Tax Series 1 – Tax treatment of Salaries

All income received as salary under employer-employee relationship is taxed under the head, “Salary”, on due or receipt basis, whichever arises earlier. Thus, for any income to be taxable under the head salary, the following primary conditions are required to be cumulatively satisfied:

  1. Salary income is chargeable to tax on “due basis” or “receipt basis” whichever is earlier.
  2. Existence of relationship of employer and employee is must between the payer and payee to tax the income under this head.

Consequently, employers must withhold tax compulsorily, if income exceeds minimum exemption limit, as Tax Deducted at Source (TDS), and provide their employees with a Form 16 which shows the tax deductions and net paid income.

Further, there are various types of salaries, such as advance salary, arrears of salary, bonus, fee or commission, etc. I would be discussing the taxability of the same in the foregoing paragraphs.

Tax treatment of “Advance Salary”

Advance salary received by an employee is taxed in the year of receipt. The rule behind this is the basis of taxability of salary, i.e., salary is taxed on due or receipt basis, whichever is earlier. However, an employee can claim relief under section 89 in respect of advance salary.

Illustration

In March, 2013, Ria received advance salary of Rs. 50,000 pertaining to the month of April, 2013. In which year, advance salary will be charged to tax?

Salary is taxed on due or receipt basis, whichever is earlier. Thus, advance salary of April, 2013 received in the year 2012-13, i.e., in March, 2013 will be taxed in the financial year 2012-13.

Tax treatment of “Arrears of salary”

Arrears of salary received by an employee are taxed in the year of receipt if the same were not taxed earlier on due basis. However, an employee can claim relief under section 89 in respect of arrears of salary.

Illustration

In March, 2013, Sagar received arrears of salary of Rs. 1,50,000 pertaining to the year 2011-12. The arrears were not taxed earlier on due basis. In which year, arrears will be charged to tax?

Arrears of salary received by an employee are taxed in the year of receipt if the same were not taxed earlier on due basis. In this case, the arrears of Rs. 1,50,000 were not charged to tax on due basis earlier and, hence, the same will be charged to tax in the year 2012-13.

Tax treatment of “Bonus”

Bonus received by an employee is charged to tax in the year of receipt. Relief under section 89 can be claimed in respect of arrears of bonus received during the year.

Illustration

Apart from regular salary, in March, 2013, Sudhir received bonus of Rs. 125,000. In this case, bonus will be charged to tax in which year?

Bonus received by an employee is charged to tax in the year of receipt. In this case, bonus is received in March, 2013 and, hence, will be charged to tax in the financial 2012-13.

Tax treatment of “Fees or Commission”

Fees or commission received by the employee from the employer are charged to tax as salary income. Commission will be taxed as salary income, irrespective of the fact that it is received as fixed monthly amount or is received as a percentage of any particular item like turnover achieved by the employee.

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Illustration

Kunal is working in XYZ Ltd. as Sales Manager. Apart from his routine pay of basic salary and various allowances amounting to Rs. 84,000 per month, the company also pays him commission @ 5% of the turnover achieved by him. During the year 2012-13 he had achieved sales of Rs. 1,00,00,000. Company paid him commission of Rs. 5,00,000. What will be the tax treatment of commission?

Fees or commission received by the employee from the employer are charged to tax as salary income. Commission will be taxed as salary income, irrespective of the fact that it is received as fixed monthly amount or is received as percentage of turnover. In this case, the commission of Rs. 5,00,000 (i.e. @ 5% of Rs. 1,00,00,000) will be charged to tax as salary income and it will be charged to tax during the previous year 2012-13.

Tax treatment of “Salary in lieu of Notice Period”

Salary in lieu of notice period is charged to tax on receipt basis, i.e., it is charged to tax in the year of receipt.

Illustration

In April, 2012, Kunal joined XYZ Ltd. As per the terms of employment, the company can remove him from job after giving a notice of one month. If the company wants to remove him by an immediate effect, then the company has to pay him one month’s salary. In June, 2012, the company removed him and paid him one month’s salary (Rs. 50,000) as salary in lieu of notice period. In this case, what will be the tax treatment of Rs. 50,000?

Salary in lieu of notice period is charged to tax on receipt basis, i.e., it is charged to tax in the year of receipt. In this case, Rs. 50,000 is received in June, 2012 and, hence, will be charged to tax in the previous year 2012-13.

Tax treatment of “Compensation received from the employer”

Compensation received from the employer in connection with modification of terms of employment will be charged to tax as salary income, i.e., profits in lieu of salary.

Illustration

Mr. Subodh is working in XYZ Ltd. as mechanical site head. He is deputed in morning shift on a monthly salary of Rs. 84,000. Due to change in the work schedule of the company, Mr. Subodh is deputed in the night shift. As per the terms of employment, if the shift of the employee is changed then he will be paid compensation of Rs. 1,00,000. In pursuance of this, Mr. Subodh received Rs. 1,00,000 on account of change in shift. What will be the tax treatment of Rs.1,00,000?

Compensation received from the employer in connection with modification of terms of employment will be charged to tax as salary income, i.e. profits in lieu of salary. Considering the same, Rs. 100,000 received on change in terms of service will be charged to tax and will be charged to tax under the head “salaries”.

  • Pay for extra work

If an employee receives any payment in respect of extra work done by him then the same is charged to tax under the head “Salaries”. In other words, remuneration received for extra work will be charged to tax as salary income.

