“Explore the complexities of Income Tax on Salary Income. From the employer-employee relationship to the nuances of salary accrual and chargeability, understand the intricacies of contracts and tax implications. Learn about allowances, exemptions, and deductions, ensuring comprehensive insight into salary-related tax matters. Stay informed and navigate the tax landscape with clarity.”

Employer employee relationship:

There must exist a relationship of employer employee between the payer & the Payee. It does not matter whether employee is a full time or Part time employee. The Act does not specifically define the term ’employee.’ However, various judicial pronouncements and interpretations have established certain criteria to determine whether a person is an employee or not. Some factors considered include the level of control and supervision exercised by the employer, the nature of work performed, the mode of payment, and the existence of a contract of service.

Place of accrual of salary income (Section 9)

It specifies certain types of income that are considered to be earned in India, regardless of the residential status of the recipient. Regarding the accrual of salary income, the Act considers the following scenarios:

Salary received in India: If an individual is working in India and receives salary for services rendered in India, the salary income is deemed to accrue or arise in India. It does not matter whether the employer is an Indian or foreign entity. Any salary received in India by an individual for services performed in India is taxable in India.

Salary received for services rendered outside India, where the services are in connection with an Indian project: If an individual, who is not a resident in India, receives salary for services rendered outside India, but such services are in connection with a project in India, then the salary income is deemed to accrue or arise in India. In this case, the salary income will be taxable in India.

Chargeability of salary income (Section 15)

Salary includes all payments, earnings, and allowances received by an employee from an employer. It comprises basic salary, dearness allowance (DA), house rent allowance (HRA), bonus, commission, perquisites, and any other payments received as a result of employment.

Contract of Service & Contract for service

Contract of Service (Employee-Employer Relationship):

A “Contract of Service” refers to an employment relationship where an individual provides services to an employer under the terms of a contract. In this arrangement, the individual is considered an employee of the employer, and the employer exercises control and supervision over the work performed.

The individual works under the direction and control of the employer.

The employer deducts taxes (TDS) from the employee’s salary and is responsible for depositing it with the government.

The employer provides various benefits to the employee, such as leaves, insurance, bonuses, etc.

The employer is liable for any acts or omissions of the employee while performing official duties.

Tax Implications for Contract of Service (Employee):

Salary income earned under a Contract of Service is taxable as “Income from Salaries” under the Income Tax Act.

Contract for Service (Independent Contractor Relationship):

A “Contract for Service” refers to a relationship where an individual provides services to another person or organization under a contract, but the individual is not an employee of the recipient of the services. In this arrangement, the individual is an independent contractor and is not under the direct control and supervision of the recipient of the services.

The individual provides services as per the terms of the contract but maintains independence and control over the manner in which the work is performed.

Salary Income

The recipient of the services does not deduct TDS from the payments made to the independent contractor.

The independent contractor is responsible for their own taxes and compliance with tax laws.

Tax Implications for Contract for Service (Independent Contractor):

Income earned under a Contract for Service is taxable under the head “Profits and Gains from Business or Profession.”

Advance salary & Advance Against salary

“Advance Salary” refers to the payment made by an employer to an employee before the regular salary due date. It is a partial payment of the salary that the employee will receive for the upcoming pay period. Employers may offer advance salary for various reasons, such as financial emergencies faced by the employee.

Tax Implications for Advance Salary:

Advance salary is considered a part of the employee’s taxable income in the financial year in which it is received, irrespective of the period for which it is given. Therefore, if an employee receives advance salary in a particular financial year, it will be added to the employee’s regular salary for that year and taxed accordingly.

“Advance Against Salary” refers to the amount advanced by an employer to an employee against the salary that will be due to the employee in the future. This type of advance is generally given to employees to meet urgent financial requirements. It is not an additional income but a temporary arrangement where the employee receives a part of their upcoming salary in advance.

Tax Implications for Advance Against Salary:

Advance against salary is not considered taxable income at the time of receiving the advance. It is treated as an adjustment or a temporary cash flow arrangement, and there is no tax liability for the employee when they receive the advance. The advance amount is adjusted against the employee’s salary in the future period, and the tax liability arises only when the actual salary is paid.

