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Salary means remuneration paid to the employee by the employer for the services rendered by
him during a period of time. It is taxed on due basis or receipt basis, whichever is earlier. Salary
comprises of 5 components namely:
Basic Salary
Fees, Commission and Bonus
Allowances
Perquisites
Retirement Benefits
Basic Salary
Basic salary is a fixed component of the salary which is agreed upon as per terms of employment
or as per the graded system of salary. As per the graded system, the increments are fixed till the
basic salary reaches a prescribed limit for the grade.
Allowances
Allowances are fixed amounts paid by an employer to an employee to meet his expenses for
personal use or for performance of his professional duties. The allowances are over and above the
basic salary and are taxable as per their nature and guidelines laid by the Income Tax Act. These
allowances can be classified as:
Fully Taxable
Fully taxable allowances are as under:
Dearness Allowance
This allowance is paid to meet the mounting expenses due to inflation. In some cases it forms
part of basic salary for computing retirement benefits.
Overtime Allowance
Any allowance paid for working over and above the prescribed hours is called overtime
allowance and is fully taxable
Other Allowances
There are many other allowances that are taxable such as deputation allowance, servant
allowance, etc.
Partly Taxable
Partly taxable allowances are as under:
Actual HRA
Additional rent paid over and above 10% of salary due to him
An amount equal to 50% of salary due to him if living in metros (40% of salary if living
in other places)
Entertainment Allowance
This allowance is first included in the salary and is then allowed as an exemption only to Central
and State Government employees.
Special Allowance
This allowance is given to the employee for carrying on his official duties and is exempt to the
extent it is actually incurred. This includes uniform allowance, travel allowance, research
allowance, etc.
Fully Exempt
Perquisites
Perquisites are emoluments received by an employee by virtue of holding the position and office
over and above his salary. They benefit the employee and are not just reimbursement of expenses.
These benefits are also in kind and can be valued. Perquisites can be again classified under three
heads:
Perquisites that are taxable for all employees: Some perquisites that are taxable for all employees
are:
The perquisites which are taxable are valued as per the rules laid down in the Income Tax Act.
Retirement Benefits
These benefits are provided either at the time of retirement or during the period of the service.
Each benefit has a different tax treatment. The various benefits are:
Pension
Pension is a reward for the services rendered by the employee> It is usually disbursed as a monthly
payment, but sometimes the employee may opt for a lump sum payment. The tax treatment
depends on the option chosen and on the category of employee.
Gratuity
Gratuity is a payment received in appreciation of past performance. It is received on retirement. It
is exempted upto a certain limit and also dependent on the type of employee.
Leave Salary
Privilege leave is accumulated in the account of the employee. The employee may avail of leave
or may opt for encashment of leave accumulated. This is permitted either during the tenure of
service or at the time of retirement. The tax treatment will depend on the option chosen and on the
category of employee.
Provident Fund
Contribution towards Provident fund is deducted on a monthly basis from the salary of the
employee. An equal amount is also contributed by the employer. At the time of retirement the
accumulated balance in the Provident fund account along with the interest is given to the employee.
The tax treatment of the proceeds depends on the type of provident fund maintained by the
employer.
Deductions allowed from Salary: The following deductions are made from the salary
income to reach the net salary income:
Standard Deduction: This deduction has been discontinued from Assessment year 2006-07
Entertainment Allowance: This is first included in the salary and then allowed as a
deduction to the State and Central Government employees. The deduction amount is the least of
Rs.5000/Entertainment allowance actually received
20% of basic salary
Professional Tax: Professional tax also known as tax on employment is first paid by the employer
and then allowed as a deduction from salary. It is allowed only in the year in which it is actually
paid.
Agreed-upon and regular compensation for employment that may be paid in any frequency but,
in common practice, is paid on monthly and not on hourly, daily, weekly, or piece-work basis
Salary is the remuneration received by or accruing to an individual, periodically, for service
rendered as a result of an express or implied contract. The actual receipt of salary in the previous
year is not material as far as its taxability is concerned. The existence of employer-employee
relationship is the sine-qua-non for taxing a particular receipt under the head salaries. For
instance, the salary received by a partner from his partnership firm carrying on a business is not
chargeable as Salaries but as Profits & Gains from Business or Profession. Similarly, salary
received by a person as MP or MLA is taxable as Income from other sources, but if a person
received salary as Minister of State/ Central Government, the same shall be charged to tax under
the head Salaries. Pension received by an assessed from his former employer is taxable as
Salaries whereas pension received on his death by members of his family (Family Pension) is
taxed as Income from other sources.
