Taxation of Salary Components - Part 1

The term salary in income tax includes any emoluments so received by providing adequate service or with the completion of duties. It includes:-

·      Wages, Salary due during the previous year

·      Advance salary , Arrears salary, Bonus

·      Annuity or pension

·      Gratuity

·      Fees ,commission, perquisites or profits in addition to salary / wages

·      Any payment received for any period of leave not availed

·      Cash allowance

·      Any sum received under key man insurance policy

And any other payment received by an employee from the employer received during the year.

Employer-Employee relationship –

To charge income under head salary, it is essential that employee has earned such income from his employer. So employer-employee relationship must exist. It is similar to master-servant relation. Exception where employer-employee relationship doesn’t exist:

·         Remuneration received by a director of the company

·         Remuneration received by partner of a firm

·         Salary received by the MP or MLA

The salary income is chargeable to tax under the head “income from salaries” which is due / paid / which represents arrears paid.

Salary payments and its components-

A)   Salary payments that are fully taxable:-

            1.       Basic salary, Wages

            2.       Advance salary

            3.       Arrears salary  

            4.       Commission

            5.       Fees

            6.       Contractual bonus

            7.       Annuity

            8.       Remuneration for extra work

B)    Salary payments that are partially taxable:-

            1.       Gratuity [sec10(10)]

Government employee - Any death cum retirement gratuity received by an employee of the central government, state government or local authority is exempt from tax.

For Non-Government Employees the taxability depends on whether Gratuity is covered under the Gratuity Act, 1972 or not.

1. Gratuity covered under the Gratuity Act, 1972
For the Gratuity covered by the Gratuity Act, total of gratuity received by an employee from various employers in whole of service is exempt from tax to the extent of least of the following three amounts:-
• Rs. 10,00,000/ or
• The gratuity actually received.

·(15÷26)*Last drawn salary per month * Years of service (Round-off if fraction in excess of 6 months)

Note: – Salary here is basic salary + dearness allowance

2. Gratuity not covered under the Gratuity Act, 1972
For Gratuity not covered under the Gratuity Act any gratuity not covered by the Gratuity Act, is exempt from tax to the extent of least of the three amounts-
• Rs.10,00,000/ or
• The gratuity actually received.
• (1÷2) * Average salary of last 10 months * Years of service (Fraction to be ignored)

Note: - Salary here basic salary + dearness allowance + Commission as fixed % of turnover

For Non-Government Employees, gratuity received during period of service is fully taxable.

           2.       Commuted pension [sec(10(10A)]:-

Commuted pension means pension received in the form of lump sum amount taken by commuting the whole or part of the pension.

Uncommuted pension refers to pension received periodically.

A. Government employee – Any commuted pension received is fully exempt from tax.

B. Non-government employee – Any commuted pension received is exempt in the following manner:

1) If the employee receives gratuity then 1/3rd of full value of commuted pension will be exempted from tax.

2) If the employee do not receive gratuity then 1/2 of full value of commuted pension will be exempted from tax.

[Example: If 20% of pension is commuted for Rs. 1,00,000.00 then full value of commuted pension will be Rs.5,00,000.00 (i.e.1,00,000/20 x 100) and 1/2 or 1/3 (as applicable) of Rs. 5,00,000.00 will be exempted from tax] 

Note:

i) Family pension received by the family member after the death of employee then 1/3rd of the pension or Rs. 15,000.00 whichever is less is exempted from tax and balance will be chargeable in the hands of Member who receives the pension (Pension should not be covered by pension for armed forces).

ii) Uncommuted pension is fully taxable in the hands of both government and non-government employees.

iii) If any employer contributes to the notified pension scheme of Govt. (U/s. 80CCD) then is should first be included in the income of the employee and contribution to the extent of 10% of Salary shall be allowed as deduction. In this case the employee should have joined the service on or after 01.01.2004. [Salary here means Basic + D.A. (if terms of employment so provides)].

           3.       Leave salary[Sec10(10AA)]:-

Leave encashment while in service is taxable. Encashment of sick leave is taxable.

A. Government employees:- Leave encashment received at the time of retirement is fully exempt

              B. Non-government employees: - Leave encashment received at the time of retirement is exempt to the  extent of the least of the following four amounts:-

• Leave encashment actually received at the time of retirement.
• Rs. 3, 00,000/-
• Ten months' average salary; (Here the average salary means the average of the salary drawn during the last ten months before retirement),
• Cash equivalent of the leave due at the time of retirement.

Note:-

1. Salary for this purpose means basic salary + dearness allowance (if provided for retirement benefits) and commission as fixed % of turnover.

