY”.

• Leave Salary received during the continuity of employment will

be chargeable to tax for all.

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• However , leave salary is encashed on retirement by a
Government employee central or state govt will be
fully exempt;
• But for others- (non govt employees) it will be exempt
up to a limit & balance shall be taxable;
• Who are govt employees and non govt employees for
leave encashment?

Status of Exempt Taxable Taxable Taxable

taxability

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Procedure for taxing leave encashment in case
of non govt. employee at the time of retirement
• In case of non-govt. employee only ( including employees of public
authority, statutory corporations, and other private-sector employees)
leave salary is exempt up to the least or minimum of the following 4
figures:
A. An amount specified by the govt. (its 3,00,000 applicable from 1.4.1998; for earlier
period it was different; less any exemption availed earlier by the assessee);
B. Leave encashment actually received at the time of retirement ;
C. Period of earned leave in months to the credit of employee at the time of his
retirement or leaving the job x Average monthly salary
D. 10 x Average monthly salary;

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 Calculation of period of earned leave

1. Period of Earned leave in months is calculated by this formula:

Formula

= Cash equivalent of pending leave days. The leave basis is a maximum of 30

days leave for every year of service.

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 Calculation of average salary

2. Average salary = average of salary for 10 months

preceding the date of retirement.

Average salary be inclusive of Basic Salary, D.A. (%of

retirement benefit) and commission as a % of turnover.

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 2021

2021
2021
2021
2021
2021

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Solution

2021

2021

2022-23

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 Benefit -2 Gratuity
 Gratuity is a kind of retirement benefit, like a provident fund or pension. It is a
payment, which is intended to help an employee after his or retirement
whether the retirement is the result of the completion of age of retirement or some
physical disability.

 The general principle underlying gratuity schemes is that by faithful service over a
long period the employee is entitled to claim a certain amount as a
retirement benefit.

 Thus it is earned by an employee as a reward for long and meritorious service.

 For this item govt employee includes central govt employees, state govt employees
and even employees of the local authority :
 And non-govt employees are covered under two sub categories:
 Employees who are Covered under Payments of Gratuity Act, 1972
 Employees who are Not covered under Payments of Gratuity Act, 1972
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 Gratuity to be included under Salary =
Amount of Gratuity received less Exemption
u/s. 10(10)

20,00,000 20,00,000

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 Meaning of certain terms for employees
covered under Gratuity act and not covered
under the act
Types of employee Length of service 15 day’s salary or average salary
calculation
Non govt employees If the period of service is 6 Salary here includes last salary drawn
covered under months or less, then we ignore by the employee and D.A. only.
Payments of Gratuity that part of year under length of Last drawn salary plus DA is multiplied
Act 1972 service calculation; if > 6 months by 15 and divided by 26 days for
its taken as 1 full year average monthly figure.

Non govt Employee not Here completed years of service Salary = Basic + DA+ Commission as a
covered by the payments does not include fractions may it % of turnover;
of Gratuity Act, 1972 be more or less than 6 months Average monthly salary is
does not matter computed for 10 months
preceding the retirement month.

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 Points to remember
 When the gratuity is received from more than one employer in the same
previous year, the aggregate maximum amount exempt from tax cannot
exceed ₹20,00,000/-.

 Any gratuity paid to an employee while he continues to remain in

service is not exempt in any case; except :-

 On retirement
 On Death
 On Resignation
 On Termination
 On becoming incapacitated prior to such retirement

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Questio
n
• N, who is not covered by the Payment of Gratuity Act 1972, retires
on November 5, 2020 from XYZ Ltd. and receives Rs. 2,50,000 as
gratuity after service of 38 years and 7 months.

• His salary is Rs. 8,000 per month up to July 31, 2020 and Rs.
9,000 per month from August 1, 2020. Besides, he gets Rs. 500 per
month as dearness allowance (69 per cent of which is part of salary
for computing all retirement benefits but 100% of dearness
allowance is considered for computing pension).

• Compute the exempted amount of gratuity?

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Calculation of average monthly salary –

Since the employee is retired in the month of November, salary for 10

months will be taken till October (the preceding month in which the
employee has retired).

