Income under the Head “Salaries” [Sections 15 to 17] – Direct and Indirect Taxes with Tax Ready Reckoner

Table of Contents

1. Computation of Income under the head Income from “Salaries”

The first head of income is income from “Salaries”.

Sections 15, 16 and 17 of the Income-tax Act deal with the computation of income under the head “Salaries”.

To understand the computation of income under the head “Salaries”, the following important concepts must first be understood:

(A) Employer and employee relationship:

An income can be taxed under the head “Salaries” only if there is a relationship of an employer and employee between the payer and the payee. If this relationship does not exist, then the income would not be deemed to be income from salary. The relation of employer and employee should be of master and servant. A master is one who not only directs what and when a thing is to be done but how it is to be done, and the servant is one who is bound to carry out the instruction given to him by such masters.

For example, in the case of a lecturer of a college who is also appointed vice-principal of the college and gets vice-principal allowance, the allowance would be taxed under the head “Salaries” because it is being received from the employer by the employee although for non-academic work. However, if this lecturer sets the Question Paper of a university, the remuneration which he receives for setting the paper will not be taxable under the head “Salaries” as the university is not the employer of the lecturer. Such remuneration would, however, be taxable under the head “Income from other sources”.

A Member of Parliament or State Legislature is not a Government employee and therefore, remuneration received by him is not taxable as salary income, but as income from other sources. However, salary received by the Minister in the Government is taxable under the head salary.

Any salary, bonus, commission or remuneration due to/received by an assessee from a firm, in which he is a partner, shall not be taxable under the head ‘Salaries’ as there is no employer-employee relationship. It will, however, be taxable under the head ‘Profits and gains of business or profession’.

(B) Surrender of Salary:

Any salary surrendered by the employee to the Central Government, under the Voluntary Surrender of Salaries (Exemption from Taxation) Act, 1961, will not be included while computing his taxable income, whether he is a private sector/public sector or Government employee.

(C) Place of Accrual [Section 9(1)]:

The golden rule is that salary will be deemed to accrue or arise at a place where services are rendered. If the services are rendered in India and salary on account of such services are received outside India, it will be treated as an income which is deemed to accrue or arise in India. Similarly, if a person, who after rendering services in India, retires and settles abroad, receives any pension on account of the same, such pension shall be an income which is deemed to accrue or arise in India as the services on account of which pension accrues, were rendered in India.

However, there is one exception to the above rule. In case of a citizen of India who is a Government employee and renders any service outside India, salary received by him would be treated as income deemed to accrue or arise in India although the services are rendered outside India. But as per section 10(7) already discussed, in case of such Government employees, who are citizens of India, any perquisite or allowances received outside India shall, however, be exempt.

(D) Tax Free Salary:

When the employee receives tax-free salary from his employer, it normally means that the employer himself pays the tax which is due on the salary of such employee. The amount of tax, so paid by the employer, is also to be considered as the income of the employee and will be added to his salary.

(E) Foregoing of Salary:

Once salary has been earned by an employee, it becomes taxable in his hands though he may subsequently waive the right to receive the same from the employer. The waiver of salary by the employee would be treated as application of the income and salary though waived would be taxable in his hands.

(F) Salary paid by Foreign Government/Enterprises:

Salary paid by foreign government/Enterprises to its employees serving in India is taxable under the head Salaries, unless it is specifically exempt under section 10.

2. Section 15, Incomes Chargeable to Income-Tax under the head Salaries

As per section 15, the following income shall be chargeable to income-tax under the head Sa1aries”:

(a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid in that previous year 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 in that previous year 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 in any earlier previous year.

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.
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 purpose of this The same shall be taxable under the head ‘profit or gains from business and profession’ as per section 28.
The expression ‘paid’ includes every receipt by the employee from the employer whether it was due to him or not. The expression ‘allowed’ is of wider connotation and any credit to the employee’s account is covered, thereby and it should imply that right is conferred on the employee in respect of the same. [CIT v Russet (L. W.) (1964) 53 ITR 91 (SC)].
If the salary is payable on monthly basis, it normally becomes due at the end of the month although it is paid in the next month. In this case, it will be taxable on ‘due’ basis because ‘due’ is earlier than ‘receipt’. Therefore, salary is normally taxable from April to March as the salary of March becomes due at the end of the month. However, in some cases the salary becomes due on the 1St day of the next month. In that case we shall tax the salary from March to February because salary of month of March of current year will be due only in the next financial year and the salary of month of March of last previous year became due only on I St April of the current year.

