Salary Income Guide

Understand all aspects of salary income, deductions, allowances, tax free income, and remote work for a foreign company and exceptions

To understand the computation of Income under the head Salaries, the following important concepts must be understood.

This document covers

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

A Note on Employee Residence

A very common question to EZTax can I live in India and be an employee of a foreign company / business? It is important to understand that the employee and employer must be in the same tax jurisdiction to call him as an employee and earning "salary".

Giving money as "Salary" for an Indian resident by a foreign entity is not legal in India (unless it is extremely temporary).

Otherwise it is a different relationship like a freelancer / contractor. In such a case, part of export of services category one must take GST and invoice monthly etc. Take a consultation service from EZTax in case you are working remote for a foreign entity.

2. Basis of charge [Section 15]

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.
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.
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:

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.
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.

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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.

Examples:

If any income taxable under head Salaries is earned in India, it is deemed to accrue or arise in India.
If a person employed in India goes on leave outside the country and draws his salary for the leave period there, the leave salary shall be deemed to have been earned in India.
Important Example: If a person after having served in India, retires from service and settles outside India, then the pension drawn by him in the foreign country will be deemed to have been earned in India and will be treated as Indian Income.

Exceptions:

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. As per section 10(7), allowances and perquisites received by him in the foreign country from the Indian government are exempt from tax.

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.

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Important Note

Per Budget 2023, India is heading towards New Tax Regime where no deductions possible in conjunction with lower tax rates to have more take home salary and giving the opportunity for the taxpayer to spend based on his priorities rather a template of investments which he may not needed to have. The existing old tax regime would possibly be sunset in future as is uncommon among progressive nations in the world (OECD and beyond)

Use the above income tax calculator to know which tax regime is good for you? or take the tax consultation service from EZTax

6. Allowances

Payments in cash made by the employer to his employees usually at regular intervals, other than salary are known as allowances. In other words, it is defined as a fixed quantity of money given regularly in addition to salary for meeting specific requirements of the employees. From Income Tax point of view, there are 3 types of allowances which are as under:

Taxable allowances
Allowances exempt upto specified limits
Fully exempt allowances.

6a. Taxable Allowances :

Are those allowances which are fully taxable under Income tax act, 1961.While computing taxable salary whole amount is added into the salary. Following are the allowances which are fully taxable

Dearness Allowance and dearness pay
Fixed medical allowance
Tiffin allowance
Servant allowance
Non practicing allowance
Hill allowance
Warden/ Proctor allowance
Deputation allowance
Overtime allowance
Other allowances like City Compensatory allowance, 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.

1. Dearness Allowance :

This allowance is given to employees on account of high prices. Sometimes Dearness Allowance is given as Dearness pay. Normally these 2 words are synonyms, but in actual they have different treatment. Dearness Allowance is an allowance granted to the employees to compensate for the cost of inflation. However, when certain portion of the Dearness Allowance is converted into Dearness Pay, then the applicable allowance would get calculated on (Basic Pay + Dearness Pay).

For instance normally Dearness Allowance is calculated as a 0/0 of Basic Pay. In cases where there is Dearness Pay, then the Dearness Allowance would get calculated on (Basic Pay + Dearness Pay). To that extent the employee would get increased amount in absolute terms.

Such DP is also taken into account at the time of arriving at the pension benefits etc from doing private practice. This allowance is given to them to compensate this ban.

2. 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.

3. 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

6b. Allowances exempt upto the specified limits:

House rent allowance
Entertainment allowance
Special allowances for meeting certain expenditures

1. 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.

HRA is exempt to the extent of the minimum of following 3 amounts:

Actual Amount Received
Excess of Rent paid by the assessee over 10% of salary due to him for the relevant period,
50% of the salary if residential house is situated at Mumbai, Kolkata, Delhi, Chennai.
40% of the salary if residential house is situated at city other than above metropolitan cities.

2. 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

Amount Actual received
1/5th of the salary , where salary = Basic Salary
Rs. 5000

EPF is taxable if we withdrawn within 5 years.
EPF can be withdrawn only if he is unemployed for more than 2 months. However EPF can be withdrawn after 5 years for purchase of Site (for construction of house/flat) or for purchase/construction of house/flat.

3. Special allowances for meeting certain expenditures:

There are two types of special allowances under this category:

Special allowances for performance of official duties:
These allowances are exempt to the extent of actual amount received or the amount spent for the purpose of official duties, whichever is less. E.g. Travelling allowance, Daily allowance, Helper allowance, etc.
Allowances to meet personal expenses:-

There are many allowances covered under this category, but here I am explaining the provisions of few allowances which are as follows:

2.1 Children Education Allowance:

Exempt upto actual amount received per child or Rs.100 p.m. per child upto a maximum of 2 children, whichever is less.

2.2 Tribal Area Allowance:

Exempt upto actual amount received or Rs. 200 per month, whichever is less.

2.3 Transport Allowance:

It is exempt upto Rs.800 p.m. but in case of blind or orthopedically handicapped, it is exempt upto Rs. 1600 p.m. or or Rs. 19,200 per annum. In case of handicapped, blind, or deaf employees, the exemption limit is set @ Rs. 3,200 per month.

2.4 Allowance allowed to transport employees working in any transport system :

It covers Fixed Allowance given by employer to his employee working in any transport system, to meet his personal expenditure during his performance of duty and amount of exemption shall be 70% of such allowance or Rs.10,000 per month, whichever is less.