Income tax is the kind of tax that is deducted from the income or earnings of an individual in a financial year. Different types of incomes have different types of taxes levied upon them. The Income-Tax Act, 1961 (hereinafter “the Act”) talks about five types of incomes:
- Income from salary- which includes rate, register pension, etc. given by an employer to the employee working under him.
- Income from house property- this type of income includes rent from any property.
- Income from capital gains- This includes games from the sale of any capital assets
- Income from business and profession- this includes income from any business or profession like lawyer etc.
- Income from other sources- this includes income which is not covered under the above heads for example remuneration lottery etc.
Income from Salary
Income from salary includes
- Taxable allowances,
- Profits in lieu of salary, and
- Lawful deductions.
Salary also includes pension received by the person who himself or herself has retired from the services. Sections 15 to 17 of the Income Tax Act, 1961 deals with income from salary.
Salary is the income which the employer gives to the employee as a result of the contract of services provided to him. An income shall be considered under the head of salary which shall have ‘employer-employee’ relationship and ‘contract of service’ instead of ‘contract for service’. Under the ‘contract for service,’ the employer is not bound to pay, rather the employee offers service for consideration like a freelancer whereas under the ‘contract of service’ it is the contract where the employee is bound to work for the employer and the income received is called salary.
For the salary, there must exist a relationship of master-servant which means the employee or servant is working under the direct supervision and control of the employer or master. There must not exist a principal-agent relationship as the principal issues instructions and the agent is not bound to carry out instructions given by his master and take the decision in his own manner.
Section 17(1) defines salary as including:
(ii) any annuity or pension;
(iii) any gratuity;
(iv) any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages;
(v) any advance of salary;
(v) Any payment received by an employee in respect of any period of leave not availed of by him;
(vi) Provident fund
(vii) The aggregate of all sums that are comprised in the transferred balance of an employee participating in a recognised provident fund
(viii) The contribution made by the Central Government or any other employer in the previous year, to the account of an employee under a pension scheme referred to in Section 80CCD;
Section 15 lays the basis of the charge of salary under Income Tax as:
Salary taxable on due basis
This is the taxable amount from a salary which is paid or not paid to an employee by the employer in the previous financial year.
If a salary is paid to the employee before it becomes due to him, it is called an advance salary. It is taxable on the basis of receipt
Arrears of salary
If the salary is increased in the past and the difference is received on the past basis then it is called arrears. It is taxable on receipt basis.
Exceptions to Salary
The following have been excluded from under the head of Salary:
- Remuneration- it is not considered as income from salary but it is considered under income from other sources.
- MP’s and MLA’s- they are not covered under the head of income from salary as they are not a government employee and do not have employer-employee relationships.
- Remuneration received by judges- judges have a contract with the constitution of India, thus they are taxable under the income from salaries.
- Fees received by advocate general- advocate general is a profession and fees received by him is considered under income from business or profession and not under income from salary.
- Pay and allowances to chief minister- Article 164 of the Constitution of India provides a state for the payment of salaries to the ministers including the chief minister.
Allowance is an amount received by an employee from an employer other than salary which is for specific purposes. It is the monetary benefit given to the employee to compensate his/her expenditure. The employers provide different kinds of allowances to the employee working under him. Following are the allowances that are taxable under the Act:
House Rent Allowance (HRA)
This is the allowance paid by the employer for the employee’s house rent. The employer pays or deducts the amount from the salary of the employee for the payment of his house rent.
The exemption to the HRA is provided under section 10(13A) of the Act. The exemption is provided on the following three basis:
- The actual house rent allowance received
- The rent paid minus 10% of salary
- The rent paid minus 40% of the salary (this will be considered 50% of the salary if the residence is provided in Delhi, Mumbai, Chennai or Kolkata).
Among the above exemptions whichever is lower, it is exempted.
- Dearness allowance on forming part of retirement benefits
This is paid by the employer to the employee to compensate for the inflationary effect on the cost of living of the employee. Due to inflation the purchasing power of money declines and this is because the employer provides allowances known as dearness allowances to compensate the inflation and maintain the purchasing power of the employee. Generally, dearness allowances do not have an exemption under the Act but in the terms of retirement benefits, the dearness allowance provided with the pension is exempted.
There are broadly three categories of allowances:
- Fully-taxable allowances
- Partly taxable allowances
- exemption available to the extent of the amount spent
- An exemption is granted in a fixed amount
- Wholly exempted
Fully Taxable Allowance
The following types of allowances are fully taxable and are added in the gross salary:
- Dearness allowance
- City compensation allowance
- Entertainment allowance
- Tiffin allowance
- Cash allowance
- Project allowed
- Overtime allowance
- Fixed medical allowance
- Marriage allowance
- Family allowance
- Interim relief allowance
- Special allowance
- Deputation allowance
Partly Taxable Allowance
To the extent of the amount spent
If the allowance is received under this category and the spent amount is lower than the received allowance then the amount spent is taxable. Following are the allowances taxable under this category:
- Travelling allowances
- Conveyance allowance
- Daily allowances
- Uniform allowance
- Research allowance
- Helper allowance
An exemption is granted in a fixed amount
If the amount is received under this category and the exemption is deducted then the remaining amount is a taxable amount. For the amount which is to be taxed, there is no relationship with the actual expenditure.
