Salary Income Guide

This document covers

1. Employer and employee relationship
2. Basis of charge (section 15)
3. Place of accrual of salary (section 9(1))
4. Tax-free salary
5. Salary paid by foreign govt. / enterprises
6. Allowances

Now, let's get into a detailed analysis on each of these aspects.

1. Employer and employee relationship

Any Income can be taxed under the head "salaries" only if there is a relationship of an employer and employee between payer and payee. Any income would be deemed to be income from salary only if relation of employer and employee exist. Their relationship should be of master and servant. A master is a person who directs what is to be done and how it is to be done, and the servant is one who is required to conduct the work in manner prescribed by master.

Learn more on @ Income under Income Tax Act — Explained

2. Basis of charge [Section 15]

1. 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.
2. 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.
3. 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.

Important Points:

1. If 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.

2. Any salary, bonus, commission or remuneration due to or received by a partner of a firm from the firm shall not be regarded as salary for the purpose of this section. The same shall be taxable under the head Profits and gains of business and profession as per section 28 of Income Tax Act,1961.

3. Place of accrual of Salary [sec. 9(1) (ii)]

The Golden Rule is that salary will be deemed to accrue or arise at a place where services are rendered.

4. Tax-free salary

When the employee receives tax-free salary from his employer, it means employer himself pays the tax which is due on salary of such employee and for the purpose of computation of Income from Salaries under Income Tax act 1961, such amount will be added to his salary.

5. Salary paid by foreign government /enterprises

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

6. Allowances

• Allowances means the monetary payments made by the employer to employees for meeting personal expenditure or expenditure for the performance of duties.
• Allowances are taxable unless exempted
• From Income Tax point of view, Allowances are classified into below three categories
  
  • Taxable Allowances
  • Fully Exempt Allowances
  • Partially Exempt Allowances

6a. Taxable Allowances:

Taxable Allowances means the allowances which are fully taxable under old and new tax regime. Following are the allowances which are fully taxable under Old and New tax regimes

1. Dearness Allowance (dearness pay): This allowance is given to employees on account of high prices. Dearness Allowance is an allowance granted to the employees to compensate for the cost of inflation.
2. City Compensatory Allowance: This allowance is paid to employees who are posted in big cities. The idea is to compensate the high cost of living in cities like Delhi, Mumbai, Bangalore, and other metropolitan cities. However, it is a fully taxable allowance. i.e. the amount of this allowance will be taxed with the salary received.
3. Deputation allowance: When an employee is sent from his permanent place of service to some other place or institution or organization on deputation for a temporary period, this allowance is given to them.
4. Entertainment Allowance: This allowance is given to employees to meet the expenses towards hospitality in receiving customers etc. The deduction is allowed only to Government employees under Old tax regime
5. Fixed medical allowance
6. Tiffin allowance
7. Servant allowance
8. Non practicing allowance
9. Warden/ Proctor allowance
10. Overtime allowance
11. Other allowances like Telephone allowance, Holiday allowance, Special qualification allowance, etc.

All the above allowances can be understood by their names but yet there are some allowances, which needs an explanation.

6b. Fully exempted allowances:

Allowances which are fully exempted under Old Tax regime

The following allowances are only exempted under Old Tax Regime. However, the following allowances are taxable under New Tax Regime.

• Allowances to High Court or Supreme Court Judges: Any allowance paid to a judge of High Court and Supreme Court is exempted under Old Tax Regime.
• Allowances received from UNO: Salary and Allowances paid by UNO to its employees is exempted under Old Tax Regime
• Sumptuary Allowances: Sumptuary allowances given to judges of High court or supreme court is exempted under Old Tax Regime. Sumptuary allowance means allowance given to cover the cost of entertaining visitors and hosting special events.

Allowances which are fully exempted under Old Tax regime and New Tax Regime

The following allowances are exempted both under Old and New tax regime upto certain limits

• Allowances payable outside India: Allowances or perquisites paid outside India by the Government to a citizen of India for services rendered outside India are exempt from tax.

6c.Allowances which are partially exempt

Allowances which are partially exempt under Old Tax regime and fully taxable under New Tax Regime

Following allowances are partially exempted under Old Tax Regime. However the following allowances are not exempted under New Tax Regime.

• House Rent Allowance (HRA): HRA is given to meet the cost of a rented house taken by the employee for his stay. The Income Tax Act allows for deduction in respect of the HRA paid to employees. The exemption on HRA is covered under Section 10(13A) of the Income Tax Act and Rule 2A of Income Tax Rules.

Learn more from @ House Rent Allowance (HRA) Exemption - Explained

• Entertainment Allowance: It is an allowance given by an employer to his employee. It is first included in income from salary under section 15 and then deduction is allowed to a govt. employee under sec 16(ii).

  Least of the following amounts shall be deducted:

  • Amount Actual received
  • 1/5th of the salary , where salary = Basic Salary
  • Rs. 5000
• Any special compensatory allowance in the nature of special compensatory (Hilly areas) allowance or High Altitude Allowance or Uncongenial Climate Allowance or Snow Bound Area Allowance or Avalanche Allowance – Rs 800 or Rs 300 per month depending on specified locations and Rs 7000 per month in Siachen area of Jammu & Kashmir.
• Any special compensatory allowance in the nature of border area allowance or remote locality allowance or difficult area allowance or disturbed area allowance - Rs 1300 or Rs 1100 or Rs 1050 or Rs 750 or Rs 300 or Rs 200 per month depending on specified location.
• Special Compensatory Allowance for Tribal areas or scheduled areas or agency areas – Rs 200 per month
• Any allowance granted to an employee working in the transport system to meet his personal expenditure during his duty if such employee is not in receipt of daily allowance – 70% of such allowance upto a maximum of Rs 10000 per month
• Children Education Allowance- Rs 100 per month per child (Maximum – 2 children)
• Children Hostel Allowance - Rs 300 per month per child (Maximum-2 children)
• Compensatory Filed Area Allowance – Rs 2600 per month
• Compensatory Modified Field Area Allowance – Rs 1000 per month
• Counter Insurgency allowance given to the members of the armed forces operating in areas away from permanent locations – Rs 3900 per month
• Underground allowance (Who works in unnatural and uncongenial climate in underground mines) – Rs 800 per month
• High Altitude Allowance given to the members of armed forces operating in high altitude areas
  • 9000 ft to 15000 ft – Rs 1060 per month
  • Above 15000 ft – Rs 1600 per month
• Special compensatory highly active field area allowance granted to the members of armed forces – Rs 4200 per month
• Special Duty allowance granted to the members of armed forces in Andaman & Nicobar and Lakshadweep group of islands – Rs 3250 per month

Allowances which are partially exempt under Old and New Tax Regime

The following allowances are partially exempt under Old and New Tax Regime

• Travelling Allowance: Any allowances granted to meet the cost of travel on tour or on transfer. This includes any expenses in connection with the transfer, packing and transportation of personal effects on such transfer.
• Daily Allowance: Any allowance granted on tour or for the period of journey in connection with transfer to meet the ordinary daily charges incurred by an employee on account of absence from his normal place of duty
• Conveyance Allowance: Any allowance granted to meet the expenditure incurred on conveyance in performance of duties of an office.

In case of above, the actual allowance received or actual amount spent which ever is less is exempt