Foregoing of salary & surrender of salary

“Foregoing of Salary” refers to the act of an employee willingly giving up a part of their salary or emoluments due to them. This can be done for various reasons, such as contributing to a charitable cause, supporting the employer during financial difficulties, or for any other philanthropic purpose. When an employee voluntarily chooses to forgo a portion of their salary, it results in a reduced salary income.

Tax Implications for Foregoing of Salary:

The Income Tax Act treats the foregone salary as taxable income for the employee. Even though the employee chooses not to receive the salary, it is still considered part of their income for tax purposes. The employee is liable to pay taxes on the foregone amount as if they had received it. However, if the employee donates the foregone amount to eligible charitable institutions, they may be eligible to claim a deduction under Section 80G of the Income Tax Act for the amount donated, subject to specific conditions and limits.

“Surrender of Salary” refers to a situation where an employee voluntarily surrenders a portion of their salary back to the employer or the company they work for. This surrender could be for various reasons, such as supporting the company during financial difficulties or as part of cost-cutting measures. The surrendered amount is typically returned to the employer.

Tax Implications for Surrender of Salary:

In the case of surrender of salary, the employee does not receive the surrendered amount, and therefore, it is not treated as part of their taxable income. Since the employee does not receive the amount, there is no tax liability on the surrendered portion.

Profit in Lieu of salary [Section 17(3)]

Any payment made by an employer to an employee in addition to their regular salary or wages, such as bonuses, commission, or any other similar payments.

House rent allowance [Section 10 (13A) & Rule 2A

Eligibility for HRA Exemption:

To claim the HRA exemption, the employee must be living in a rented accommodation.

The rented accommodation must not be owned by the employee himself/herself or by their spouse, minor child, or any member of the HUF (Hindu Undivided Family) of which the employee is a member.

Exemption Calculation:

The HRA exemption is calculated as the minimum of the following three amounts:

  1. Actual HRA received from the employer.
  2. Rent paid by the employee for the accommodation, minus 10% of the salary.
  3. 50% of the salary for metro cities (i.e., Mumbai, Delhi, Kolkata, Chennai) or 40% of the salary for non-metro cities (i.e., other cities).

Definition of Salary for HRA Calculation:

For HRA exemption calculation, “salary” includes basic salary, dearness allowance (if provided as part of the salary), and any commission based on a fixed percentage of turnover achieved by the employee.

Proof of Rent Payment:

To claim the HRA exemption, the employee needs to provide evidence of rent paid, such as rent receipts or a rent agreement with the landlord.

Submission of PAN of Landlord:

If the annual rent paid by the employee exceeds Rs. 1 lakh, the employee needs to submit the Permanent Account Number (PAN) of the landlord to the employer to claim the HRA exemption.

Personal Allowance [Section 10(14) & Rule 2BB

Children education allowance Rs. 100 p.m. per child ( max 2 children)

Allowance paid for hostel facilities is exempt from tax upto Rs. 300 per month per child upto a maximum of 2 children.

Outstation Allowance: This is an allowance provided by roadways, railways, and airways in place of the daily allowance. The exemption applicable is 70% of the allowance or Rs. 10,000, whichever is lower.

Transport allowance under Section 10(14) of Income-tax Act,1961 read with rule 2BB of Income-tax rules can be either of the following: Allowance granted to an employee to meet his expenditure for the purpose of commuting between his place of residence and office/place of duty.

Tribal Area Allowance: This is a partially taxable allowance given to employees posted in tribal areas of Madhya Pradesh, Tamil Nadu, Uttar Pradesh, Karnataka, Tripura, Assam, West Bengal, Bihar and Orissa. In this case, tax exemption is allowed up to Rs. 200 per month.

Underground allowance to employees working in underground mines- INR 800 per month. INR 1,060 per month for an altitude of 9000 – 15000 feet. INR 1,600 per month for an altitude above 15000 feet.

Official Allowance [Section 10(14) & Rule 2BB

Daily allowance an employee receives is not taxable if these conditions are met: It is a special allowance granted solely for performing duties; Provided on tour and separate from the normal place of duty; and. Expenses were actually incurred.

