What is Salary?
Salary refers to a fixed and regular payment that is being paid by an employer to his/her employees usually on a monthly basis. This amount is paid by an employer to employee in lieu of employee’s work. The salary is often expressed as an annual sum and is mostly given to professionals and people doing white-collar jobs. This is the generic definition of salary. However, for the purpose of taxation, salary has been defined under Section 17(1) of the Income Tax Act, 1961.
Table of Content
- 1 What is Salary?
- 2 Definition of Salary Under Section 17(1) of the Income Tax Act, 1961
- 3 Types of Emoluments/Perquisites
- 4 Gratuity
- 5 Commutation of Pension
- 6 Leave Encashment
- 7 Retrenchment Compensation
- 8 Keyman Insurance Policy
- 9 Value of Leave Travel Concession
- 10 Valuation in Respect of Unfurnished Rent-free Accommodation
- 11 Provisions of Educational Facilities for an Employee’s Family
- 12 Interest-free Loan and Loan at Concessional Rate of Interest
- 13 Profits in Lieu of Salary
- 14 Medical Facilities Treated as Perquisite
- 15 Perquisite for Motor Cars
- 16 Deductions From Salary
- 17 Tax Treatment on Provident Funds
- 18 Computation of Income From Salaries
Definition of Salary Under Section 17(1) of the Income Tax Act, 1961
According to Section 17(1) of the Act, salary is defined to include:
- Annuity or pension
- Fees, commission, perquisites, profits in lieu of or in addition to salary or wages
- Advance of salary
- Leave encashment
- Annual accretion to the balance at the credit of an employee participating in a Recognised Provident Fund, i.e., RPF employer’s contribution in excess of 12% of salary and interest credited in excess of 9.5% p.a.
- Transferred balance in an RPF
- Contribution by the Central Government or any other employer to Employees Pension Account as referred to in Section 80CCD.
Types of Emoluments/Perquisites
Emoluments or perquisites can be described as any reward or some extra benefit linked to an office or position in addition to salary or wages which may be legally due by way of contract for services rendered. Perquisite is defined in Section 17(2) of the Income Tax Act, which includes the following:
- Value of rent-free/concessional rent accommodation provided by the employer to the assessee.
- Any sum paid by an employer in respect of an obligation which was actually payable by the assessee.
- Value of any benefit/amenity granted free or at concessional rates to specified employees, such as the director or any person who has substantial interest in the company.
- 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 rates to the assessee.
- The amount of any contribution to an approved superannuation fund by the employer in respect of the assessee to the extent it exceeds ₹1,50,000 is chargeable as perquisites.
- The value of any other fringe benefit or amenity as may be prescribed.
Gratuity refers to a payment that is made in appreciation of an employee’s past services rendered by him/her to the employer. Gratuity can be received by:
- the employee himself at the time of his retirement
- the legal heir of the employee in the event of death of the employee
Any amount of gratuity received at the time of retirement or death of the employee is taxable to the extent as shown is Table:
|Category||Taxable Value of Gratuity|
|Employee of Central Government or local authority or member of Civil Services – Section 10(10)(i)||Fully exempt|
|Employee covered under the Payment of Gratuity Act, 1972 – Section 10(10)(ii)||Least of the following is exempt from the amount of gratuity received:|
Gratuity actually received
15/26 × Last drawn salary × No. of completed years of service or part thereof in excess of 6 months
|Employee not covered under the Payment of Gratuity Act, 1972 – Section 10(10)(iii)||Least of the following is exempt from the amount of gratuity received:|
Gratuity actually received
15/30 × Average salary of last 10 months preceding retirement month × No. of completed years of service ignoring fractions
Commutation of Pension
Pension refers to a payment made by an employer to an employee on his or her retirement or death as a reward for past service. Pension is paid to an employee on a monthly basis. However, at the time of retirement, the employee may decide to receive a particular percentage of his/her monthly pensions for a particular period of time in a lump sum amount. This is called the commutation of pension. The pension can be commuted either fully or partly. Therefore, there are two categories of pension, namely commuted pension and uncommuted pension.
