When is the salary of a salaried person taxable?

Salary can be defined as the compensation a person receives for providing services that are implied or explicit. Section 17​​ of the Income-tax Act defines the term 'Salary'. However, not going into the technical definition, generally, whatever is received by an employee from an employer in cash, kind, or as a facility [perquisite] is considered as Salary.

Salary has been defined in Section 15, which is as follows

The following Income shall be chargeable to income-tax under the head "Salaries"

(a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid91 or not;

(b) any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him;

(c) any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.

Explanation 1.: For the removal of doubts, it is hereby declared that where any salary paid in advance is included in the total Income of any person for any previous year it shall not be included again in the total Income of the person when the salary becomes due.

Explanation 2.: Any salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from the firm shall not be regarded as "salary" for the purposes of this section.

A reading of section 15 along with the section reveals the following bases for bringing salary charge:

1. Due basis [Section 15(a)]
2. Payment basis [Section 15(b) and 15(c)]
3. Allowance basis [Section 17]

*Please note these case laws are based on erstwhile "The Income Tax Act' 1922"

Calcutta High Court had earlier held in Bhuban Mohan Banerjee* vs CIT (1956) 29 ITR 229 (Cal), that section 15 does not give assessing officer the option to assess the Income in the year of accrual or in the year of receipt according to his choice. Further, assesse does not also have the choice to offer Income when it becomes due or when it is received. Thus, if the Salary has become due, it will be chargeable to tax irrespective of whether it has been paid or not.

If directors, in terms of Board resolution, were entitled to receive a commission for rendering services to the company and if it was in terms of employment on the basis of which they had been rendering services, then such remuneration/commission would be part and parcel of Salary. - ITAT-DELHI in Deputy Commissioner of Income-tax v. Abro Technologies (P.) Ltd. [2020] 118 taxmann.com 65 (Delhi - Trib.)

Where Assessee's case was that a part of the amount received by him from employer constituted Commission which was liable to be taxed as business income, in view of the fact that Assessee had been issued Form No. 16 for Salary received and Form No. 16A for the Commission paid and, moreover, the applicable rate of TDS had been deducted, the impugned order passed by AO bringing to tax entire Income as 'salaries', was to be set aside and, the matter was to be remanded back for disposal afresh. - ITAT-CUTTACK in Jalendra Sahoo v. Income-tax Officer, Bhubaneswar [2020] 114 taxmann.com 574 (Cuttack - Trib.)

There are various receipts which are chargeable to Salary or not let's examine them all:

1. ADVANCE AGAINST SALARY LIKE TEMPORARY LOANS

As per Section 17 "Salary" includes wages, fees, commissions, perquisites, profits in lieu of, or, in addition to Salary, the advance of Salary, annuity or pension, gratuity, payments in respect of encashment of leave etc. Therefore, Salary Advance or Temporary Loans are not Taxable as Salary.

2. FICTICIOUS SALARY

Amount taxable under the head "Salaries" is real Salary and not fictitious Salary. There should be an intention for both payment and receipt of a salary. There should be an intention to render services.

3. WAIVER OF SALARY BEFORE IT ACCRUED OR BECOME PAYABLE

In Commissioner of Income Tax vs L. W. Russel* (1964) 53 ITR 91 (SC), Supreme Court held that where employer contributed sum towards premium payable by assessee-employee to which employee would be entitled on his attaining age of superannuation, said sum was not a perquisite.

Delhi High Court in Commissioner of Income Tax vs Mehar Singh Sampuran Singh Chawla (1973) 90 ITR 219 (Del) held that accrual of Salary is necessary for taxing it. In this case, Assessee was entitled to remuneration consisting of Salary, which was made payable at end of accounting year, though computed on a monthly basis and Commission and bonus which also accrued at close of accounting year. Assessee had forgone all three items prior to close of relevant accounting year. On above facts found, since nether Salary nor Commission nor bonus had accrued to Assessee, they could not be regarded as income taxable in his hands.

4. WAIVER OF SALARY AFTER IT HAS BECOME DUE

Foregoing of Salary means the right to receive Salary i.e., work has been performed and Salary has accrued but employee voluntarily says that he will not take the Salary.