Uniform Allowance: Any allowance, by whatever name called, granted to meet the expenditure incurred on the purchase or maintenance of uniform for wear during the performance of duties of an office or employment of profit.

Conveyance allowance exemption limit under Section 10 sub-section 14(ii) of the Income Tax Act (1961) and Rule 2BB of Income Tax rule is Rs. 1,600 per month which comes out to be Rs. 19,200 per year.

Helper Allowance (Partially Exempt Income): If the employer authorizes the employee to hire or appoint a helper to perform/help in official duties, the employee will receive a Helper Allowance.

Academic allowance: 10,000 and maximum exemption can be Rs. 10,000 or 70%, whichever is lower. Academic/Research Allowance: Academic/research allowance from employer can be claimed for tax exemption.

Travelling Allowance granted to an employee to meet his expenditure for the purpose of commuting between his place of residence and office/place of duty.

Foreign Allowance [Section 10(7)]

As per section 10(7), any allowances or perquisites paid or allowed as such outside India by the Government to a citizen of India for rendering service outside India is exempt from tax.

Benefits not available under section 115BAC :

Leave travel concession

House rent allowance

Personal allowance (other than transport)

Official allowance (other than daily, travelling & conveyance)

Standard Deduction

Entertainment allowance

Professional tax

Deduction from Gross Salary

Standard Deduction [Section 16(ia)]

The standard deduction under Section 16(ia) is also applicable for retired individuals having a pension income. As the pension is chargeable to tax under the head – Income from salary, the standard deduction of ₹50,000 on such pension income is allowable every financial year.

Entertainment Allowance [Section 16(ii)]

As per section 16(ii), Government employees can claim a deduction for entertainment allowance by considering the lowest from the following: 20% of an individual’s basic salary. Rs. 5,000.

Professional Tax [Section 16(iii)]

The deduction for employment tax is allowed by Section 16(iii) of the Income Tax Act. A taxpayer may deduct the sum paid on account of an employment tax or professional tax under section 16.

Arrears of Salary & Relief under Section 89

“Arrears of Salary” refers to the unpaid salary that was due to an employee in a previous financial year but was received in a subsequent year. Section 89 of the Income Tax Act provides relief to individuals who receive arrears of salary or any other sum in a lump sum. This relief is designed to prevent undue hardship due to the higher tax liability that may arise when arrears are received in a lump sum in a later year.

Computation of Relief: When an employee receives arrears of salary or any other sum in a lump sum, the income tax liability is computed for the total income (including the arrears) of the year in which the arrears are received. However, the tax payable on the arrears of the previous years is calculated separately based on the tax rates applicable in those years.

Calculation of Average Rate: To determine the relief under Section 89, the difference between the tax payable on the total income of the year in which arrears are received and the tax that would have been payable if the arrears had been taxed in the years to which they relate is computed. Then, the average rate of tax is calculated on the total income of the year in which arrears are received and the difference amount.

Form 10E: To claim relief under Section 89, the taxpayer needs to file Form 10E with the Income Tax Department. This form provides details of the arrears and the relief computation.

Perquisite Value of Accommodation Rule 3(1)

Rent free accommodation [Section 17(2)(i)] & Accommodation at concessional rates [Section 17(2)(ii)]

Accommodation provided by the Central Government or State Government: The value of perquisite is the license fee determined by the government for the accommodation, reduced by the rent actually paid by the employee. If the employer owns furniture in the accommodation, an additional 10% per annum of the furniture cost is added to the perquisite. If the furniture is hired from a third party, the actual hire charges paid, reduced by any employee contributions, are added to the perquisite.

Accommodation provided by any other employer:

(a) If the accommodation is owned by the employer, the perquisite value is:

15% of salary in cities with a population > 25 lakhs

10% of salary in cities with a population > 10 lakhs and ≤ 25 lakhs

7.5% of salary in other areas

These values are reduced by the rent paid by the employee. Similar to above, if the employer owns furniture, 10% per annum of the furniture cost is added, or if furniture is hired, the actual hire charges paid (reduced by employee contributions) are added to the perquisite.