The treatment of these two kinds of pension is as shown in Table:
|Category||Taxable Value of Pension under Section 10(10A)|
|Uncommuted Pension||Fully taxable in the hands of both Government and Non-Government employees|
|Commuted Pension in case of Government employees||Fully exempt from tax|
|Commuted Pension in case of Non-Government employees||If the employee is in receipt of gratuity, following amount is exempt from the amount of commuted pension received:|
1 Commuted pension received 100%
3 % of commutation
If the employee is not in receipt of gratuity, following amount is exempt from the amount of commuted pension received:
1 Commuted pension received 100%
2 % of commutation
During the tenure of service of employees, the employees are entitled to various kinds of leaves. In case an employee has leaves to his/her credit for the given year, but he/she does not utilise some or all of those leaves, then the leaves may either be:
- Lapsed (due to non-use)
- Encashed each year
- Accumulated and encashed after retirement or death
Payment received in respect of encashment of unavailing leave forms part of salary subject to exemptions specified under Section 10(10AA) as shown in Table:
|Received during the tenure of service||Fully taxable|
|Received on retirement by a government employee||Fully exempt|
|Received on retirement by a non-government employee||Least of the following is exempt from the amount of leave salary received:|
Leave salary actually received
10 months’ salary based on average salary of the last 10 months preceding the retirement month
Leaves standing to the credit of employee × Average salary of the last 10 months preceding retirement month
Retrenchment is defined as forced laying off of employees in order to cut down the payroll. When an organisation decides to retrench certain workforce, the workmen are entitled to retrenchment compensation at the time of their retrenchment. Retrenchment compensation is governed by the provisions of the Industrial Disputes Act, 1947.
As per Section 10(10B), the retrenchment compensation shall be exempt from tax to the extent of minimum of the following limits:
- Actual amount received as retrenchment compensation
- 15 days’ average pay for every completed year of service or part thereof in excess of six months
Any compensation received by the employee in excess of the above-mentioned amount is taxable as salary.
Keyman Insurance Policy
A person whose service has a significant effect on the profitability of the company is known as a keyman. A key person could be an employee or the director of a company with technical background, experience, entrepreneurial vision and/or market image whose death will have a bearing on the profitability of the company. There can be more than one key person within the same company who possesses the requisite background, knowledge, experience, etc.
The purpose of keyman insurance is to indemnify or protect the company against financial loss upon the death of a key employee. The death of a key person creates a vacuum in the company which eventually leads to a setback in profitability. A keyman insurance policy is a life insurance policy taken by an employer on the life of the employee who is a key person in the company.
Three necessary constituents of a keyman insurance policy are as follows:
- Insurance so purchased is a life insurance policy.
- Insurance policy is taken by one (first) person on the life of another (second) person.
- The relationship between the first and second persons should be either that of an employer-employee or any other business relationship.
Value of Leave Travel Concession
Certain allowances paid by employers to employees are exempted in the hands of an employee subject to limits specified under the Act. Leave Travel Concession (LTC) is one of them. Section 10(5) specifies the amount of exemption which can be claimed/deducted by employees from the sums received from employers for travelling to any place in India.
The exemption is available for travel concessions received in the following cases:
- By employee on leave
- By employee after retirement from service
- By employee after termination of his service
The amount of exemption available in respect of LTC is summarised in Table:
|Journey Executed by||Amount of Exemption|
|Air||Exemption shall be equal to the amount not more than air economy fare of the National Carrier by the shortest route to the destination place|
|Any transport mode other than air where rail service is available||Exemption shall be equal to the amount not more than first-class air-conditioned rail fare by the shortest route to the destination place|
|Any transport mode other than||air where rail service is not available|
|A recognised public transport system exists|
A recognised public transport system does not exist
|Exemption shall be equal to the amount not more than first-class or deluxe-class fare of such transport by the shortest route to the destination place|
Exemption shall be equal to the amount not more than first-class air-conditioned rail fare by the shortest route to the destination place, assuming that the journey was executed by rail
This exemption is available to an employee for 2 trips in a block of 4 calendar years. However, he can carry forward LTC up to one trip which is not availed during the current block to the succeeding block. Moreover, the exemption in respect of LTC can be claimed by an assessee for expenditure spent by him on himself, spouse, two surviving children, brothers and sisters, parents and any other individual wholly dependent upon the assessee.
