Arrear of Salary: Taxation and Relief Under Section 89(1)

Arrears of salary refer to payments received by an employee for work done in previous financial years but paid in the current year. These payments can significantly increase taxable income, potentially pushing the taxpayer into a higher tax bracket. The Income Tax Act, 1961, provides relief under Section 89(1) to mitigate this additional tax burden.

What is Arrear of Salary?

Arrear salary is past-due income that should have been paid in an earlier financial year but was delayed due to:

• Salary revisions
• Pending increments
• Legal disputes
• Administrative delays
• Retroactive pay adjustments

Example:
An employee was due a ₹50,000 increment in FY 2021-22, but it was paid in FY 2024-25. This ₹50,000 is considered arrear salary.

Taxability of Arrear Salary

Under Section 15, salary arrears are taxable in the year they are received, not when they were due. This can lead to higher tax liability if the arrears push the taxpayer into a higher slab rate.

Key Tax Implications

• Arrears are added to current-year income, increasing taxable income.
• May lead to higher TDS deductionsby the employer.
• Could affect eligibility for tax deductions/exemptions (e.g., HRA, 80C).

Relief Under Section 89(1)

To prevent unfair taxation due to delayed payments, Section 89(1) allows recalculating tax liability by spreading arrears over the years they relate to.

Eligible Incomes for Relief

1. Salary received in arrears or advance
2. Gratuity(if taxable beyond exemption limit)
3. Commuted pension
4. Family pension arrears
5. Compensation on termination of employment
6. Premature PF withdrawal

How Relief is Calculated (Step-by-Step)

1. Compute tax for the current year (including arrears).
2. Compute tax for the current year (excluding arrears).
3. Find the difference (X) = Additional tax due to arrears.
4. Compute tax for the past year (including arrears).
5. Compute tax for the past year (excluding arrears).
6. Find the difference (Y) = Extra tax had arrears been paid on time.
7. Relief = (X – Y).If Y > X, no relief is allowed .

Example:

• FY 2024-25 Income (with arrears):₹12L (Tax: ₹1.5L)
• FY 2024-25 Income (without arrears):₹10L (Tax: ₹1.1L)
• X = ₹40,000
• FY 2021-22 Income (with arrears):₹8L (Tax: ₹70,000)
• FY 2021-22 Income (without arrears):₹6L (Tax: ₹50,000)
• Y = ₹20,000
• Relief = ₹40,000 – ₹20,000 = ₹20,000

How to Claim Relief? (Mandatory Steps)

1. File Form 10E Online
   • Must be submitted before filing ITRon the Income Tax e-filing portal.
   • Contains details of arrears, related financial years, and tax calculations.
   • Non-filing leads to denial of relief.
2. Report in ITR
   • Include arrears in “Income from Salaries”while claiming relief under Section 89(1).
3. Keep Supporting Documents
   • Salary slips
   • Employer’s arrears certificate (Part B of Form 16)
   • Past-year tax returns (for verification)