Chargeability of Income from Salary

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Employer-Employee Relationship:

Every payment made by an employer to his employee for service rendered would be chargeable to tax as salaries. Before an income can become chargeable under the head ‘salaries’, it is vital that there should exist between the payer and the payee, the relationship of an employer and an employee.

Once the relationship of employer and employee exists, the income is to be charged under the head “salaries”. It does not matter whether the employee is a full-time employee or a part-time one.

If, for example, an employee works with more than one employer, salaries received from all the employers should be clubbed and brought to charge for the relevant previous years.

Waiver of Salary: Once salary accrues to employee, the subsequent waiver by the employee does not absolve him from liability to income-tax. Such waiver is only an application and hence, chargeable to tax.

Surrender of Salary to Central Government: If an employee surrenders his salary to the Central Government under section 2 of the Voluntary Surrender of Salaries (Exemption from Taxation) Act, 1961, the salary so surrendered would be exempt while computing his taxable income.

Tax free salary: This, in other words, means that the employer bears the burden of the tax on the salary of the employee. In such a case, the income from salaries in the hands of the employee will consist of his salary income and also the tax on this salary paid by the employer.

Salary to be taxed in India: Under section 9(1)(ii), salary earned in India is deemed to accrue or arise in India even if it is paid outside India or it is paid or payable after the contract of employment in India comes to an end.

If an employee gets pension paid abroad in respect of services rendered in India, the same will be deemed to accrue in India. Similarly, leave salary paid abroad in respect of leave earned in India is deemed to accrue or arise in India.

Section 10(10CC), the income-tax paid by the employer on non-monetary perquisites on behalf of the employee would be exempt in the hands of the employee.

Section 15: Basis of chargeability of Income from Salary.

Section 15 deals with the basis of charge. Salary is chargeable to tax either on ‘due’ basis or   on ‘receipt’ basis, whichever is earlier.

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.

If the salary paid in arrears has already been assessed on due basis, the same cannot be taxed again when it is paid.

Understand from the following Example:

  • If A draws his salary in advance for the month of April 2018 in the month of March 2018 itself, the same becomes chargeable on receipt basis and is to be assessed as income of the P.Y.2017-18 i.e., A.Y. 2018-19. However, the salary for the A.Y. 2019-20 will not include that of April 2018.
  • If the salary due for March 2018 is received by A later in the month of April 2018, it is still chargeable as income of the P.Y. 2017-18 i.e., A.Y. 2018-19 on due basis. Obviously, salary for the A.Y. 2019-20 will not include that of March 2018.

 Advance Salary:

Advance salary is taxable when it is received by the employee irrespective of the fact whether it is due or not. It may so happen that when advance salary is included and charged in a particular previous year, the rate of tax at which the employee is assessed may be higher than the normal rate of tax to which he would have been assessed. Section 89(1) provides for relief in these types of cases.

Advance against Salary:

advance against salary is different from advance salary. It is an advance taken by the employee from his employer. This advance is generally adjusted with his salary over a specified time period. It cannot be taxed as salary.

Arrears of Salary Taxed on receipt Basis:

Normally speaking, salary arrears must be charged on due basis. However, there are circumstances when it may not be possible to bring the same to charge on due basis.

Eg: If the Pay Commission is appointed by the Central Government and it recommends revision of salaries of employees, the arrears received in that connection will be charged on receipt basis. Here also, relief under section 89(1) is available.

What is Salary?

The meaning of the term ‘salary’ for purposes of income tax is much wider than what is normally understood. The term ‘salary’ for the purposes of Income-tax Act, 1961 will include both monetary payments (e.g. basic salary, bonus, commission, allowances etc.) as well as non-monetary facilities (e.g. housing accommodation, medical facility, interest free loans etc.).

Section 17(1) defined the term “Salary”. It is an inclusive definition and includes monetary as well as non-monetary items.

Wages / Salary:

In common parlance, the term “wages” means fixed regular payment earned for work or services. The words “wages”, “salary”, “basic salary” are used interchangeably. Moreover, the payments in the form of Bonus, Allowances etc. made to the employee are also included within the meaning of salary.

Under the Income-tax Act, there are certain payments made which are fully taxable, partly taxable and fully exempt. For Example, wages, salary, bonus, dearness allowance etc. are fully taxable payments. Whereas monetary benefits in the form of allowances such as House Rent Allowance, conveyance allowance etc. are partially taxable.

What is an Allowances under Income Tax Act?

Different types of allowances are given to employees by their employers. Generally, allowances are given to employees to meet some particular requirements like house rent, expenses on uniform, conveyance etc.