(b) If the accommodation is taken on lease or rent by the employer, the perquisite value is the actual amount of lease rental paid by the employer or 15% of salary (whichever is lower), reduced by the rent paid by the employee. The same rules for adding furniture-related costs as mentioned above apply.

Accommodation provided by any employer in a hotel: The perquisite value is either 24% of salary paid or payable for the previous year or the actual charges paid to the hotel (whichever is lower), reduced by the rent paid by the employee. There will be no perquisite if the employee is provided with such accommodation for a total of fifteen days or less on transfer from one place to another.

If an employee retains accommodation at the old place after transfer to a new place, the lower valued accommodation is considered for the first 90 days, and after that, both accommodations’ perquisites are charged.

If an employee is on deputation from the Central or State Government to a different body or undertaking, the employer will be considered the body or undertaking, and the perquisite value is calculated accordingly.

The term “accommodation” includes houses, flats, farmhouses, hotels, motels, service apartments, guest houses, caravans, mobile homes, ships, or other floating structures.

The term “hotel” includes licensed accommodation like motels, service apartments, or guest houses.

Perquisite Taxable in case of specified employees Section 17 (2) (iii)]

When the employer provides perquisites in the form of facilities instead of discharging the employee’s monetary obligations, these perquisites are taxable only for specified employees.

The value of any benefit or amenity granted or provided free of cost or at a concessional rate, which has not been included in previous categories, will be taxable for specified employees. Examples of such services include provision of a sweeper, gardener, watchman, or personal attendant; use of gas, electricity, or water supplied by the employer; free or concessional tickets; use of a motor car; and free or concessional educational facilities.

The valuation of these perquisites should follow the discussion on the valuation of perquisites.

The term “specified employees” includes the following:

(i) Director employee: An employee who is also a director of a company, regardless of their full-time or part-time status, nominee status, or duration of directorship.

(ii) Employee with substantial interest: An employee who has a substantial interest in the company, defined as being a beneficial owner of equity shares carrying 20% or more of the voting power in the company. Beneficial ownership, rather than legal ownership, is considered.

(iii) Employee with income exceeding ₹50,000: An employee whose income chargeable under the head ‘salaries’ exceeds ₹50,000 (excluding the value of non-monetary benefits or amenities) and does not fall under the categories (i) and (ii) above.

Other Perquisite taxable under Section 17 (2)

 Section 17 (2)(iv)

Amount paid by an employer in respect of any obligation which otherwise would have been payable by the employee

Section 17 (2)(v)

Amount payable by an employer directly or indirectly to effect an assurance on the life of the assessee or to effect a contract for an annuity, other than payment made to RPF or approved superannuation fund or deposit-linked insurance fund established under the Coal Mines Provident Fund and Miscellaneous Provisions Act, 1948 or Employees’ Provident Fund and Miscellaneous Provisions Act, 1952.

Section 17 (2)(vi)

The value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer or former employer, free of cost or at concessional rate to the assesse.

Section 17 (2)(vii)

The amount or aggregate of amounts of any contribution made

-in a recognised provident fund

-in NPS referred to in section 80CCD(1)

-in an approved superannuation fund

by the employer to the account of the assessee, to the extent it exceeds Rs7,50,000.

Section 17 (2)(viia)

Any annual accretion by way of interest, dividend or any other amount of similar nature during the previous year to the balance at the credit of the recognized provident fund or NPS or approved superannuation fund to the extent it relates to the employer’s contribution in excess of Rs. 7,50,000.

Any Other Fringe Benefit [Section 17(2)(vii)]& Rule 3(7)

Rule 3(7)(i)

(a) Valuation of Benefit: The value of the benefit derived from the interest-free or concessional loan is determined as the interest computed at the rate charged per annum by the State Bank of India on loans for the same purpose, as of the 1st day of the relevant previous year. This value is calculated on the maximum outstanding monthly balance of the loan, reduced by any interest actually paid by the employee or any member of his household.

(b) Exemption for Medical Treatment: No value is charged for loans made available for medical treatment related to prescribed diseases (e.g., cancer, tuberculosis) or if the aggregate amount of such loans does not exceed Rs. 20,000.