- Children education allowance
- Hostel expenditure allowance
- Transport allowance
- Transport allowance to employees of the transport system
- Tribal area allowance
- Underground allowance
- Island duty allowance
Wholly Exempted Allowance
- Sumptuary allowance to the Judges of High Court and Supreme Court
- Allowance to employees of UNO
- Allowance to Government employees rendering service outside India
Perquisites are the benefits or the facilities provided by the employer to the employee other than the salary. It is different from the allowance as under allowance the employer pays to the employee on a monthly basis and the employee arranges for himself to avail the facilities whereas in perquisites all the facility is provided by the employer himself.
Characteristics of Perquisites
- Perquisites donate a personal advantage
- Perquisites can be given in cash or kind
- Perquisites are taxable only when the employer has provided these to the employee
- If benefits are given by the client to the professionals then it will be considered as professional income
- Even if there is no agreement between the employer and the employee, perquisites are still taxable.
According to the provision, the following are considered perquisites:
- i) Rent free accommodation
- ii) Conceptional residential accommodation
iii) Other benefits only for the specified employees
- Specified employees are the persons that qualify any one of the following categories
- Director of the company, or
- Is an equity shareholder of 20% or more of the company, or
- Whose income under ‘salary’ exceeds Rupees 50,000 per annum after deduction under Section 16
iv)Expenses of employee reimbursed by the employer
v)Life Insurance paid by employers is taxable on a due basis. The following insurances are not taxable:
- Personal accident insurance
- Employees State Insurance
vi) Sweat equity shares allotted by the employer to an employee on the minimum amount or free of cost, is taxable
vii) Employer’s contribution to superannuation funds of Rs 10,000 per annum
viii) Fringe benefits
Profits in Lieu of Salary
Profits in lieu of salary is the payment received by the employee from the employer other than the salary. This is taxable under the Act. Unlike the allowance, it is not received regularly.
According to Section 17(3) of the Act, Profit in lieu of salary includes:
- Any compensation due for received by an employee from the employer in connection with the termination of his employment,
- Any compensation due or received by an employee from the employer in connection with the modification of the terms and conditions relating to the employment,
- Payment from an unrecognised provident fund which is only to the extent of employers contribution
- Payment under a keyman insurance policy (keyman is the most important person of the company like the CEO)
- Payment before joining any service or after joining any service.
The following profits are exempted under the act:
- Section 10(10): any death come retirement gratuity
- Section 10(10A): any payment in commutation of pension
- Section 10(10B): any compensation received by a workman under the industrial dispute act 1947
- Section 10(10C): any amount received by an employee of:
i) Public sector company
ii) Any other company
iii) An authority established under Central or state or province shall act
iv) A local authority
v) A cooperative society
vi) University established by central state or province shall act
vii) An Indian Institute of Technology
viii) the University of Management as the central government specifies on this behalf.
- Section 10(11): any payment from provident fund
- Section 10(12): accumulator and becoming payable to an employee participating in a recognised provident fund
- Section 10(13): any payment from an approved superannuation fund made in the following cases:
i) on the death of a beneficiary
ii) to an employee in lieu of his retirement
iii) by way of refund of contribution on the death of a beneficiary
iv) by way of refund of contribution to an employee on leaving his services in connection with the fund
v) by way of transfer to the account of the employee under a pension scheme
4. Section 13(A): any special allowance granted to the employee to meet expenditure incurred on payment of rent.
To calculate the income chargeable under salaries the deductions are made in the gross salary. The following deductions are reduced and the remaining will be called the taxable salary under the Act:
i) Standard Deduction
A deduction of Rs. 50,000 or the amount of the salary, whichever is lower
ii) Entertainment Allowance
A deduction is available only to Government Employees. A deduction of 20% of the Salary or Rs 5,000 or the actual entertainment allowance received, whichever is lower.
iii) Professional Tax
If any employee has paid any professional tax then it is deductible under this section. If the tax has been already paid by the employee then it will be taxable as a facility and thereafter allowed as a deduction of maximum Rs. 2,500.
Tax is a compulsory contribution to the government which is taken for public welfare. Thus, it is a personal responsibility of a person to pay the tax. Income Tax is a direct tax which is to be paid from the income and earnings. Salary is the amount paid by the employer to the employee working under him. However, this salary includes not only the basic salary but many other benefits which are provided by the employer other than the basic salary. All these are taxable under the Income Tax Act. However, there are some exemptions which are not taxable. Once the gross salary becomes taxable, a person can claim a deduction if it is covered under the deduction from the salary head of the Act.
- Justice Deoki Nandan Agarwala v. Union of India, Civil Appeal no. 411 of 1982.
- Commissioner of Income Tax v. Jawaharlal Nagpal, 1988 65 CTR MP 227.
- Commissioner of Income Tax v. S.S.M. Lingappan, 1981 129 ITR 597 Mad HC.
BY ROOPAM VISHWAKARMA | GAUTAM BUDDHA UNIVERSITY