Assessee, who was managing director of the company, by his unilateral Act, waived part of Salary subsequent to relevant accounting years - Whether in the absence of any arrangement between Assessee and company during relevant accounting years, Assessee was liable to be taxed on amount to which he was entitled. - Madras High Court in Commissioner of Income Tax vs VR. Rajaratnam (1979) 119 ITR 89 (Mad)

Even if the Salary is forgone, still it is taxable under the head "Income from Salaries" because Income is accrued. The subsequent waiver does not absolve him from liability to pay Income Tax.

5. COMMISSION APART FROM REGULAR SALARY

Madras High Court in the case of Commissioner of Income Tax vs R. Rajendran (2003) 260 ITR 476 (Mad) ruled that Commission earned while working as an employee is chargeable under head Salary. In this case, assessee claimed deduction of expenses incurred by him for earning sales commission which was given to him in addition to Salary for working as regional sales organiser of a certain company. Held that Commission so paid to Assessee formed part of Salary and as such there was no question of allowing any expenses to earn that Commission to him.

The mere existence of two separate agreements would not change the chargeability of the amount. Assessee-firm paid Commission to two of its employees under an agreement, in addition to Salary, which was paid under a separate agreement for procuring export orders and claimed it as business expenditure. Court held that the mere existence of two separate agreements, i.e., one for Salary and another for Commission, would not necessarily imply that payment of Commission made under one agreement was not salary, when undisputably all work done under agreements was performed for benefit of employer. In view of the wide and inclusive definition of the term 'salary' in section 17(1), Commission paid to employees should be regarded as part of Salary. Madras High Court in case of Commissioner of Income Tax vs T Abdul Wahid & Co. (2000) 243 ITR 467 (Mad)

Thus, after considering above discussions Commission apart from Salary should be Taxable as Salary.

6. FAMILY ALLOWANCE DIRECTLY ARISING BY VIRTUE OF EMPLOYMENT

Madras High Court in the case of Commissioner of Income Tax vs Dr PL Meyyappan (2000) 244 ITR 543 (Mad) held that Allowance arose by virtue his employment has to be treated as a part of his salary and assessed as such. FACTS of the case: The Madras Government sanctioned payment of family allowance to each medical officer in the Madras Medical Service who was recommended to the armed forces. The assessee, a regular Assistant Surgeon in said Services, claimed exemption on the ground that the family allowance was given to his wife during his service in the Defence Ministry and was intended to be given to the family. The ITO as well as the AAC rejected the claim. On second appeal, the Tribunal held that the amount was paid as compensation on account of high cost of maintenance of the family, and that the amount having been paid to the family members could not be regarded as ‘salary'. HELD by the High Court: Assessee claimed exemption in respect of family allowance sanctioned by Government during his service in armed forces. The allowance arose by virtue of his employment in Government and, therefore, amount had to be treated as a part of his salary and assessed as such. Tribunal's views that said amount was paid to family members and was payable either to assessee or to family members, whether married or single, were not agreeable. Thus the decision of Tribunal was overruled in this case.

Therefore, Family allowance directly arising by virtue of employment is taxable as Salary.

Madras High Court in the case of Commissioner of Income Tax vs Dr PL Meyyappan (2000) 244 ITR 543 (Mad) held that Allowance arose by virtue his employment has to be treated as a part of his salary and assessed as such. FACTS of the case: The Madras Government sanctioned payment of family allowance to each medical officer in the Madras Medical Service who was recommended to the armed forces. The assessee, a regular Assistant Surgeon in said Services, claimed exemption on the ground that the family allowance was given to his wife during his service in the Defence Ministry and was intended to be given to the family. The ITO as well as the AAC rejected the claim. On second appeal, the Tribunal held that the amount was paid as compensation on account of high cost of maintenance of the family, and that the amount having been paid to the family members could not be regarded as ‘salary'. HELD by the High Court: Assessee claimed exemption in respect of family allowance sanctioned by Government during his service in armed forces. The allowance arose by virtue of his employment in Government and, therefore, amount had to be treated as a part of his salary and assessed as such. Tribunal's views that said amount was paid to family members and was payable either to assessee or to family members, whether married or single, were not agreeable. Thus the decision of Tribunal was overruled in this case.