Basic salary:
January 2020 to July 2020 (Rs. 8,000*7) Rs. 56,000
August 2020 to October 2020 (Rs. 9,000*3) Rs. 27,000
Total = Rs. 83,000
Add: DA (Rs. 500*10 months*69%) =Rs. 3,450
Add: Commission based on fixed percentage= Nil
Total =Rs. 86,450
Average monthly salary= Rs. 86,450/10 = 8,645

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 Employee receives gratuity at the time of retirement and he is not
covered by the Payment of Gratuity Act, 1972.

 Therefore, out of Rs. 2,50,000 received as gratuity, least of the following

is exempt from tax:

 a. Rs. 2,50,000 (gratuity actually received)

 b. Rs. 20,00,000 (amount specified by the Government)
 c. Rs. 1,64,255 [Rs. (8,645/2)*38] (half month’s salary for each
completed year of service)
 Rs. 85,745 is subjected to tax. (Rs. 2,50,000 – exemption of Rs. 1,64,255)

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 Retirement Benefit 3
Pension

 Refers to Periodic Payment made by the employer after retirement or death

of the employee as a reward for past services rendered by the employee.

 Pension can be Uncommuted or Commuted or combination of both

types
 Pension payable to an employee periodically e.g. every month, after
retirement from service is known as uncommuted pension.

 It is Fully Taxable in the hand of all employees, whether central/state

government or non-governmental employees and it is included in Gross
salary for computing tax liability for Assessee/employee.

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 TAX TREATMENT OF COMMUTED PENSION

 The lump-sum payment which he receives on foregoing the monthly pension is

known as commuted value of the pension.

 Commutation of pension is done having regards to age of recipient, state of his

health ,rate of interest and tables of mortality.

 Though it is also taxable, but exemption u/s 10(10A) can be claimed by the
employee as follows:

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 What is Exemption u/s 10(10A) for pension?:

 Treatment/exemption for employees of Government, local authority &

Statutory Corporations receiving commuted pension :
 Commuted pension received by these employees is 100% Exempt so its not
included in their gross salary calculation. Exemption of Commuted pension
is also available to Judges of High courts and the supreme Court.

 Treatment in the case of Other Employees

 Commuted value of pension received is exempt to the following extent
depending the person receives gratuity as a retirement benefit or not:

 (a) If the other employee also receives Gratuity from employer : 1/3 of
commuted value of full pension is exempted,
 (Commuted value of full pension means amount of pension which
would have been fully received, if 100% pension was commuted) or
 (b) If he does not receive Gratuity : 1/2 of Normal commuted pension is
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 Question
 An employee drawing a salary of Rs. 15,000 per month retires from service and becomes
entitled to receive pension of Rs. 9,000 per month.

 He gets half his pension commuted and receives Rs. 1,80,000 as lump sum payment.
Hence forth he shall be entitled to pension of Rs. 4,500 per month. Compute the
exemption available under section 10(10A) in respect of commuted pension. He is also
entitled to gratuity.

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 Solution
• In the question above the employee was entitled to receive a pension of Rs. 9,000
per month out of which he commuted 50% and received a sum of Rs. 1,80,000.

• Exemption however will be available to the extent of commuted value of 1/3 of

total pension as he received gratuity also.

• If commuted value of Rs. 4,500 per month pension, is Rs. 1,80,000 then full
commuted value of entire pension will be (1,80,000/4,500)*9,000= Rs. 3,60,000
• Now exemption is 1/3 of this Rs. 3,60,000= Rs. 1,20,000.

• So, out of the commuted pension received by the employee of Rs. 1,80,000, the
Rs. 1,20,000 amount is exempted and balance Rs. 60,000 pension will be taxable
and included in Gross salary calculation under the head income from salary.

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 Family Pension
 Payment by the employer to the family of such employee after his/her death is known
as family pension.

 The family pension is taxable as “Income from other source” if its

received by the legal heirs of the family after the death of employee
because there is no relationship of employee and employer in this
pension.
 So its treatment is discussed under the head “Income from other
sources”.

 Deduction against such family pension received is available as follows:

 1/3rd of family pension amount or Rs. 15,000, whichever is less.

 Pension received from a United Nations organization is not taxable.

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 Benefit 4
Retrenchment Compensation
 Compensation received at the time of retrenchment under Industrial dispute Act or under
any other act or rule, order or notification.
 Taxable Amount of Compensation to be included under income from Head Salary and gross
salary calculation is:
 = Amount of Retrenchment Compensation received Less Exemption u/s10 (10B)

 What is Exemption u/s.10 (10B)?:

 Minimum of following amounts is exemption:
 i) Actual Compensation received.
 ii) Rs.5,00,000/- the amount specified by the Central government.
 iii) 15days average pay for every completed year of service or part thereof in
excess of 6 months.
 After exemption, the balance retrenchment compensation is taxable and
included in Gross salary for taxation.

 Average Monthly salary means Average of last 3 months preceding the date of
retrenchment; Word Salary includes all but does not include bonus &
employers’ PF contribution.
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 Benefit – 5
Voluntary Retirement Scheme
 Refers to compensation received on voluntarily retirement or termination of service
before the date of actual retirement. This compensation is exempt in the hands of the
employees of the following:

 A public sector company

 Any other company
 An authority established under a Central, state or Provincial Act
 A local Authority
 A cooperative society
 University established under Central, State or provincial Act or University under Sec 3 of
UGC Act, 1956
 Voluntary retirement compensation after exemption, to be included under head Salary;

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 Taxable voluntary retirement compensation that is included in Gross
salary =
Voluntary Retirement Compensation Less Exemption

Exemption for this item is lower or minimum of the following:

 Actual Compensation received/receivable
 5,00,000

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 Benefit- 6 Provident fund
A welfare scheme for the benefit of the employee. In this scheme employer
and employee both contribute similar or equal % of salary of employee.
Interest is also earned on this fund and keeps on accumulating. At the time of
retirement or resignation the accumulated amount is given to the employee.
Facts related to PF Account of employee:

I. Contribution by employee is being made out of his salary which is

already taxed as income hence employee’s contribution to PF is not taxed
rather it is deduction from Gross salary
II. Contribution by employer is over and above salary of employee hence it
is taxed but certain exemptions are also there
III. Interest credited to PF account of employee is also an income over his
salary income but its also exempt up to certain limits

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 Provident Fund types:

Statutory Provident Fund – [Section 10(11)]

 Statutory Provident Fund is mainly meant for Government/Semi
Government Employees, university/ educational institutions or
other specified institutions.

 Employer’s contribution to SPF and interest from this fund is fully

exempt.

 Further, employee’s contribution to this fund is allowed as

deduction under section 80C.

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 Recognised Provident Fund –
[Section 10(12)]
 A provident fund scheme to which the Employee’s Provident Fund and Miscellaneous
Provisions Act, 1952 (hereinafter referred to as PF Act, 1952) applies is Recognised Provident
Fund.

 As per PF Act, 1952 any establishment employing 20 or more persons is covered by the PF
Act, 1952 (establishments employing less than 20 persons can also join the provident fund
scheme if the employer and employees want to do so).

 Employer’s contribution is exempt to the extent of 12% of employee salary and excess over it
is taxable.
 Interest on provident fund is exempt upto 9.5% pa and excess over it is taxable.
 Deduction under section 80C is allowed for employee contribution.
 Repayment from RPF is exempt under certain conditions.
 Recognised provident fund under the govt., is set up by PF Commissioner under PF Act, 1952
and also already recognized by the Commissioner
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of Income Tax.
 Unrecognised Provident Fund

• It’s a scheme where you don’t have approval from the PF commissioner or from the
commissioner of income tax.

• For the employee’s own contribution to this fund, no deduction under 80C is
available to the employee or assessee;

• Employer’s contribution and interest earned on such PF is though not exempted

but as per the Act it is not taxable every year, means it is taxed at the time of
Lumpsum payment to the employee;

• If repayment of Lumpsum amount is made at the time of retirement of the

employee or resignation or termination, then accumulated value of employer’s
contribution and interest on employer’s contribution part in PF is taxable as profit
in lieu of salary; interest on employee’s contribution part to PF is taxable as “salary”

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 Public Provident Funds

 Any member of the public, whether in employment or not, may contribute to this fund.
It is a scheme where there is assessee’s contribution only i.e. no employer contribution.

 As decided the minimum contribution under this scheme is Rs. 500 and Maximum Rs.
1, 50, 000 per year. The payment made to PPF account and the interest obtained can be
withdrawn after a period of 15 years. The applicant has an option of extending this
scheme for another 5 years term at the end of 15 years period.

 Deduction from Gross salary under section 80C is allowed upto Rs. 1,50,000/‐ per year
 Interest from PPF is fully exempt under section 10(11).

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Salary for this purpose means – Basic salary (+) dearness allowance/
dearness pay (if terms of employment so provide) (+) commission
based on fixed percentage of turnover achieved by an employee.

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