2. As per the act, leave due per year is maximum 30 days per completed year of service. If company provides leave less than 30 days, then leave due for above calculation will be the lower value.

          4.       Retrenchment compensation [sec 10 (10B)]:-

The compensation received by an employee is exempted to the least of the following:-

i)      Actual amount received

ii)    Rs. 5,00,000

            iii)    Amount calculated as per Industrial Dispute Act i.e. -

             (15÷26) * Average salary of last 3 months x Completed years of service and any part in excess of 6 months     will be counted as one year.

[Example: Say Mr. X earns Rs. 9,000 p.m. as salary income at the time of retrenchment and worked for 36 years 9 months.

The amount as per Industrial Dispute Act = (15÷26)*9000*(36+1) = Rs. 192115]

         5.       Voluntary retirement scheme [sec10(10c)]:-

The scheme is drawn to reduce existing strength of the employees of the company. The amount received by an employee is exempted to the least of the following:-

i)       Actual amount received

ii)     Rs. 5,00,000.00

             iii)      Last drawn salary x 3 x No. of years worked

             iv)      Last drawn salary x No. of years left for service

             Note:

i)         Salary means salary last drawn and includes Basic + D.A. (if terms of employment so provides) + Commission of fixed % of turnover.

ii)       The employee has completed 10 years of service and has become 40 years of age or more. This is not applicable in case of public sector companies (i.e. he will be allowed the exemption even if he has not completed 10 years of service and has not become 40 years of age.)

iii)      It will be allowed once in the life time of the assessee. It applies to all employees except the directors of the company.

iv)      The vacancy caused is not to be filled up.

         \6.       Leave travel concession:-

This is taxable on the basis of Receipt or due whichever is earlier. The amount of leave travel concession received by an employee for himself or for his family member will be exempted from tax if the amount received is in connection with the following:- > On leave to any place in India.

(Note 1) > On leave to any place in India after retirement from the service or termination of service.

(Note 2) The Exemption shall be restricted to the amount actually incurred by the assessee. The amount actually incurred shall be restricted to the followings:-

Sr. no.	Journey Performed by	Amount of exemption
1	Air	Air economy fare of the national carrier by the shortest route or the amount spent whichever is less.
2	Rail	A.C. 1st class fare by the shortest route to the place of destination or Amount actually incurred whichever is less.
3	Any other mode	Amount of A.C. 1st class fare shortest route to the place of destination or Amount actually incurred whichever is less.
4.	If not connected by rail
	If recognized Public Transport system exists	The amount of 1st class or Deluxe class fare on such transport or the amount actually incurred whichever is less.
	If no recognized Public Transport system exists	The amount of 1st class fare by the shortest route(as if the journey is performed by rail) or Amount actually incurred whichever is less.

1. Family means spouse, children, and parents, brother, and sister of the employee mainly dependent of the assessee.

2. Only two journeys performed in a block of 4 calendar year is exempted from tax.

3.  If an assessee has not availed travel concession or assistance during any of the specified four-year block periods only 1 trip can be carried forward to be availed in the 1st calendar year of the next block. This is known as “carry over” concession.

4. Exemption is available in respect of fare only (Rail fare, Bus fare and Air fare). No exemption can be availed for the expenses incurred in respect of taxi charges, scooter charges, lodging/boarding expenses.

5. Exemption is available to Indian as well as Foreign citizen.

           7.       Provident fund(PF) :-

Particulars	Recognized PF	Unrecognized PF	Statutory PF
Employer’s Contribution	Amount in excess of 12 % of salary is taxable	Not taxable yearly	Fully exempt
Employee’s contribution	Eligible for deduction u/s 80C	Not eligible for deduction	Eligible for deduction u/s 80C
Interest credited	Amount in excess of 8.5% p.a. is taxable	Not taxable yearly	Fully exempt
Amount received on retirement	See Note 2	See Note 3	Fully exempt

              Notes:-

1. Salary = basic salary + dearness allowance (if provided for retirement benefits) + Commission as fixed % of turnover

2. Amount received is fully exempt if employee has rendered continuous service for a period of 5 years or more.

3. Employee’s own contribution is not taxable but the interest earned on it will be taxable under “income from other sources”. Both employer’s contribution and interest is taxed as income from “Salary”.

C)    Salary payments that are fully exempt from tax:-

       1)       Any payment from an Approved Superannuation Fund

       2)       Salary from United Nations Organization

       3)       Salary to non-resident technicians

       4)       Remuneration to consultants

       5)       Remuneration to employees of such consultants

       6)       Remuneration to Foreign Citizens

So these are all salary payments in general and their tax treatment. In further articles, I will post tax treatment on various allowances and perquisites provided by the employer to the employee. Any comments over this are welcome!!