(c) Exclusion of Medical Insurance Reimbursement: If the loan is provided for medical treatment as mentioned above, any portion of the loan that has been reimbursed to the employee under a medical insurance scheme is not eligible for the exemption.

Rule 3(7)(ii)

(a) Expenses Paid or Reimbursed: If the employer pays, bears, or reimburses the expenses for traveling, touring, accommodation, or any other related expenses for a holiday availed of by the employee or any member of his household (except for leave travel concession or assistance), the taxable value will be the actual expenditure incurred by the employer for that purpose.

(b) Non-Uniform Facilities: In cases where such facilities (e.g., holiday resorts, accommodations) are maintained by the employer but are not available uniformly to all employees, the taxable value will be determined based on the value at which similar facilities are offered to the public by other agencies.

(c) Expenses on Accompanying Family: If the employee is on an official tour, and expenses are incurred for any member of his household accompanying him, the amount of such expenditure shall also be considered as a fringe benefit or amenity.

(d) Vacation Extension: In situations where an official tour is extended as a vacation, the taxable value of the fringe benefit shall be limited to the expenses incurred during the extended period of stay or vacation. This value will be reduced by any amount paid or recovered from the employee for such benefit or amenity.

Rule 3(7)(iii)

(a) Valuation of Free Food and Non-Alcoholic Beverages: The taxable value of free food and non-alcoholic beverages provided by the employer to an employee is the actual expenditure incurred by the employer. However, this value shall be reduced by the amount, if any, paid or recovered from the employee for such benefit or amenity.

(b) Exceptions – Not Treated as Perquisites: The following scenarios are not considered as perquisites and are exempt from tax:

Free Food at Workplace: Free food and non-alcoholic beverages provided by the employer during working hours at the office or business premises are not treated as a perquisite. Similarly, if the employer provides paid vouchers that are non-transferable and can only be used at eating joints, the value of such vouchers is not a perquisite, as long as the value of each meal does not exceed fifty rupees.

Tea or Snacks during Working Hours: The provision of tea or snacks during working hours is not considered a perquisite.

Remote Area or Offshore Installation: Free food and non-alcoholic beverages provided during working hours in a remote area or an offshore installation are not treated as perquisites.

Rule 3(7)(iv)

(a) Valuation of Gifts: The taxable value of any gift, voucher, or token provided by the employer, or in lieu of which such a gift is received, is equal to the amount of the gift.

(b) Exemption for Low-Value Gifts: However, if the total value of all such gifts, vouchers, or tokens received by the employee or any member of his household during the previous year is below Rs. 5,000 in aggregate, the value of the perquisite shall be treated as ‘Nil.’ In other words, gifts below the threshold of Rs. 5,000 are not taxable.

Rule 3(7)(v)

(a) Valuation of Credit Card Expenses: The taxable value of credit card expenses, including membership fees and annual fees, incurred by the employee or any member of his household, which are charged to a credit card provided by the employer or paid for or reimbursed by the employer, is taken as the perquisite value. However, this value is reduced by the amount, if any, paid or recovered from the employee for such benefit or amenity.

(b) Exemption for Official Expenses: Credit card expenses incurred wholly and exclusively for official purposes are not treated as a perquisite if the following conditions are fulfilled:

(1) Complete Details: The employer maintains complete details regarding the expenditure, including the date and nature of the expenditure.

(2) Certificate from Employer: The employer provides a certificate stating that the expenses were incurred wholly and exclusively for the performance of official duties.

Rule 3(7)(vi)

Any expenditure incurred by the employer on club facilities for an employee or their household is considered a taxable perquisite, except for the initial fee paid for corporate club memberships. However, if the expenditure is entirely for business purposes and certain conditions are met, it may be exempted from being treated as a perquisite. Additionally, if health club and sports facilities are provided uniformly to all employees, they will not be considered a perquisite.

Rule 3(7)(vii)

The value of perquisite arising from the use of laptops and computers is treated as Nil, while for other movable assets, it is calculated as 10% per annum of the asset’s actual cost or the rent/charge paid by the employer. Any amount paid by the employee towards the asset’s use is subtracted from the taxable perquisite value.