Under the Income-tax Act, 1961, allowance is taxable on due or receipt basis, whichever is earlier.

Various types of allowances normally in vogue are discussed below:

Fully Taxable Allowances:

  • Entertainment Allowances.
  • Dearness Allowances.
  • Overtime Allowances.
  • Fixed Medical Allowances.
  • City Compensatory Allowance (to meet the increased cost of living in cities).
  • Interim Allowance.
  • Servant Allowance.
  • Project Allowance.
  • Tiffin / Lunch / Dinner Allowance.
  • Any Other Cash Allowance.
  • Warden Allowance.
  • Non-practicing Allowance.

Partly Taxable Allowances:

  • House Rent Allowance u/s 10(13A).
  • Special Allowance u/s 10(14).

Fully Exempt Allowances:

  • Allowance granted to Government employees outside India.
  • Allowance granted to High Court Judges.
  • Sumptuary allowance granted to High Court or Supreme Court Judges.
  • Allowance paid by the United     Nations Organization.
  • Compensatory Allowance received by a judge.

Fully Taxable Allowances:

City Compensatory Allowance

City Compensatory Allowance is normally intended to compensate the employees for the higher cost of living in cities. It is taxable irrespective of the fact whether it is given as compensation for performing his duties in a particular place or under special circumstances.

Entertainment Allowances.

This allowance is given to employees to meet the expenses towards hospitality in receiving customers etc. The Act gives a deduction towards entertainment allowance only to a Government employee. The details of deduction permissible are discussed later on in this Chapter.

House Rent Allowance u/s 10(13A).

HRA is a special allowance specifically granted to an employee by his employer towards payment of rent for residence of the employee. HRA granted to an employee is exempt to the extent of least of the following

Metro Cities (i.e. Delhi, Kolkata, Mumbai, Chennai)
 1) HRA actually received.
2) Rent paid (-) 10% of salary for the relevant period
3) 50% of salary for the relevant period

                    

Other Cities
1) HRA actually received
2) Rent paid (-) 10% of salary for the relevant period
3) 40% of salary for the relevant period

 

  1. Exemption is not available to an assessee who lives in his own house, or in a house for which he has not incurred the expenditure of
  2. Salary for this purpose means basic salary, dearness allowance, if provided in terms of employment and commission as a fixed percentage of

3 Relevant period means the period during which the said accommodation was occupied by the assessee during the previous year.

Special allowances to meet expenses relating to duties or personal expenses [Section 10(14)]

This clause provides for exemption (as per Rule 2BB) in respect of the following:

  • Special allowances or benefit not being in the nature of a perquisite, specifically granted to meet expenses incurred wholly, necessarily and exclusively in the performance of the duties of an office or employment of profit [Section 10(14)(i)]

For the allowances under this category, there is no limit on the amount which the employee can receive from the employer, but whatever amount is received should be fully utilized for the purpose for which it was given to him.

  • Special allowances granted to the assessee either to meet his personal expenses at the place where the duties of his office or employment of profit are ordinarily performed by him or at the place where he ordinarily resides or to compensate him for the increased cost of [Section 10(14)(ii)]

For the allowances under this category, there is a limit on the amount which the employee can receive from the employer. Any amount received by the employee in excess of these specified limits will be taxable in his hands as income from salary for the year. It does not matter whether the amount which is received is actually spent or not by the employee for the purpose for which it was given to him.

Allowances prescribed for the purposes of section 10(14)(i) [Rule 2BB(1)] The following allowances have been prescribed in Rule 2BB:
  • any allowance granted to meet the cost of travel on tour or on transfer (Travelling Allowance);

Explanation – “allowance granted to meet the cost of travel on transfer” includes any sum

paid in connection with the transfer, packing and transportation of personal effects on such transfer.

  • any allowance, whether granted on tour or for the period of journey in connection with transfer, to meet the ordinary daily charges incurred by an employee on account of absence from his normal place of duty;
  • any allowance granted to meet the expenditure incurred on conveyance in performance of duties of an office or employment of profit (Conveyance Allowance);

Such allowance would be exempt only if free conveyance is not provided by the employer.

  • any allowance granted to meet the expenditure incurred on a helper where such helper is engaged in the performance of the duties of an office or employment of profit (Helper Allowance);
  • any allowance granted for encouraging the academic research and training pursuits in educational and research institutions;

any allowance granted to meet the expenditure on the purchase or maintenance of uniform for wear during the performance of the duties of an office or employment of profit (Uniform Allowance).