Summary: Income from Salary is the first and most common head of income under the Income-tax Act, governed by sections 15 to 17, and applies only where a clear employer–employee relationship exists. Payments lacking this relationship, such as remuneration to partners in a partnership firm, are taxed as business or professional income instead. Salary income broadly comprises basic salary, allowances, perquisites, and retirement benefits. Basic salary is a fixed contractual payment and is fully taxable with no deductions. Allowances are additional payments to meet personal or employment-related expenses and are classified as fully taxable, partly exempt, or fully exempt depending on their nature. Fully taxable allowances include dearness allowance, compensatory allowance, overtime allowance, bonus, and commission. Certain allowances like leave travel concession enjoy conditional exemption, limited to travel within India, specific family members, prescribed modes of travel, and restricted frequency. Any allowance received without meeting exemption conditions becomes fully taxable. In addition to allowances, taxable perquisites received by employees also form part of salary income.
Introduction
There are five heads of income under the Income-tax Act, 1961. Out of these, Income from Salaries is the first head of Gross Total Income, and the number of assessees earning income under this head is the highest.
The provisions relating to this head of income are covered under Sections 15 to 17 of the Act.
Basic Condition for Taxability under the Head “Salaries”
The fundamental condition for income to be taxed under the head “Salaries” is the existence of an employer–employee relationship. This means:
-
The person making the payment must be the employer, and
-
The person receiving the payment must be the employee.
Merely using the term salary is not sufficient. If the employer–employee relationship does not exist, the income cannot be taxed under this head.
For example, in the case of a partnership firm, remuneration paid to a working partner is not treated as salary. Such remuneration is taxable as Income from Business or Profession, as a partner is not an employee of the firm.
Components of Salary Income
Income from salary is generally divided into the following components:
a. Basic Salary
b. Allowances
c. Perquisites
d. Retirement Benefits
(a) Basic Salary
Basic salary is the fixed amount payable by the employer to the employee, usually on a monthly basis, as agreed at the time of entering into the employment contract.
It is an important component because many other salary elements are calculated as a percentage of basic salary.
-
Basic salary is fully taxable
-
No deduction is allowed from basic salary except those specifically permitted under the Act (such as deductions under Chapter VI-A).
(b) Allowances
Allowances are monetary payments made by the employer to the employee to meet certain personal or employment-related expenses. These are usually paid along with salary, and their tax treatment depends on their nature and purpose.
Classification of Allowances
Allowances are classified into:
-
Fully taxable allowances
-
Partly exempt allowances
-
Fully exempt allowances
Fully Taxable Allowances
The following allowances are fully taxable and are added to salary income:
Dearness Allowance (DA): This is an additional payment made to compensate for the high cost of living. It is commonly paid in the Government and public sector. The entire amount of DA is taxable under the head “Salaries”.
Compensatory Allowance / City Compensatory Allowance: This allowance is given to meet higher living expenses at the place of posting. It is fully taxable.
Overtime Allowance: Any amount paid to an employee for working beyond normal working hours is fully taxable.
Bonus and Commission:
Bonus and commission are treated as salary and are fully taxable in the following cases:
-
Bonus paid under a service agreement between employer and employee;
-
Bonus paid under the Payment of Bonus Act, 1965;
-
Bonus paid as per the decision of a trade association binding on its members;
-
Bonus paid pursuant to an award of a Labour Tribunal which is binding on both employer and employees.
Leave Travel Concession (LTC)
Leave Travel Concession is a salary component provided by employers to reimburse travel expenses incurred by employees.
Under Section 10(5) of the Act, LTC received by or due to an employee for himself and his family, in connection with travel during leave or on retirement, to any place in India, is exempt, subject to the following conditions:
-
Travel must be undertaken during leave sanctioned by the employer and within India only;
-
Exemption is available only for travel expenses. Expenses on hotel stay, food, shopping, etc., are not covered;
-
The exemption is available twice in a block of four calendar years;
-
“Family” includes the employee, spouse, children, and dependent parents, brothers, and sisters;
-
If the employee does not actually travel, the amount received as leave travel allowance is fully taxable;
-
Proof of travel, such as air, rail, or road tickets, must be maintained.
(c) Perquisites
Perquisites are non-cash benefits or amenities provided by the employer to the employee in addition to salary or wages. These benefits may be provided free of cost or at a concessional rate and are taxable under the head “Income from Salaries” as per Section 17(2) of the Income-tax Act, 1961.
Perquisites are generally provided to improve the standard of living of employees and may be either monetary or non-monetary in nature. However, purely monetary payments are normally treated as allowances, whereas non-monetary benefits are classified as perquisites.
Common Examples of Perquisites
Some common examples of perquisites include:
-
Rent-free or concessional accommodation
-
Motor car provided by the employer for personal or mixed use
-
Free or subsidised electricity, water, or gas
-
Free education for children in employer-run institutions
-
Interest-free or concessional loans
-
Payment of personal expenses by the employer
-
Free domestic servants such as a driver, sweeper, or gardener
Classification of Perquisites
For tax purposes, perquisites can broadly be classified into the following categories:
1. Taxable Perquisites for All Employees
These perquisites are taxable in the hands of all employees, irrespective of their salary level. Examples include:
-
Rent-free accommodation
-
Concessional accommodation
-
Motor car provided for personal use
-
Payment of personal obligations of the employee by the employer
The value of such perquisites is determined as per Rule 3 of the Income-tax Rules, 1962.
2. Perquisites Taxable Only for Specified Employees
Certain perquisites are taxable only in the hands of specified employees. A specified employee means:
-
A director of the company, or
-
An employee who has substantial interest in the company, or
-
An employee whose monetary salary exceeds the prescribed limit (excluding perquisites).
Examples include:
-
Free or concessional domestic servants
-
Free gas, electricity, or water supply
-
Free education to children
-
Interest-free or concessional loans
3. Exempt Perquisites
Some perquisites are fully exempt from tax, subject to prescribed conditions. Examples include:
-
Medical facilities provided in a government hospital or approved hospital
-
Health insurance premium paid by the employer
-
Use of employer-provided laptops or computers
-
Refreshments provided during working hours
-
Leave travel concession (subject to Section 10(5))
Valuation of Perquisites
The taxable value of perquisites is not arbitrary. It is determined strictly in accordance with Rule 3 of the Income-tax Rules, 1962, which lays down specific valuation methods for different types of perquisites.
Employers are required to compute the value correctly and include it in the employee’s Form 16, while employees must ensure that such perquisites are properly disclosed in their income-tax returns.
Author Bio
