Taxability of salary and related information

I have started writing this article keeping in mind the questions raised in minds of salaried class taxpayers. Also, it is aimed to address the doubts of all those who file the Return of their salaried class clients.

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”.

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.

Allowances

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.

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.

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.

 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.

Perquisites

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

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

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.

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.

Important Points:

• 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;
  3. 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;

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.

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.

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.

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.

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.

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.

Let us now discuss about different forms, which most of you would be aware of. These forms are a common sight in HR Department of the Organization.

Various Forms

1. Form 12 BB

Investment declaration has to be done in the beginning of a financial year. Your employer asks you to declare your tax-saving investments for the year to be able to deduct tax accordingly from your monthly salary. Investment declaration is important for you because it can lead to higher in-hand salary.

In the beginning of the financial year, you have to just make an estimate of the investments that you intend to make. You don’t need to submit actual proofs till the end of the financial year. You can actually invest less or more. The eventual investments don’t have to be exactly as declared.

The Form 12BB is a statement of claims by an employee for deduction of tax. With effect from 1st June 2016, a salaried employee is required to submit the Form 12BB to his or her employee to claim tax benefits or rebate on investments and expenses. Form 12BB has to be submitted at the end of the financial year.

Form 12BB applies to all salaried taxpayers. Using Form 12BB, an employee has to declare the investments that they have made during the year. Documentary evidence of these investments and expenses have to be provided at the end of the financial year as well.

When do I have to submit Form 12BB?

Usually, employers ask for a declaration at the start of the financial year to estimate TDS calculations for the whole year. Form 12BB has to be later submitted towards the end of the financial year. 

Do I need to submit Form 12BB to the Income Tax Department?

No, Form 12BB does not have to be submitted to the tax department. It has to be submitted to your employer.

2. FORM 12B

Form 12b is an income tax form that needs to be furnished according to Rule 26A by an individual joining a new organisation or company in the middle of the year. The main purpose of the form is to furnish details of the income earned by the individual from the previous employer. Every new employee has to submit Form 12b to their new employer. Furnishing Form 12b is not compulsory.

What happens after the Employee submits the Form 12b?

Once the employee submits Form 12b with the correct details required, the new employer will furnish a Consolidated Form 16 at the end of the year based on the details provided by the new employee in Form 12b.

Whose responsibility is it to fill Form 12b?

It is the employee’s responsibility and not the previous employer’s responsibility to fill Form 12b. The employee has to fill in the declaration in Form 12b and also attach Form 16, if provided by the previous employer.

Can the current employer refuse to deduct TDS on the individual’s previous salary after the submission of Form 12b?

It is the employer’s obligation to deduct TDS on the individual’s consolidated salary after accounting for TDS deducted by the individual’s previous employer.

3. FORM 16

Form 16 is a certificate, in which employer certifies the details about the salary and the tax deducted at source from the salary during the year.

Form 16 is issued once in a financial year, on or before 31st May of the next year immediately following the financial year in which tax is deducted.

Form 16 has two parts:

Part A- It contains the information of the employer & employee, like name & address, PAN and TAN details, a period of employment, details of TDS deducted & deposited with the government.

Part B- It contains the details of salary paid, other incomes, deductions allowed, tax payable etc.

What if no taxes have been deducted from salary, is there any need for employer to issue Form-16 ?

Form-16 is a certificate of TDS and in this case it will not apply. However the employer must issue a salary statement.

4. FORM 26AS

Form 26AS is required to be issued Under Section 203AA of the Income-tax Act. It is a consolidated tax credit statement issued to a taxpayer and shows the Income tax that has been deposited with the government with respect to the taxpayer and Form 26AS

Form 26AS Contains all the details of the taxes paid and deposited with the Income Tax Department.

5. Form 10C

Form 10C is the primary form to be submitted for claiming the benefits under the employee pension scheme.

The contributions made by your employer towards your PF account is segmented into EPF funds and EPS funds.

The part of the contribution from your employer that goes into the EPS scheme can be withdrawn by using Form 10C.

Who can Apply?

All members of the EPS scheme satisfying the below mentioned criteria can apply:

• A person who has left employment before completion of 10 years and who has attained 58 years of age before completion of 10 years of service.
• A person who has completed 10 years in service and not attained 50 years of age, or a member who is between 50 to 58 years of age and is unwilling to settle with reduced pension.
• Family/nominee of a member who died before completing 10 years of service and was more than 58 years at the time of death.

Detailed Discussion on Various Components of Salary

I have tried to explain the meaning of a few terms which might be used in your salary slip in the most simple language. Wikipedia came as a great help to me while writing this section.

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 lump sum 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 lump sum 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.

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 organizations
• 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.

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.

Recent Amendment for Salaried Class

FM Arun Jaitley in his Budget 2018 speech has proposed to provide a standard deduction of Rs 40,000 from salary income to employees. However, at the same time he has also proposed to take away existing annual transport allowance of Rs 19,200 and Rs 15,000 medical reimbursement. Prima facie income exempted from tax after setting off the gain and loss comes to only Rs 5800. The tax saved for each employee on this income would depend on the tax slab that income falls into. The saving in tax would be Rs 290 for those currently paying 5% tax on this income; Rs 1160 for those paying 20% as tax on this income; and Rs 1740 for those paying 30% tax on this income. 

With this, I have reached to the end of this Article. I have tried to address some of not much talked areas in Salary. Besides discussing about taxability of various allowances and perquisities (which is often formula based in this Chapter), the main purpose was to make masses aware of something which is not much known. Hope the content of the article helps.

Your feedbacks will be highly appreciated.