Valuation in Respect of Unfurnished Rent-free Accommodation
At times, some employers provide an additional perquisite to their employees in the form of rent-free or concessional accommodation for which the employee would have to incur charges. Such a perquisite is received and given in kind. However, it is taxable under the Income Tax Act, 1961.
Taxable value of rent-free residential accommodation is computed as discussed in Table:
|Category||Taxable Value of Rent-Free Accommodation|
|Government employee||License fee determined by Government rules|
|Non-Government employee||15% of salary (In the city having population more than 25lakhs as per 2001 census)|
10% of salary (In the city having population between 10 lakhs and 25 lakhs as per 2001 census)
7.5% of salary (In the city having population less than 10 lakhs as per 2001 census)
|Non-Government employee where the accommodation is taken on lease or rent by an employer||Actual charges paid or payable by the employer, or 24% of salary, whichever is lower|
|Any of the above cases||Taxable value as determined herewith|
Add: 10% cost per annum of furniture owned by an employer
Provisions of Educational Facilities for an Employee’s Family
Sometimes, employers provide free or concessional education facilities to any member or members of the employee’s household. The taxable value of this perquisite provided by an employer to an employee is as discussed in Table:
|Circumstance||Taxable value of benefit in the hands of an employee|
|If education facility is offered in an educational institution owned and maintained by the employer||Taxable value is the cost of such educational expenditure in a similar institution in the nearby location as reduced by any amount paid or recovered by an employee.|
|If education facility is offered in any other educational institution owing to the reason of employee being in employment of such employer||Taxable value is the amount of such educational expenditure incurred by the employer as reduced by any amount paid or recovered by an employee.|
However, no perquisite shall be taxable in the above cases if the value of education facility per child does not exceed ₹1,000 per month. In simple words, if the value of education facility offered by the employer is more than ₹1,000 per month, then the whole perquisite value is subject to tax.
Interest-free Loan and Loan at Concessional Rate of Interest
Employees (or any member of his/her household) may be provided interest-free loans or loans at concessional rates by his or her employer. Interest-free loans and concessional loans are taxable perquisites in the hands of all employees.
However, no tax would be charged if such loans are provided to an employee or any member of his/her household:
- where the amount of petty loans does not exceed ₹20,000.
- where the loan is for the purpose of medical treatment with respect to diseases specified in rule 3A, which include neurological diseases, cancer, AIDS, chronic renal failure and haemophilia (specified diseases).
Profits in Lieu of Salary
Profits in lieu of salary are referred to as payments that are received by an employee in lieu of or in addition to his or her salary or wages. These are mentioned under Section 17(3) of the Income Tax Act. These payments include:
- Terminal compensation
- Compensation for modification of the terms of employment
- Payment from an unrecognised provident fund or an unrecognised superannuation fund
- Payment under Keyman Insurance Policy
- Any amount received or due to be received before joining or after cessation of employment
Medical Facilities Treated as Perquisite
Fixed medical allowance is always fully taxable. However, medical facilities provided by an employer to an employee are taxable subject to certain specified limits under Provision to Section 17(2). Medical facilities are not regarded as a perquisite, and, hence, are not taxable (fully exempt from tax) if:
- Provided by an employer in respect of medical treatment of employee or any member of his family in a hospital owned and maintained by the employer.
- The value of medical facility is reimbursed by an employer to an employee in respect of medical treatment of employee or any member of his family in a central, state or any local hospital/a private hospital recommended by the Government.
