Arrears of Salary – Taxability & Relief under Section 89(1)

What is arrear of salary?

Arrears of salary refer to the outstanding salary of the previous period received during the current year. Arrears may be received due to a revision in the salary of an employee from a retrospective effect for the past year(s), disputed salary released later on by the employer, receipt of unpaid salary that was due in the past year(s) but was not charged to tax for any reason, or receipt of unquantified salary that was quantified in a later year.

Taxability of arrear salary

Arrears of salary shall be taxable in the year of receipt under Section 15(c) of the Income Tax Act, 1961 if the following two conditions are satisfied.

1. That the arrears of salary must have been received in the year; and

2. That the arrears so received were not charged to income-tax in any earlier year.

Section 15(c) extends its scope to include the cases described in the preceding part of the article.

Relief under section 89(1)

There has been a continuous rise in the rates of taxes year after year. Thus, it is clear that the arrears of salary, which increase the total income in a later year, attract a higher rate of tax merely because they were received late. Therefore, relief under section 89 of the Income Tax Act, 1961 is granted to the assessee in respect of such higher rate of taxes to relieve them from the hardship.

Assessee can take advantage of the provisions of section 89(1) whenever any arrear of salary is received from his employer and such sum is covered in the definition of salary as given in Section 17. These receipts are:

1. Salary received in arrear or in advance,

2. Arrear of Family pension received,

3. Compensation received in connection with termination of employment,

4. Premature withdrawal from Provident Fund

5. commuted value of pension

6. Receipt of gratuity

We will discuss the provisions of law to understand how to calculate the relief and claim it in the income tax return.

Calculation of tax relief (Quantification)

The employer paying arrears of salary must calculate relief under Section 89(1) and indicate such relief in Part B of Form 16. Let us discuss the steps involved in the calculation of relief under Section 89(1) that will be allowed as relief against arrears of salary.

Step 1 – The tax is to be first calculated on the total income, inclusive of arrear of salary, of the year in which the such arrear is received.

Step 2 – Tax is to be calculated on the total income excluding the arrear of salary, of the year in which the such arrear is received.

Step 3 – Now we need to calculate the difference of Step 1 and Step 2.

Step 4 – Tax is to be computed on the total income, including the arrear salary relating to the year in which such salary income is accrued.

Step 5 – Tax is to be calculated on the total income exclusive of such arrear salary relating to the previous year in which such salary income is accrued.

Step 6 – Difference of Step 4 and Step 5 is to be arrived.

Step 7 – The excess of tax computed at Step 3 over tax computed at Step 6 is the amount of relief available to the assessee under section 89(1).

In other words, no relief is available if tax computed at Step 3 is less than the tax computed at Step 6.

The same steps are equally followed where the arrear salary relates to more than one previous year.

Filing Form 10E

Employees receiving arrears can claim relief by invoking the provisions of Section 89(1) and filing Form 10E, which must be filed before filing an Income Tax Return. Assessee can file the form after logging into the income tax portal using their login credentials.

Let us understand the whole procedure for quantifying the amount of relief through an illustration.

Illustration: –

In the case of Mr. Ayansh, who turned 48 years on 28.3.2022, you are informed that the salary for the previous year 2022-23 is ₹10,42,000 (computed) and arrears of salary received is ₹ 4,50,000. Further, you are given the following details relating to the earlier years to which the arrears of salary received is attributable to:

Financial Year	Taxable salary (₹)	Arrears now received (₹)
2016-17	8,25,000	1,50,000
2017-18	8,75,000	1,25,000
2018-19	9,00,000	1,75,000

Compute the relief available under section 89 and the tax payable for the A.Y. 2022-23. Assume that Mr. Ayansh does not opt for section 115BAC.

Solution: –

Step 1: –Calculation of the tax on total income, including arrear salary, for the assessment year 2023–24 relevant to the previous year 2022–23 in which the arrear was received.

Particulars	₹
Current year salary (computed)	10,42,000
Add: Arrears of salary	4,50,000
Taxable Salary	14,92,000
Income-tax thereon	2,60,100
Add: Health & education cess @4%	10,404
Total payable	2,70,504

Step 2: – Calculation of the tax on total income, excluding the arrear of salary, for the assessment year 2023–24 relevant to the financial year 2022–23 in which the arrear was received.

Particulars	₹
Current year salary (computed)	10,42,000
Add: Arrears of salary	–
Taxable Salary	10,42,000
Income-tax thereon	1,25,100
Add: Health & education cess @4%	5,004
Total payable	1,30,104

Step 3: – Calculate difference between Step 1 & step 2.

Particulars	₹
Tax on income including arrears Less: Tax on income excluding arrears	2,70,504 1,30,104
Difference of Step 1 and Step 2	1,40,400

Step 4: – The computation of tax payable on total income, including arrears of salary if these were charged to tax in the respective assessment years in which they were earned.

Particulars	AY 2017-18 ₹	AY 2018-19 ₹	AY 2019-20 ₹
Taxable salary Add: Arrears of salary	8,25,000 1,50,000	8,75,000 1,25,000	9,00,000 1,75,000
Taxable salary	9,75,000	10,00,000	10,75,000
Tax on the above Add: Cess at applicable rate	1,20,000 3,600	1,12,500 3,375	1,35,000 5,400
Tax payable	1,23,600	1,15,875	1,40,400

Step 5: – Computation of tax payable on total income, excluding arrears of salary if not charged to tax in the respective assessment years in which these were earned.

Particulars	AY 2017-18 ₹	AY 2018-19 ₹	AY 2019-20 ₹
Taxable salary	8,25,000	8,75,000	9,00,000
Tax on the above Add: Cess at applicable rate	90,000 2,700	87,500 2,625	92,500 3,700
Tax payable	92,700	90,125	96,200

Step 6: – Difference between Step 4 and Step 5

Particulars	₹
Tax on total income including arrears (1,23,600 + 1,15,875 + 1,40,400)	3,79,875
Less: Tax on total income excluding arrears (92,700 + 90,125 + 96,200)	2,79,025
Difference of Step 4 and Step 5	1,00,850

Step 7: – Amount of relief will be Step 3 minus Step 6.

=   ₹1,40,400 – ₹1,00,850

=   ₹39,550

Calculation of tax payable after relief

Particulars	₹
Income-tax payable on total income including arrears of salary	2,70,504
Less : Relief under section 89 as computed above	39,550
Tax payable after claiming relief	2,30,954

Note: – Rates of Taxes:

Assessment Year	Tax rates applicable to a resident individual below the age of 60 years
	Slab rates of income-tax
	Slab	Rate
2017-18	Upto ₹2,50,000	Nil
	₹2,50,000 to 5,00,000	10%
	₹ 5,00,000 to 10,00,000	20%
	₹10,00,000 & above	30%
	Education Cess @2% and Secondary and Higher Education Cess @1% was attracted on the income tax for this assessment year.
2018-19	Upto ₹2,50,000	Nil
	₹2,50,000 to 5,00,000	5%
	₹5,00,000 to 10,00,000	20%
	₹10,00,000 & above	30%
	Education Cess @2% and Secondary and Higher Education Cess @1% was attracted on the income tax for this assessment year.
2019-20	Upto ₹2,50,000	Nil
	₹2,50,000 to 5,00,000	5%
	₹5,00,000 to 10,00,000	20%
	₹10,00,000 & above	30%
	Health cess@1%, education cess@2% and secondary and higher education cess @1% was attracted on the income-tax for this assessment year.