Salary

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Salary
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.

Fees, Commission and Bonus
Fees and bonus paid to the employee is part of taxable salary. Commissions paid to employees
maybe fixed or a percentage of turnover achieved by the employee. If commission is paid a s part
of percentage of turnover, the same is added to the basic salary for the purpose of computation of
retirement benefits.

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.

City Compensatory Allowance
This allowance is paid to employees who are transferred to big metros like Mumbai, Delhi, and
Chennai where the cost of living is higher than other cities.

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:

House Rent Allowance (HRA)
This allowance is paid to the employee to meet the rental expenses for residential accommodation
for self. If the employee lives in his own house, then the HRA is completely taxable. The
exemption amount of HRA for rental property is least of the following:




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.

Special Allowance to meet personal expenses
A fixed allowance is paid to the employee to meet his personal expenses. This allowance is fixed
and a reimbursement of the entire expenditure incurred. Eg: Children Education Allowance,
Children Hostel Allowance, etc.

Fully Exempt




Fully exempt allowances are as under:
Foreign Allowance
Allowances given to employees posted abroad for carrying out their professional duties are
completely exempt from tax






Allowance given to High Court and Supreme Court Judges
Allowances of any kind given to High Court and Supreme Court judges are completely
exempt from tax
Allowance given to UNO Employees
Allowances given to employees of United Nations Organisation are completely exempt
from tax.

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:






















Rent free accommodation
Concession in rent of accommodation
Interest free loans or subsidized loans
Movable assets or transfer of assets
Payment of club fees
Payment of educational expenses
Payment of insurance premium, on behalf of employees
Perquisites that are taxable only for specified employees
Specified employees are employees who are either directors in the organization or have
substantial interest in the organization or their salary was over Rs.50000/- in the previous
year:
Free gas, electricity, water supply for domestic purposes
Free or concessional educational expenses
Gardener, sweeper, attendant
Free or concessional transport facility
Any other benefit or amenity
Perquisites that are exempt from tax
Some perquisites are notified by the Income Tax Departmentwhere fringe benefit tax has
to be paid by the employer on the expenses incurred by them on the perquisites. These
fringe benefits are absolutely exempt from tax in the hand of the employee. These
include:
Medical Benefits
Leave Travel Concession
Health Insurance Premium
Car, laptop, computers for personal use



Staff Welfare Schemes

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

(i) Special Compensatory Allowance for hilly
areas or high altitude allowance or
climateallowance.

Rs.800 common for various areas of North East, Hilly
areas of UP, HP. & J&K and Rs. 7000 per month for
Siachen area of J&K and Rs.300 common for all places
at a height of 1000 mts or more other than the above
places.

(ii) Border area allowance or remote area allowance
or a difficult area allowance or disturbed area
allowance.

Various amounts ranging from Rs.200 per month
to Rs.1300 per month are exempt for various
areas specified in Rule 2BB.

(iii) Tribal area/Schedule area/Agency area
allowance available in MP, Assam, UP., Karnataka,
West Bengal, Bihar, Orissa, Tamilnadu, Tripura

Rs.200 per month.

(iv) Any allowance granted to an employee working
in any transport system to meet his personal
expenditure during duty performed in the course of
running of such transport from one place to another
place.

70% of such allowance upto a maximum of Rs.6000
per month.

(v) Children education allowance.

Rs.100 per month per child upto a maximum 2
children.

(vi) Allowance granted to meet hostel expenditure on
employee’s child.

Rs.300 per month per child upto a maximum two
children.

(vii) Compensatory field area
allowance available in various areas of
Arunachal Pradesh, Manipur Sikkim,
Nagaland, H.P., U.P. & J&K.

Rs.2600 per month.

(viii) Compensatory modified field area allowance
available in specified areas of Punjab, Rajsthan,
Haryana, U.P., J&K, HP., West Bengal & North
East.

Rs.1000 per month

(ix) Counter insurgency allowance to members of
Armed Forces.

Rs.3900 Per month

(x) Transport Allowance granted to an employee to
meet his expenditure for the purpose
of commuting between the place of residence &
duty.

Rs.800 per month.

(xi) Transport allowance granted to physically disabled
employee for the purpose of commuting
between place of duty and residence.

Rs.1600 per month.

(xii) Underground allowancegranted to an
employeeworking in under groundmines.

Rs.800 per month.

(xiii) Special allowance in thenature of high
altitudeallowance granted to members of the
armed forces.

Rs. 1060 p.m. (for altitude of 9000-15000 ft.)
Rs.1600 p.m. (for altitude above 15000 ft.)

(xiv) Any special allowancegranted to the
members of the armed forces in the nature of
special compensatory highly active field area
allowance

Rs. 4,200/- p.m.

(xv) Special allowance
granted to members of
armed forces in the
nature of island duty
allowance.
(in Andaman & Nicobar
& Lakshadweep Group
of Islands)

Rs. 3,250/- p.m.

House Rent Allowance

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.