Salary Include
Section 17(1) of the Income tax Act gives an inclusive and not exhaustive definition of Salaries
including therein
Wages
Annuity or pension
Gratuity
Fees, Commission, perquisites or profits in lieu of salary
Advance of Salary
Amount transferred from unrecognized provident fund to recognized provident fund
Contribution of employer to a Recognised Provident Fund in excess of the prescribed limit
Leave Encashment
Compensation as a result of variation in Service contract etc.
Contribution made by the Central.
Exemption Allowances
Allowance is defined as a fixed quantity of money or other substance given regularly in addition
to salary for meeting specific requirements of the employees. As a general rule, all allowances are
to be included in the total income unless specifically exempted. Exemption in respect of following
allowances is allowable to the extent mentioned against each.
Type of Allowance
Amount exempt
Provided that expenditure on rent is actually incurred, exemption available shall be the
least of the following:
HRA received.
Rent paid less 10% of salary.
40% of Salary (50% in case of Mumbai, Chennai, Kolkata, and Delhi) Salary here means
Basic + Dearness Allowance, if dearness allowance is provided by the terms of
employment.
50% of the salary where residential house is situated at Bombay, Calcutta, Madras or Delhi
and 40% of the salary where residential house is situated at any other place.
House Rent Allowance actually received by the Employee in respect of the period during
which the residential accommodation is occupied by him during the year.
Amount of rent paid in excess of 10% of the salary. Besides the above, there are certain
other incomes also, which are totally exempt or exempt subject to fulfillment of certain
conditions.
The term salary includes Basic Pay, Dearness Allowance to the extent included in retirement
benefits and commission based on fixed percentage of turnover.
80GG The employee takes on rent, a house in the place of his work. Under this section deduction
is available to the employee for the rent paid by him subject to satisfaction of other conditions
specified therein.
Deduction to the least of the following is available to the assesse:
Total income for this purpose means Gross total Income (excluding Long term Capital gains) as
reduced by deductions under sections 80CCC to 80U except section 80GG.
Rent paid.
1. Rs. 60000
2. Rs. 50000
3. Rs. 75000
Particulars
Taxable
Income (Rs.)
-do-do-
Rent free
HRA of Rs.
accommodation 60000 is given
is provided by by employer
the employer
(leased)/ No
HRA
Rs. 60000 is
given as
special
allowance and
not as HRA.
440000
440000
80GG
deduction
claimed.
446000
440000
440000
450000
425000
456000
431000
Where the rent paid is equal to HRA, then one can choose between both rent free
accommodation and receiving HRA.
It is never beneficial to receive an amount as a special allowance and to claim 80GG
deduction. The deduction under 80GG (in normal cases) will always be less than exemption
under 10(13A) for HRA. Hence HRA is always beneficial than 80GG deduction.
Where rent paid is lesser than HRA it is beneficial to claim HRA than RFA. Though taxable
income is higher by Rs.10000, on receipt of HRA the employee will be better off by
Rs.7000 (Rs.10, 000/- tax on extra income i.e. Rs.3000).
Where rent paid is higher than HRA it is beneficial to claim rent free accommodation than
HRA, as the extra rent has to be borne by the employee in case of HRA, which will
definitely be higher than the tax impact on the difference in both incomes. Like in above
example, it is evident that though tax difference is Rs.4500 (Rs.15000*30%), the extra rent
works out to Rs.15000. Hence RFA is beneficial in such circumstances.
In all the above calculations it has been assumed that in case the employer leases the
accommodation, he does it so from a person not related to the employee. Keeping the above facts
in mind, an employee can exercise his option, if any.
RFA
An employer can provide a rent free accommodation (RFA). Such accommodation is treated as a
perquisite in case of all employees. The perquisite is valued as follows:
Where the accommodation is owned by the employer:
in case the accommodation is in a city having a population exceeding 400000 as per 1991
census:
The taxable perquisite shall be 10% of the salary
in any other case:
The taxable perquisite shall be 7.5% of the salary
Let us explain with the help of an example: Total outflow of the employer assumed to be INR
10000/-
Let us explain the observations arising from the above analysis with the help of a diagram
Total emoluments of the employee in both the cases will be INR 10000/-