Tax Treatment of Employee Welfare Fund Contributions under Section 56(2)(ic)

1. Applicability of Section 56(2)(ic)

This provision covers any sum of money received by an employer from an employee for:

• Welfare funds(e.g., employee welfare trust, group insurance, provident fund)
• Other similar contributionsdeducted from salary

Key Condition: The amount must not be statutory (e.g., EPF, ESI) but voluntary or contractual.

2. Taxability in Employer’s Hands

• Taxable as “Income from Other Sources”if:
  • The amount is not credited to a recognized welfare fund(e.g., approved PF, superannuation fund).
  • The fund does not complywith Income Tax Act provisions (e.g., unapproved trusts).
• Exemptions:
  • Statutory deductions (EPF, ESI, etc.) are not taxable.
  • Contributions to approved welfare funds(Section 10(23AAA) or 10(25)).

3. Tax Implications for Employees

• Deductions:
  • Section 80C: Applicable for recognized PF, LIC, etc. (up to ₹1.5 lakh).
  • Section 80D: For health insurance contributions.
• No Double Taxation: If taxed in employer’s hands, employee cannot claim deductionsfor the same amount.

4. Judicial Precedents

• CIT vs. Karnataka State Road Transport Corp (2017):
  • Held that unutilized welfare fund balancesare taxable under Section 56(2)(ic) if not refunded to employees.
• ITAT Mumbai Ruling (2020):
  • Employer must prove fund utilizationfor employee welfare to avoid taxation.

5. Compliance & Reporting

• For Employers:
  • Report taxable amounts in ITR-6under “Income from Other Sources”.
  • Maintain records of fund utilization (audit reports, expense proofs).
• For Employees:
  • Verify if contributions qualify for Section 80C/80D
  • Ensure employer does not treat voluntary deductions as taxable perquisites.

6. Example

Scenario: ABC Ltd. deducts ₹50,000/year from employees for an unapproved welfare fund.

• Taxable Income: ₹50,000/year for ABC Ltd. under Section 56(2)(ic).
• Employee Impact: No deduction under Section 80C unless fund is approved.