Example 1:

X is an employee of ABC Ltd. getting a salary of ₹40,000 p.m. which is “due” on the last day of the month but is paid on the 7th of next month. Salary for which months will be taxable for assessment year 2023-24?

Solution:

For assessment year 2023-24 the relevant previous year is 2022-23. Therefore, salary will be taxable for the months of April, 2022 to March, 2023.

Example 2:

In the above case, assume that salary becomes due on the 1st of next month and is paid on the 7th of the next month. Salary for which months will be taxable for assessment year 2023-24?

Solution:

The salary for the months of March, 2022 to February, 2023 will be taxable for assessment year 2023-24 because salary for March, 2022 was due on 1.4.2022 and salary of March, 2023 will become due on 1.4.2023, i.e., the next financial year.

Example 3:

In the illustration No. 4.3, assume that he is paid the salary of April, 2023 and May, 2023 in advance in March, 2023. What will be his gross income for the assessment year 2023-24?

Solution:

Salary for the months of April, 2022 to March, 2023 will be taxable on “due” basis. However, salary paid in advance in the month of March, 2023 for the months of April and May, 2023 will also be included in the income of the previous year 2022-23 because the same has been paid in March, 2023 although it is not “due”. The gross income shall be as under:

Particulars	Rs.
Salary for the months of April, 2022 to March, 2023 (40,000 x 12)	4,80,000
Advance salary of April and May, 2023 received in March, 2023 (40,000 x 2)	80,000
Gross Salary	5,60,000

3. Arrears of Salary

Although salary is taxable on ‘due’ or ‘receipt’ basis whichever is earlier, but if there are any arrears of salary which have not been taxed in the past, such arrears will be taxed in the year in which these arrears are paid or allowed to the employee. For example, if the government announces increase in dearness allowance in the previous year 2021-22 which is effective from 1.1.2014 then arrears from 1.1.2014 to 3 1.3.2021 were never due earlier. These arrears will be taxed in the previous year in which these are paid or allowed although the arrears of salary relate to the past years. In such cases the assessee can claim relief of income-tax under section 89, if he so desires.

4. Meaning and Definition of Salary under Income Tax [(Section 17(1)]

Section 17(1) gives an inclusive definition of ‘Salary

Salary includes—

(i) wages;

(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;

(va) any payment received by an employee in respect of any period of leave not availed by him;

(vi) Employer’s contribution to Recognized Provident Fund (RPF) in excess of 12% of employee’s salary and interest credited to recognized provident fund in excess of 9.5% p.a.);

(vii) the aggregate of all sums that are comprised in the transferred balance of an employee participating in a recognised provident fund to the extent to which it is chargeable to tax;

(viii) the contribution made by the Central Government or any other employer in the previous year, to the account of an employee under a notified pension scheme referred to in section 80CCD.

Although the above incomes are included in salary, but there are certain incomes, mentioned above, which are either fully exempt or exempt, up to a certain limit. The aggregate of above incomes, after the exemption(s) available, if any, is known as “Gross Salary”. From the gross salary, the following three deductions, are allowed under section 16:

(a) Standard deduction Rs. 50,000 or the amount of the salary, whichever is less (Section 16(ia))

(b) Deduction for entertainment allowance [Section 16(ii)]; and

(c) Deduction on account of any sum paid towards tax on employment [Section 16(iii)].

The amount arrived at, after allowing the above deductions, is the income under the head “Salaries”.

Wages

Conceptually there is no difference between salary and wages. Therefore, wages are treated just like salary and are taxable on the same basis as salary.

Annuity

Annuity is an annual grant and when made by an employer falls under the head “Salaries”, it may be paid by the employer voluntarily or on account of a contractual agreement. When annuity is payable by a present employer, it is taxable as salary. If it is received from a former employer then it is taxed as profits in lieu of salary. A deferred annuity will not be taxable until the right to receive the same arises. Other forms of annuities, for example, those made under a will by settlor or granted by a life assurance company, or accruing under a contract, come under the head “Income from other Sources” and they shall have to be assessed under section 56.

Retirement benefits

(A) Gratuity

(B) Pension

(C) Leave encashment

(D) Retrenchment compensation

(E) Compensation received on voluntary retirement

The above mentioned retirement benefits have been discussed later in this Chapter.