- The value of specified medical facility for prescribed diseases reimbursed by an employer in respect of medical treatment of an employee or any member of his family in a hospital approved by the Chief Commissioner. Value of specified medical facility for prescribed diseases reimbursed by an employer in respect of medical treatment of an employee or any member of his family in a hospital approved by the Chief Commissioner.
- Any medical health insurance premium paid by an employer on behalf of an employee on the health of the employee or a member of his family under a scheme approved by the Central Government or IRDA.
Medical Treatment Outside India
Expenses incurred by an employer on the medical treatment of an employee or his/her family members outside India are also treated as tax-free perquisite in the following cases:
- Boarding and lodging expenses incurred on the medical treatment of the employee or any of his/her family members plus one attendant, outside India would be treated as tax-free perquisite to the extent permitted by the Reserve Bank of India.
- Treatment expenses are exempted from tax up to an extent permitted by the Reserve Bank of India.
- Travel expenses of the patient (employee or his/her family member) along with one attendant of patient shall be tax-free provided that the gross total income of the employee does not exceed ₹2,00,000 p.a. For gross total income greater than ₹2,00,000 p.a., these will be fully taxable.
Perquisite for Motor Cars
As prescribed under Rule 3(2) of the Income Tax Act, the motor car perquisite is taxable in the following manner:
- No perk value is to be added when a car is used for official purpose.
- The entire expense cost including the driver’s salary and depreciation of the motor car @10% will be added if the car is used by the employer for private purposes only.
- If the car is used partly for official purpose, the rate has been specified as per rules, and, hence, there is no role of estimation either from employer or from the assessing officer’s side.
On the other hand, the taxability of cars which have been used partly for official purposes and partly for personal purposes will be as follows:
- Small cars with engines below 1.6 litres of capacity will have a perquisite value of ₹1,800 a month.
- Cars with an engine above 1.6 litres of capacity will have a perquisite value of ₹2,400 a month, if expenses on maintenance and running are reimbursed by the employer.
- If a chauffeur is also provided by the employer, ₹900 per month should be added to the perquisite value
Certain specific documents to be maintained by the employer for cars used for official purpose are as follows:
- Complete details of the journey undertaken for official purpose including the date of journey, destination, mileage and the amount of expenditure incurred thereon
- A certificate that the expenditure was incurred wholly and exclusively for the performance of his official duty
Deductions From Salary
Section 16 of the Act is related to deductions from salaries. According to this section, the income chargeable under the head ‘Salaries’ shall be computed after making certain deductions from gross salary which are as follows:
- Section 16(ia) – Standard Deduction
- Section 16(ii) – Entertainment Allowance
- Section 16(iii) – Professional Tax
These deductions are explained in Table:
|Name of Deduction||Deductible Amount|
|Standard Deduction||A standard deduction of ₹50,000 or amount of gross salary, whichever is lower, is allowed to the employees.|
|Entertainment Allowance||Entertainment allowance received has to be first included in gross salary and, thereafter, deduction can be allowed to the least of the following:|
One-fifth of basic salary
Entertainment allowance received
Deduction in respect of entertainment allowance is available only in case of Government employees.
|Professional Tax||Any sum actually paid by the employee on account of tax on employment is allowed as a deduction. In case where professional tax is reimbursed or paid by an employer on behalf of an employee, such amount should be first included in gross salary as a perquisite and, thereafter, deduction can be allowed.|
Tax Treatment on Provident Funds
Provident Fund Scheme refers to a welfare scheme for employees, wherein a certain percentage of an employee’s salary is deducted each month as contribution towards the provident fund. The employer also contributes a certain percentage of the employee’s salary into the fund each month.
This amount is deposited or invested and the interest built up on investments is also credited to the provident fund account of the employees. The interest, thus, keeps getting accumulated every year and the final accumulated amount is given to the employee at the time of his/her retirement or death, provided that certain conditions are satisfied.