Leave Travel Allowance
The amount actually incurred on performance of travel on leave to any
place in India by the shortest route to that place is exempt. This is subject to a maximum of the air
economy fare or AC 1st Class fare (if journey is performed by mode other than air) by such route,
provided that the exemption shall be available only in respect of two journeys performed in a block
of 4 calendar years. Certain allowances given by the employer to the employee are exempt u/s
10(14). All these exempt allowance are detailed in Rule 2BB of Income-tax Rules and are briefly
given below: For the purpose of Section 10(14) (i), following allowances are exempt, subject to
actual expenses incurred:







Allowance granted to meet cost of travel on tour or on transfer.
Allowance granted on tour or journey in connection with transfer to meet the daily charges
incurred by the employee.
Allowance granted to meet conveyance expenses incurred in performance of duty,
provided no free conveyance is provided.
Allowance granted to meet expenses incurred on a helper engaged for performance of
official duty.
Academic, research or training allowance granted in educational or research institutions.
Allowance granted to meet expenditure on purchase/ maintenance of uniform for
performance of official duty. Under Section 10(14) (ii), the following allowances have
been prescribed as exempt.

HOUSE RENT ALLOWANCE – SEC 10 (13A) READ WITH RULE 2A
When the employee is occupying a rented residential accommodation, the amount of house rent
allowance received by him is exempt to the extent of least of the following amounts:


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 least of the following is exempt:




Rent paid in excess of 10% of salary
50% of salary in case of metros or 40% in other cases.
Actual HRA received

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:




Excess of rent paid over 10% of total income
25% of total income
Rs.2000 per month.

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

The conclusions are as follows:



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

Where the accommodation is leased by the employer
The taxable perquisite shall be actual amount of lease rent incurred by the employer or 10% of the
salary whichever is lower. Hence generally in the case of major cities the taxability is restricted to
10% of the salary. In other cities it is restricted to 7.5%. The term ‘salary’ for this purpose shall
include all taxable allowances.

House Rent Allowance (HRA) Vs. Rent Free Accommodations (RFA)
If you are getting House Rent Allowances (H. R. A.) then there will tax savings. It is mainly
because of the method of Income Tax Acts & Rules employs for valuation of tax-ability of House
Rent Allowances (H. R. A.) and Rent Free Accommodation (R. F. A.). The main components /
differences between House Rent Allowances (H. R. A.) And Rent Free Accommodations (R. F.
A.) are explained here with the help of table given below

House Rental allowance(Section 10(13A) of
Income tax act, 1961 & Rule 2A of Income
Tax rules, 1962)
Salary for this purpose consists of following
components:
Basis Salary.
Dearness Allowance (Only the DA which
forms part of the salary).
Percentage bases commission.
In this whole H.R.A received is
taxable subject to the deduction ofleast of the
following :
H.R.A received
50% of salary
Rent Paid – 10% of salary
Please note if the rent
paid is zero,exemption will be zero and
wholeHRA received will become taxable.
Taxability under this is dependent upon the
following factors:
H.R.A received
Rent Paid by the employee for hiringthe
accommodation out of HRA received.
Salary Computed for this purpose.

Rent Free accommodation(Rule 3(1) of
Income Tax rules, 1962
Salary for this purpose consists of following
components:
Basis Salary.
Dearness Allowance (Only the DA which
forms part of the salary).
All allowance to the extent taxable.
Leave salary received during employment.
Bonus (on receipt basis)
Commission (both Percentage based as well
as fixed commission).
There is no separate exemption under
this,
least of the following is taxable (In
case accommodation ishired by the
employer) :
Hire charges
OR
15% of Salary
Taxability under this is dependent upon the
following factors:
Hire charges paid for the accommodation by
the employer.
Salary computed for this purpose.

Let us explain with the help of an example: Total outflow of the employer assumed to be INR
10000/-

House Rental Allowances
Basis salary = INR 5000/HRA = INR 2500/Other allowances
= INR 2500/Computation of Taxable HRA
HRA received
= INR 2500/Deduction will be least of the following:
50% of salary i.e. INR 2500/HRA received i.e. INR 2500/Rent Paid – 10% of salary i.e.
INR 2500 – INR 500 = INR 2000/(Please Refer Note-1)
The taxable HRA comes out to be INR 500/-

RENT FREE accommodation
Basis salary = INR 5000/RFA(Hire charges paid) = INR 2500/Other allowances
= INR 2500/Computation of Taxable RFA
Least of the following will be taxable:
15% of salary i.e. INR 1125/OR
Hire charges i.e. INR 2500/The taxable RFA comes out to be INR 1125/Income under the head salary = INR 8625/-

Income under the head salary = INR 8000/Note: 1
Rent Paid also assumed to be INR 2500/-.
In order to claim 100% deduction of the
HRA received, the employee needs to
pay Rent to
the extent of HRA received plus 10% of
salary.
This way the whole HRA received will be
exempt.

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/-

House Rental Allowances
In this case the Income taxable under the head
salary comes out to be INR 8000/-.
In this case amount of income which will be
avoided from being taxed, as compared to a
case of other alternative in which it would
have been taxed, will be to the extent of INR
625/-.
There will be a tax savings to the extent of INR
187.5/-.

RENT FREE accommodation
In this case the Income taxable under the head
salary comes out to be INR 8625/-.
In this case additional income which will be
taxed, as compared to a case of other
alternative in which it would have been saved,
will be to the extent of INR 625/-.
In this case there will be additional tax
implication to the extent of 187.5/-.

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