Rule 3(7)(viii)

Computers and electronic items: The value of the perquisite is calculated based on the depreciated value of the asset. Depreciation is computed at a rate of 50% on the Written Down Value (WDV) for each completed year of usage.

Motor cars: The value of the perquisite is determined based on the depreciated value of the asset. Depreciation is computed at a rate of 20% on the Written Down Value (WDV) for each completed year of usage.

Any other asset: For movable assets other than computers, electronic items, and motor cars, the value of the perquisite is calculated based on the depreciated value of the asset. Depreciation is computed at a rate of 10% on the Straight Line Method (SLM) for each completed year of usage.

Rule 3(7)(ix)

The value of the benefit or amenity provided by the employer is reduced by any contribution made by the employee towards it. In other words, if the employee shares the cost of the benefit or amenity, the taxable value of the perquisite will be reduced by the amount contributed by the employee.

Medical Facilities Proviso to [Section 17(2)]

(I). Medical Facilities / Reimbursement in INDIA:

Medical facility provided by the employer in certain hospitals/clinics is NOT taxable:

Hospital owned/maintained by the employer.

Hospital of Central Government/State Government/local authority.

Private hospital recommended by the Government for the treatment of Government employees.

Specified medical facility in a hospital approved by the Chief Commissioner.

Health insurance premium paid or reimbursed by the employer is NOT taxable.

Other medical facility expenditures reimbursed by the employer in India are taxable.

(II). Medical Facilities Outside INDIA:

Expenditure incurred by the employer or reimbursement to the employee for medical treatment outside India is taxable, subject to certain conditions:

Medical treatment of the employee or any family member outside India.

Travel cost of the employee/family member and one attendant accompanying the patient.

Cost of stay abroad for medical treatment and stay cost of one attendant.

Conditions to be satisfied:

The expenditure shall be excluded from perquisites only to the extent permitted by the Reserve Bank of India.

The exclusion is applicable only if the employee’s gross total income, computed before including the expenditure on traveling, does not exceed Rs. 2,00,000.

Leave Travel Concession/Assistance Section 10(5) & Rule 2B

Leave Travel Allowance (LTA) or Leave Travel Concession (LTC) is a reimbursement provided by a business to its employees for domestic travel in India, covering the cost of public transportation like airfare, train, or bus. It is exempt from income tax under Section 10(5) and Rule 2B of the Income Tax Regulations, subject to specific conditions.

Eligibility:

Employees of any nationality (Indian or non-Indian) are eligible for this deduction under the Income Tax Act.

The trip must be within the current fiscal year and should be taken during the employee’s leave in any part of India.

The employee or their immediate family members (spouse, children, and dependent parents, siblings, etc.) must be on the trip to qualify for the exemption.

Dispensing LTA for eligible individuals:

The exemption applies only to actual travel expenses like airfare, train, or bus fare. Incidental costs like taxis, admissions, hotels, meals, etc., are not covered.

The LTA exemption is limited to two trips made during a consecutive four-year period.

Deduction:

The LTA concession should not exceed the actual cost of providing the concession.

The mode of travel should be the most direct and least expensive, following specific guidelines for air, train, or bus travel.

Taxability of withdrawals from Notified Pension Scheme

Withdrawal of funds from National Pension Scheme is taxable as it follows Exempt-Exempt-Taxed (EET) rule of taxation system. However, 40% of the maturity proceeds are exempt from the income tax.

Income Tax is not applicable on the balance that is reinvested in annuity plan. However, monthly pensions received out of the annuity will be subjected to income tax based on the individuals tax slab.

Taxability of Gratuity [Section 10(10)]

Gratuity is a voluntary payment made by an employer to appreciate an employee’s services and has become a common practice nowadays. The Payment of Gratuity Act, 1972, provides a statutory recognition of gratuity, and most employers have agreements to pay gratuity to their employees.

The tax treatment of gratuity depends on when it is received:

Gratuity received during service is fully taxable for all employees.

Gratuity received at the time of retirement/death:

i. For employees covered under the Payment of Gratuity Act, 1972:

The least of the following is exempt under Section 10(10)(ii):

Rs. 20 lakh

Actual gratuity received

15 days’ salary (based on last drawn salary) for every completed year of service or part thereof in excess of 6 months (considering 26 days in a month).

ii. For employees not covered under the Payment of Gratuity Act, 1972:

The least of the following is exempt under Section 10(10)(iii):

Rs. 20 lakh

Actual gratuity received

Half-month salary (based on the average of the last 10 months’ salary) for every completed year of service (fraction to be ignored).

Taxability of Leave Salary [Section 10(10AA)]

Section 10(10AA) of the income tax act provides an exemption in respect of the amount received by an employee as encashment of unutilized earned leave at the time of their retirement, whether due to superannuation or any other reason. This means that the amount received as leave encashment at the time of retirement is partially or fully exempt from income tax, depending on certain conditions and limits specified by the tax laws. The purpose of this exemption is to provide some tax relief to employees when they receive their accrued leave benefits at the time of retirement.

Taxability of Pension [Section 10(10A)] & [Section 17(1)]

A pension is a periodic payment made by the government or an employer to an employee in consideration of their past service, payable after their retirement. There are two types of pensions: uncommuted and commuted.

Uncommuted Pension: Uncommuted pension refers to the regular periodic pension received by retired employees. It is fully taxable for both government and non-government employees.

Commuted Pension: Commutation involves converting a part or the entire future pension into a lump sum amount that the employee receives immediately. The tax treatment of commuted pension is as follows:

Employees of Central Government, local authorities, Statutory Corporations, and members of Civil Services/Defence Services: The commuted pension is fully exempt under Section 10(10A)(i).

Other Employees:

If the employee is in receipt of gratuity, 1/3 of the commuted pension received divided by the commutation percentage multiplied by 100 is exempt under Section 10(10A)(ii)(a).

If the employee does not receive any gratuity, 1/2 of the commuted pension received divided by the commutation percentage multiplied by 100 is exempt under Section 10(10A)(ii)(b).

Taxability of Retrenchment compensation [Section 10(10B)]

Retrenchment compensation refers to the compensation paid under the Industrial Disputes Act, 1947, or any Act, Rule, Order, or Notification issued under any law. This compensation also includes amounts paid on transfer of employment under section 25F or the closing down of an undertaking under section 25FF of the Industrial Disputes Act, 1947.

While compensation on account of termination or modification in terms and conditions of employment is taxable as “profits in lieu of salary,” retrenchment compensation is exempt under section 10(10B) up to certain limits. The exemption is subject to the following conditions:

(a) The exempted amount should be calculated based on the provisions of section 25F of the Industrial Disputes Act, 1947. This is determined as 15 days’ average pay multiplied by completed years of service and part thereof in excess of 6 months.

OR

(b) The exemption can also be an amount not less than ₹5,00,000, as notified by the Central Government.

The employee can claim the exemption based on either of the above limits, and the lower amount will be considered for tax exemption purposes.

Taxability of VRS Compensation [Section 10(10C)]

Lump sum payments or other benefits received by an employee at the time of voluntary retirement are taxable as “profits in lieu of salary.” However, they are exempt from taxation under section 10(10C) subject to certain conditions:

Eligible Undertakings: Employees of various undertakings, including public sector companies, other companies, authorities established under Central/State Acts, local authorities, co-operative societies, universities, Indian Institutes of Technology, Institutes of Management specified by the Central Government, State Governments, and the Central Government are eligible for the exemption.

Exemption Limit: The maximum limit of exemption should not exceed ₹5 lakh.

Scheme Criteria: The voluntary retirement or separation schemes must be framed in accordance with prescribed guidelines and should include economic viability criteria.

Eligibility Criteria: Normally, the exemption is available to employees who have completed 10 years of service or are 40 years of age. However, this requirement is not applicable to employees of public sector companies under their voluntary separation schemes.

Maximum Amount Receivable: The amount receivable on account of voluntary retirement or separation should not exceed either three months’ salary for each completed year of service or the salary at the time of retirement multiplied by the balance months of service left before retirement or superannuation.

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