The taxability provisions of provident fund in the hands of employees are as discussed in Table:
|Particulars||Recognised Provident Fund||Unrecognised Provident Fund|
|Employer’s contribution||Taxable amount is amount of contribution in excess of 12% of salary||It is not taxable yearly at the time of contribution|
|Employee’s contribution||Eligible for claiming as deduction under Section 80C||Not eligible for claiming as deduction under Section 80C|
|Interest credited||Taxable amount is amount of interest in excess of 9.5% p.a.||It is not taxable yearly|
|Amount received on retirement, etc||Fully exempt only if:|
Employee has rendered service for a continuous period of 5 years or more with the employer, or
Employee has retired before rendering service for a continuous period of 5 years because of the reason of ill health or contraction or discontinuance of employer’s business or reasons beyond his control
|Employee’s contribution is exempt and interest credited thereon is taxable under the head ‘income from other sources’. Employer’s contribution and interest credited thereon are taxable as salary|
For Statutory Provident Fund or Public Provident Fund notified by the Central Government, employer’s contribution, interest credited, and amounts received on retirement, etc., are fully exempt. The employee’s contribution towards Statutory Provident Fund or Public Provident Fund is eligible for deduction under Section 80C.
Computation of Income From Salaries
For the purpose of calculating the amount of tax payable by an individual/entity to the Government of India, it is important to calculate the total income of each such individual/entity under different heads of income (whichever are applicable) after applying appropriate exemptions and after deducting the amounts as applicable. In this section, you will study how income from salaries is calculated.
Income from salary chargeable to tax is calculated as shown in Table:
|Add: Components of Salary||Amount (in ₹)||Amount (in ₹)|
|+ Dearness Allowance||xxx|
|+ Arrears of Salary||xxx|
– Exempted HRA
|+ LTA received|
– Exempted LTA
– Exempted Amount
|+ Other Allowances received|
– Exempted Amount
|+ Retrenchment Compensation/VRS|
– Exempted Amount
|+ Gratuity Received|
– Exempted Gratuity Amount
|+ Leave Encashment|
– Exempted Amount
– Exempted Pension Amount
|+ Employer’s Contribution to Salary in|
Excess of 12% of Salary of Employee
|+ Interest Credited to Provident Fund in|
Excess of Notified Amount
|Less: Deductions under Section 16||(xxx)|
|Professional Tax Paid||xxx||xxx|
|Income Chargeable under the head ‘Salaries’||xxx|
Let us now understand the calculation of income from salaries chargeable to tax by working out an illustration as follows:
Illustration 1: Calculate the amount of income chargeable to tax under the head ‘salaries’ of Mr Om Prakash for the Assessment Year 2021-2022 if you are given the following information:
- Basic salary received by Om Prakash for 8 months is ₹20,000 and for the remaining 4 months, it is ₹22,000.
- Om Prakash gets Dearness Allowance at the rate of 12% of basic salary.
- He also got a bonus amounting to 2.2 times the salary he received in the last month of the assessment year.
- His employer makes a contribution towards an RPF at the rate of 20%.
- Om Prakash’s company pays a premium of ₹5,000 towards a life insurance policy in his name. The insurance has been taken from state insurer, LIC.
- Om Prakash’s employer calculated the value of all taxable allowances as ₹10,000.
- Om Prakash’s employer calculated the value of rent-free accommodation as ₹25,000.
- Om Prakash spent ₹20,000 on his daughter’s hospitalisation and his employer reimbursed him the maximum allowable amount.
Solution: Salary of Om Prakash chargeable to tax can be calculated as shown:
|Particulars||Amount (in ₹)|
|Basic salary (20,000 × 8 + 22,000 × 4)||2,48,000|
|D.A. (12% of basic salary)||29,760|
|Bonus (2.2 × 22,000)||48,400|
|Employer’s contribution towards an RPF in excess of 12% [(20 – 12%) of Basic + D.A.]||22,220.80|
|Medical insurance premium||Exempted|
Rent-free accommodation – 25,000
|Less: Deductions under Section||16 50,000|
|Income from Salary Chargeable to Tax||3,33,380.80|
Medical reimbursement is not a perquisite if conditions prescribed under Proviso to Section 17(2) are met.