Illustration

Sanya is working in XYZ Ltd. Her office hours are from 9:00 am to 6:00 pm. During the month of January, due to work pressure, she had to perform additional duties and for the same she was paid additional salary of Rs. 10,000. She is of the opinion that this additional amount is not paid to her on routine basis and hence, will not be charged to tax as salary income. What will be her tax treatment?

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If an employee receives any payment in respect of extra work done by her then the same is charged to tax under the head “salaries”. In other words, remuneration received for extra work will be charged to tax as salary income.

Tax treatment of “Salary received by a partner”

As discussed in the beginning of my blog, for taxing any income under the head “Salaries”, the relation of the payer and payee should be that of the employer and the employee. In case of a partnership firm, the partners are not the employees of the firm and, hence, salary received by the partners from the firm is not charged to tax under the head “Salaries”. Salary received by partner from the firm is charged to tax under the head “Profits and gains of business or profession”.

Illustration

Mr. Ram and Mr. Shyam are partners of XYZ Co. Apart from share of profit and interest on capital, they receive monthly salary of Rs. 84,000 from the firm. What will be the tax treatment of the salary received by the partners from the firm?

Salary received by partner from the firm is charged to tax under the head “Profits and gains of business or profession”.

Thus, salary received by Mr. Ram and Shyam will not be charged to tax as salary income but will be charged to tax as business income under the head “Profits and gains of business or profession”.

Illustration

Mr. Vipul is one of the partners in XYZ Co. Apart from share of profit and interest on capital, he receives monthly salary of Rs. 25,200 from the firm. He is also doing part time job at a monthly salary of Rs. 10,000. What will be the tax treatment of the salary received by him as the partner from the firm and salary from part time job?

Salary received by partner from the firm is charged to tax under the head “Profits and gains of business or profession”. Thus, salary received by Mr. Vipul from the firm will not be charged to tax as salary income but will be charged to tax as business income under the head “Profits and gains of business or profession”. In other words, salary of Rs. 25,200 will be taxed as business income of Mr. Vipul.

Salary of Rs. 10,000 received from part time job is received from a concern in which he is not a partner but an employee. Thus, in case of salary of Rs. 10,000 he is receiving the same as an employee and, hence, it will be charged to tax as salary income.

Tax treatment of “salary received by an Indian citizen deputed outside India”

Salary received by an Indian citizen deputed outside India by the Government is treated as income deemed to be accrued or arisen in India and will be taxed in India. However, in such a case allowance and perquisites will be exempt from tax.

Illustration

Mr. Ravi is an Indian citizen. He is deputed in Canada by the Indian Government. The details of his pay structure are as follows:

  • Basic salary: Rs. 84,000 per month.
  • Other allowances: Rs. 16,000 per month.
  • Value of various perquisites provided by the employer: Rs. 50,000
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What will be the tax treatment of above items?

Salary received by an Indian citizen deputed outside India by the Government is treated as income deemed to be accrued or arisen in India and will be taxed in India. However, in such a case allowance and perquisites will be exempt from tax. Thus, in the above case, salary received by Mr. Ravi from the Government of India will be treated as income deemed to have accrued or arisen in India. Thus, Rs. 84,000 (i.e., basic salary) will be treated as salary income in India and Rs. 16,000 (allowances) and Rs. 50,000 (value of perquisites) will be exempt from tax.

Illustration

Mr. Rahul is an Indian citizen. He is working as a general manager in the UK-based branch of an American company. He is deputed in UK since past 10 years and he has not visited India for 10 years. The details of his pay structure are as follows:

  • Basic salary: Rs. 84,000 per month.
  • Other allowances: Rs. 16,000 per month.
  • Value of various perquisites provided by the employer: Rs. 50,000

What will be the tax treatment of above items?

Salary received by an Indian citizen deputed outside India by the Government is treated as income deemed to have accrued or arisen in India and will be taxed in India. In the above case, Mr. Rahul is not deputed by the Government of India and, hence, salary earned by him will not be treated as income deemed to have accrued or arisen in India. He is non-resident and, hence, salary earned outside India will not be charged to tax in India.

Tax treatment of “salary foregone by the employee”

Salary is charged to tax on due or receipt basis whichever is earlier, hence, salary foregone by the employee is charged to tax on due basis, even though it is not received by him. In other words, salary foregone after its accrual is charged to tax, even though it is not received by the employee.

Illustration

Maneesha is working in XYZ Ltd. as branch manager at a monthly salary of Rs. 60,000. A sudden fire occurred in the plant of the company and in tune of heavy loss suffered by the company, Maneesha decided to forego one month’s salary. What will be the tax treatment?

Salary foregone after its accrual is charged to tax, even though it is not received by the employee. Thus, in this case one month’s salary foregone by Maneesha will be charged to tax, even though it is not received by her.

Tax treatment of “amount received before joining the job”

Any payment received by an employee from his present employer or former employer or prospective employer will be charged to tax under the head “Salaries” (as profits in lieu of salary). Hence, amount received from prospective employer will also be charged to tax under the head “Salaries”.

Illustration

Mr. Kapoor appeared for an interview of a multinational company and was selected. However, on request to the company he was allowed to join the job after one month. For securing his joining the company entered into an agreement with him and paid him Rs. 84,000 before joining. What will be the tax treatment of Rs. 84,000 received from prospective employer?

Amount received from prospective employer will also be charged to tax under the head “Salaries”. Thus, Rs. 84,000 received from prospective employer by Mr. Kapoor will be charged to tax under the head “Salaries”.

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