Bonus

Bonus is taxable on receipt basis. Therefore, it will be included in the gross salary only in the year in which the bonus is received. If bonus is received in arrears, the assessee can claim relief under section 89.

Salary in lieu of notice period

This is taxable in the previous year in which it is received.

Meaning of notice period:

Normally, if any employer wants to terminate the services of an employee, he gives notice of his intention to do so. e.g. as per the contract of service, he may have to give three month’s notice in advance to the employee. This is known as notice period. Sometime employer instead of giving him a notice gives him salary for the notice period and terminates him immediately. This amount paid by the employer is known as salary in lieu of notice period and is fully taxable in the hands of the employee.

Fee and Commission

Any fee or commission paid/payable by the employer to the employee shall be fully taxable and thus would be included in Gross Salary. Commission may be a fixed amount or a fixed percentage of turnover or net profit etc. But it will be taxable under the head ‘Salaries’ only when it is paid/payable by employer to employee.

Overtime Payments

Any payment made by the employer to the employees for working beyond the office hours or for any extra work done by the employees is taxable and therefore, included in Gross Salary.

Profits in lieu of Salary [Section 17(3)]

Section 17(3) gives an inclusive definition of “Profits in lieu of salary”. As the name suggests, these payments are received by the employee in lieu of or in addition to salary or wages. These payments include the following:

(1) Terminal Compensation:

The amount of any compensation due to or received by an assessee from his employer or former employer at or in connection with the termination of his employment or the modification of the terms and conditions relating thereto is regarded as profits in lieu of salary. The termination may be due to retirement, premature termination, resignation or otherwise.

(2) Payment from an unrecognised provident fund or an unrecognized superannuation fund:

The next category of such profit in lieu of salary is, payment due to or received by an assessee from an unrecognised provident fund or an unrecognised superannuation fund to the extent to which such payment does not consist of contributions by the employee or interest on such employee’s contribution.

In other words, total employer’s contribution till date and interest on such employer’s contribution would both be taxable. The accumulated balance of an unrecognised provident fund and unrecognised superannuation fund, consists of the employee’s own contribution plus interest thereon and the employer’s contribution plus interest thereon. Employer’s contribution and interest thereon and interest on the employee’s contribution are not taxed during the period of employment. When the accumulated balance of such a fund is paid to the employee either on retirement or on termination of service, the untaxed portion, i.e., the employer’s contribution and interest thereon is taxed as ‘profit in lieu of salary’. The interest on employee’s contribution is taxed as income from other sources’.

(3) Payment under Keyman Insurance Policy:

Any payment due to or received by an employee, under a Keyman Insurance Policy including the sum allocated by way of bonus on such policy, will also be regarded as profit in lieu of salary.

(4) Any amount due or received before joining or after cessation of employment:

Any amounts due to or received, whether in lump sum or otherwise by any assessee from any person—

(A) before his joining any employment with that person; or

(B) after cessation of his employment with that person.

(5) Any other sum received by the employee from the employer:

All other payments made by an employer to an employee, would be brought under the head “Profits in lieu of salary”. This is a comprehensive provision by virtue of which all payments made by an employer to an employee whether made in pursuance of a legal obligation or voluntarily are brought under profit in lieu of salary.

However, the following receipts, will not be termed as ‘profits in lieu of salary’ to the extent
they are exempt under section 10.

(i) Death-cum-retirement gratuity — Section 10(10)

(ii) Commuted value of pension Section 10(10A)

(iii) Retrenchment compensation received by a workman Section 10(10B)

(iv) Payment received from a statutory provident fund Section 10(11)

(v) Payment received from recognised provident fund — Section 10(12)

(vi) Any payment from an approved superannuation fund as per section 10(13)

(vii) House rent allowance exempt under section 10(13A)

In short, except for the terminal and other payments specifically exempted under clauses (10) to (13A) of section 10, all other payments received by an employee from an employer or former employer are liable to tax under this head.

It may be noted that any compensation or other payment, due to or received by any person, by whatever name called, in connection with the termination of his employment or the modification of the terms and conditions relating thereto shall be taxable under the head ‘Income from other sources’ if the same is not taxable as “Profits in lieu of salary”. [Section 56(2)(xi)]

Valuation of Allowances – for calculating Taxable Salary Income for AY : 2022-23 & 2023-24.

Specific Exemptions in respect of Allowances are provided under Section 10(13A) and Section 10(14) and the treatment of some of the allowances as under :