Therefore, Family allowance directly arising by virtue of employment is taxable as Salary.

7. VOLUNTARY PAYMENTS NOT RELATED TO EMPLOYMENT BUT MADE OUT OF LOVE AND AFFECTION

This is interesting case law of erstwhile the Indian Income-tax Act, 1922 whose Section 7(1) was equivalent to Section 17 of the Income-tax Act, 1961 where the matter reached Apex Court in Mahesh Anantrai Pattani* vs Commissioner of Income Tax (1961) 41 ITR 481 (SC) and it was held that such payments are gifts and not taxable.

Facts of the case

Relevant Assessment year 1951-52. Assessee was Chief Diwan of Bhavnagar State. Subsequently, Bhavnagar State merged with Saurashtra State and employment of assessee as Diwan was terminated. After said merger, on 12-6-1950, Maharaja made a gift of Rs. 5 lacs to assessee on account of his loyalty and meritorious services to State. On 27-12-1950, Maharaja while instructing his accountant as to how said amount was to be adjusted, made an order that said amount was to be debited to his personal expense account. When assessability of said sum was raised in course of assessment proceedings, at request of assessee, Maharaja wrote on 10-3-1953, a letter confirming gift of said amount as a token of affection and regard for assessee and his family. Income Tax Tribunal treating document of 27-12-1950, as contemporaneous document, disbelieved letter dated 10-3-1953 and held that amount of Rs. 5 lakhs was a taxable receipt falling under section 7(1) of 1922 Act read with Explanation 2.

Held by the Supreme Court

A document written six months after fact of payment could not be termed as a contemporaneous document particularly when object of that document was only to instruct an accountant as to how he should make a particular entry. The amount of gift was paid to assessee not in token of appreciation for services rendered as Diwan but as a personal gift for personal qualities of assessee and as a token of personal esteem and, therefore, gifted amount was not taxable.

Therefore, such payments are not taxable under head “Income from Salaries”.

8. SALARY, BONUS, COMMISSION OR REMUNERATION TO PARTNER

Extract of Explanation 2 of Section 15 of the Income Tax Act'1961

Any salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from the firm shall not be regarded as "salary" for the purposes of this section.

Therefore, Salary, Bonus, Commission or Remuneration to Partner is Not chargeable as Salary but taxable as profit from business or profession.

9. SALARY IN LIEU OF NOTICE PERIOD

Supreme Court in the case of VD. Talwar* vs Commissioner of Income Tax (1963) 49 ITR 122 (SC) held that amount paid in lieu if Salary is Taxable as Salary.

Facts of the case:

The assessee was employed as a General Manager in a company. As per the terms of the service agreement the service was for a period of five years and if the service is terminated before five years it can only be by notice of twelve months of either side or salary in lieu thereof. The services of the assessee were terminated before the term of five years. In lieu of notice the company paid to the assessee certain amount which was the amount computed as salary for twelve months after deduction of income-tax at the source. In making the assessment for the year 1948-49, the ITO held that the sum paid was a revenue receipt of the assessee liable to be taxed under the Act, and rejected the claim of the assessee that the said sum was compensation for loss of employment and the tax deducted should be refunded to him. The Tribunal held that the amount paid to the assessee was really salary in lieu of twelve months' notice and, therefore, the amount was liable to be taxed. On reference, the High Court held that the amount received by the assessee during the year was the revenue income of the assessee liable to tax under the Act.

Held by the Supreme Court:

Whether sum paid to assessee was not in consideration of surrender by recipient of his rights in respect of office and, therefore, said amount could not be treated as "compensation for loss of office". Therefore, amount received by assessee was taxable under section 7 of 1922 Act.

10. TAX FREE SALARY

Extract of Section 17 (2) (iv) of the Income Tax Act'1961

Perquisite includes any sum paid by the employer in respect of any obligation which, but for such payment, would have been payable by the assessee.

Therefore, Salary received including amount of tax paid by the employer will be taxable as Salary as payment of tax by employer is treated as perquisite under section 17(2) (iv).

11. CONCLUSION

Considering above mentioned discussion we can conclude as items taxable or non-taxable: