Guide to Income under the Head Salaries and Its Computation

Table of Contents

1. What do you understand by expression “salary”

2. What is basis of charge of salary income

3. Different forms of salary – How taxed

4. Different types of allowances

5. Perquisites

6. Employee’s provident fund

7. Deduction under section 80C

8. Meaning of “salary” for different calculations

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Sections 15, 16 and 17 of the Act deal with the computation of income under the head “Salaries”. Apart from the study of these sections, one has to keep in view the provisions of sections 7, 9, 10, 80C, 89, etc., while arriving at the tax incidence of an employee. This Chapter deals with all such provisions of the Act as have a bearing on the computation of the total income of an employee.

1. What do you understand by expression “salary”

In order to understand the meaning of expression “salary”, one has to keep in mind the following norms:

1.1 Relationship between payer and payee

The relationship between payer and payee should be of an employer and employee. In other words, the amount received by an individual shall be treated as salary only if the relationship between payer and payee is of an employer and employee or master and servant. Employer may be an individual, firm, association of persons, company, corporation, Central Government, State Government, public body or a local authority. Likewise, employer may be operating in India or abroad. The employee may be a full-time employee or part-time employee.

A Member of Parliament or of State Legislature is not treated as an employee of the Government. Salary and allowances received by him are, therefore, not chargeable to tax under the head “Salaries” but are chargeable to tax under section 56 under the head “Income from other sources”.

1.2 Salary and wages – Conceptually not different

Conceptually there is no difference between salary and wages.

1.3 Salary from more than one source

If an individual receives salary from more than one employer during the same previous year (maybe due to change of employment or due to employment with more than one employer simultaneously), salary from each source is taxable under the head “Salaries”.

1.4 Salary from former employer, present employers or prospective employer

Remuneration received (or due) during the previous year is chargeable to tax under the head “Salaries” irrespective of the fact whether it is received from a former, present or prospective employer.

1.5 Foregoing of salary

Section 15 [see para 2 infra] taxes salary on “due” basis even if it is not received. If, therefore, an employ0ee foregoes his salary, it does not mean that salary so foregone is not taxable. Once salary has accrued to an employee its subsequent waiver does not make it exempt from tax liability. Such voluntary waiver or foregoing by an employee of salary due to him is merely an application of income and is nonetheless chargeable to tax.

1.6 Salary paid tax-free

If salary is paid tax-free by the employer, the employee has to include in his taxable income not only salary received but also amount of tax paid by the employer. It does not make any difference whether tax is paid under terms of contract by the employer or voluntarily.

1.7 Voluntary payments 

Salary, perquisite or allowance may be given as a gift to an employee, yet it would be taxable. The Act does not make any distinction between gratuitous payment and contractual payment.

1.8 Salary under section 17(1) 

Under section 17(1), salary is defined to include the following :

1. 1. wages ;
   2. any annuity or pension ;
   3. any gratuity ;
   4. any fees, commission, perquisites or profits in lieu of or in addition to any salary or wages;
   5. any advance of salary ;
   6. any payment received by an employee in respect of any period of leave not availed by him;
   7. the portion of the annual accretion in any previous year to the balance at the credit of an employee participating in a recognised provident fund to the extent it is taxable ;
   8. transferred balance in a recognised provident fund to the extent it is taxable; and
   9. the contribution made by the Central Government or any other employer to the account of an employee under a notified pension scheme referred to in section 80CCD.

2. What is basis of charge of salary income

The basis of charge is explained in the following paras—

• • Basis of charge as per section 15 – As per section 15, salary consists of :

1. 1. 1. any salary due from an employer (or a former employer) to an assessee in the previous year, whether actually paid or not;
      2. any salary paid or allowed to him in the previous year by or on behalf of an employer (or a former employer), though not due or before it became due; and
      3. any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer (or a former employer), if not charged to income-tax for any earlier previous year.

The same is explained in the table given below—

Nature of salary	Is it taxable as income of the previous year 2021-22
Salary becomes due during the previous year 2021-22 (whether paid during the same year or not)	Yes
Salary is received during the previous year 2021-22 (whether it becomes due in a subsequent year)	Yes
Arrears of salary received during the previous year 2021-22 although it pertains to one of the earlier years and the same were not taxed earlier on due basis	Yes
Arrears of salary received during the previous year 2021-22 although it pertains to one of the earlier years but the same were taxed earlier on due basis	No

• • Salary is taxable on “due” or “receipt” basis whichever is earlier – Basis of charge in respect of salary income is fixed by section 15. Salary is chargeable to tax either on “due” basis or on “receipt” basis, whichever matures earlier.
    For instance, if salary of 2022-23 is received in advance in 2021-22, it is included in the total income of the previous year 2021-22 on “receipt” basis (as tax incidence matures earlier on “receipt” basis, “due” basis is not relevant in this case; therefore, salary will not be included in total income of the previous year 2022-23). On the other hand, if salary which has become due in 2020-21 and received in 2021-22, is included in total income of the previous year 2020-21 on “due” basis (as incidence of tax matures earlier on “due” basis, “receipt” basis is inapplicable; salary will, therefore, not be included in total income of the previous year 2021-22).

• • Accounting method of the employee not relevant – It is worthwhile to mention that salary is chargeable to tax on “due” or “receipt” basis (whichever matures earlier) regardless of the fact whether books of account, in respect of salary income, are maintained by the assessee on mercantile basis or cash basis. Method of accounting cannot, therefore, vary the basis of charge fixed by section 15.

Problems

2-P1 X joins a company on June 1, 2021 on monthly salary of Rs. 30,000 (he was not in employment prior to June 1, 2021). As per the terms of employment, salary becomes due on the first day of the next month and is paid on the seventh day of the next month. Determine the amount of salary chargeable to tax for the assessment year 2022-23.

Solution: The period from June 1, 2021 to March 31, 2022 is the previous year for the assessment year 2022-23. Salary of the previous year shall be calculated as under—

Different months of the previous year	Due date of salary	Date of payment
June 2021	July 1, 2021	July 7, 2021
July 2021	August 1, 2021	August 7, 2021
August 2021	September 1, 2021	September 7, 2021
September 2021	October 1, 2021	October 7, 2021
October 2021	November 1, 2021	November 7, 2021
November 2021	December 1, 2021	December 7, 2021
December 2021	January 1, 2022	January 7, 2022
January 2022	February 1, 2022	February 7, 2022
February 2022	March 1, 2022	March 7, 2022
March 2022	April 1, 2022	April 7, 2022

Salary is taxable either on “due” basis or on “receipt” basis, whichever is earlier. As the earlier date is the “due” date of salary in the above case, salary will be taxable on due basis. The previous year ends on March 31, 2022. Consequently, salary of March 2022 (which becomes “due” after March 31, 2022) is not taxable as the income of the previous year ending March 31, 2022. Therefore, the salary taxable for the assessment year 2022-23 will be Rs. 2,70,000 (Rs. 30,000 per month for 9 months).

2-P2 X joins a company on December 1, 2018 in the pay scale of Rs. 10,000 – Rs. 1,000 – Rs. 25,000 (salary at the time of joining is fixed at Rs. 12,000). As per the terms of employment salary becomes “due” on the first day of the next month, and it is generally paid on the fifth day of the next month. Find out the salary (before standard deduction) taxable for the assessment year 2022-23.

Solution: In this case, X gets an annual increment of Rs. 1,000. The amount of salary for different years will be as follows —

	Rs.
December 2018 to November 2019	12,000
December 2019 to November 2020	13,000
December 2020 to November 2021	14,000
December 2021 to November 2022	15,000

Thus, Rs. 1,000 will be added to the salary every year till he reaches at the maximum point of Rs. 25,000. For the previous year 2021-22, salary will be taxable as follows—

Different months	Due date of salary [due or receipt date whichever is earlier]	Amount
March 2021	April 1, 2021	14,000
April 2021	May 1, 2021	14,000
May 2021	June 1, 2021	14,000
June 2021	July 1, 2021	14,000
July 2021	August 1, 2021	14,000
August 2021	September 1, 2021	14,000
September 2021	October 1, 2021	14,000
October 2021	November 1, 2021	14,000
November 2021	December 1, 2021	14,000
December 2021	January 1, 2022	15,000
January 2022	February 1, 2022	15,000
February 2022	March 1, 2022	15,000
March 2022	April 1, 2022	See Note
Total		1,71,000

Note: Salary of March 2022 is taxable on due basis on April 1, 2022. April 1, 2022 falls in the next previous year (i.e., 2022-23), it will be taxable for the assessment year 2023-24. However, salary of March 2021 (which becomes “due” on April 1, 2021) is taxable for the previous year 2021-22 (i.e., the assessment year 2022-23).

2-P3 Up till June 30, 2021, X is in the employment of A Ltd. on the fixed salary of Rs. 25,000 per month which becomes “due” on the first day of the next month. On July 1, 2021, X joins B Ltd. (salary being Rs. 30,000 per month which becomes “due” on the last day of each month). Salary is actually paid on the seventh day of the next month in both cases. Find out the amount of salary (before standard deduction) chargeable to tax for the assessment year 2022-23.

Solution: Computation of salary for the previous year 2021-22 :

	Different months	“Due” date or “receipt” date, whichever is earlier	Amount Rs.
1.	March 2021	April 1, 2021	25,000
2.	April 2021	May 1, 2021	25,000
3.	May 2021	June 1, 2021	25,000
4.	June 2021	July 1, 2021	25,000
5.	July 2021	July 31, 2021	30,000
6.	August 2021	August 31, 2021	30,000
7.	September 2021	September 30, 2021	30,000
8.	October 2021	October 31, 2021	30,000
9.	November 2021	November 30, 2021	30,000
10.	December 2021	December 31, 2021	30,000
11.	January 2022	January 31, 2022	30,000
12.	February 2022	February 28, 2022	30,000
13.	March 2022	March 31, 2022	30,000
	Total		3,70,000

2.1 Place of accrual of salary income [Sec. 9(1)] 

Income under the head “Salaries” is deemed to accrue or arise at the place where the service (in respect of which it accrues) is rendered. Keeping in view the aforesaid general observation, the rules are given below—

• • Under section 9(1)(ii), salary in respect of service rendered in India is deemed to accrue or arise in India even if it is paid outside India or it is paid or payable after the contract of employment in India comes to an end.
  • Pension paid abroad is deemed to accrue in India, if it is paid in respect of services rendered in India.
  • Likewise, leave salary paid abroad in respect of leave earned in India is deemed to accrue or arise in India.
  • Section 9(1)(iii), however, makes a departure from the aforesaid rule. By virtue of this section, salary paid by the Indian Government to an Indian national is deemed to accrue or arise in India, even if service is rendered outside India. Deeming provisions of section 9(1)(iii) are applicable only in respect of salary and not in respect of allowances and perquisites paid or allowed by the Government to Indian nationals working abroad, as such allowances and perquisites are exempt under section 10(7).
  • The provisions of section 9(1)(ii)/(iii) are summarized below (it is assumed that salary is paid at the place where service is rendered)—

	Who is employee	Who is employer	Where service is rendered	Is it taxable in India
				Salary	Allowance/ perquisite
Case 1	Indian citizen (resident or non- esident)	Government of India	Outside India	YES1	No2
Case 2	Non-resident (but not covered by case 1)	Any	Outside India	No	No
Case 3	Resident and ordinarily resident (but other than case 1)	Any	Anywhere	Yes	Yes

2.2 How to compute salary income

Salary income is calculated as under—

	Rs.	Rs.
Income from salary [see para 3]	………………
Income by way of allowances [see para 4]	………………
Taxable value of perquisites [see para 5]	………………
Gross salary		* * * * *
Less: Deduction under section 16
Standard deduction under [Sec. 16 (ia)]
Entertainment allowance deduction [Sec. 16 (ii)] [see para 4.3]	………………
Professional tax [Sec. 16 (iii)]	………………	* * * * *
Income under the head “Salaries”
Notes-		* * * * *
1. Standard deduction is Rs. 50,000 or gross salary, whichever is lower.		* * * * *
2. Professional tax is deductible on “payment basis”. If it is paid by the employer on behalf of the employee, it is first included in gross salary as perquisite and then deduction is allowed under section 16(iii).		* * * * *

3. Different forms of salary – How taxed

The term “salary” signifies a recompense or consideration given to any person for pains bestowed upon another person’s business.

Tax treatment of different receipts is given below –

Different receipts	Tax treatment
Basic salary	Taxable.
Dearness allowance/pay	Taxable.
Advance salary	Taxable in the year of receipt.
Arrears of salary	Taxable in the year of receipt, if not taxed on due basis earlier.
Leave encashment while in service	Taxable
Leave encashment at the time of retirement or at the time of leaving job.	Exempt in the hands of a Government employee*. In the case of a non- Government employee*, it is exempt in some cases [see para 3.1]
Salary in lieu of notice	Taxable
Salary to partner	Not chargeable under the head “Salaries” but taxable under the head “Profits and gains of business or profession”.
Fees and commission	Taxable.
Bonus	Taxable on receipt basis if not taxed earlier on due basis.
Gratuity	Exempt in the hands of a Government employee. In the case of a non-Government employee, it is exempt in some cases [see para 3.2]
Monthly pension (i.e., uncommuted pension)	Taxable
Lump sum payment of pension (i.e., commuted pension)	Exempt in the hands of a Government employee. In the case of a non- Government employee, it is exempt in some cases
Pension under National Pension Scheme (NPS)	At the time of receipt of pension it is chargeable to tax.
Annuity from employer	Taxable as salary.
Annual accretion to the credit balance in recognized provident fund	1. Excess of employer’s contribution over 12% of salary is taxable. 2. Excess of interest over notified interest is taxable (notified rate of interest is 9.5 per cent).
Retrenchment compensation	Exempt from tax to the extent of least† of the following: a. Amount calculated under section 25F(b) of the Industrial Disputes Act; or b. An amount specified by the Government (i.e., Rs. 5,00,000).
Remuneration for extra duties	Fully taxable.
Compensation received under voluntary retirement scheme (VRS)	Exempt in some cases
Profits in lieu of salary	Taxable
Salary from UNO	Not chargeable to tax.

The following are treated as Government employees (Govt.) or non-Government employees (N Govt.) –

For the purpose of taxation of different receipts	Central/State Government employees	Employees of local authorities	Employees of statutory corporations	Other employees
Leave encashment	Govt.	N Govt.	N Govt.	N Govt.
Gratuity	Govt.	Govt.	N Govt.	N Govt.
Commuted pension	Govt.	Govt.	Govt.	N Govt.

**Compensation is equivalent to 15 days’ “salary” for each year (or part thereof exceeding 6 months) of service. The mode of computation of “salary” and length of service for this purpose and for the purpose of gratuity (covered under the Payment of Gratuity Act) is same.

3.1 Leave salary 

The provisions regarding taxability of leave salary are given below—

3.1-1 What is leave salary

As per service rules, an employee gets different leaves. An employee has to earn leave in the first instance and only when he has leave to his credit, he can apply for leave. If a leave (standing to his credit) is not taken within a year, as per the service rules, it may lapse or it may be encashed or it may be accumulated. The accumulated leaves standing to the credit of an employee may be availed by the employee during his service time or, subject to service rules, such leaves may be encashed at the time of retirement or leaving the job. Encashment of leave by surrendering leave standing to one’s credit is known as “leave salary”.

3.1-2 Broad tax treatment

The broad tax treatment is given below—

Nature of leave encashment	Status of employee	Whether it is taxable
Leave encashment during continuity of employment	Government/non-Government employee	It is chargeable to tax. However, relief can be taken under section 89
Leave encashment at the time of retirement/leaving job	Government employee	It is fully exempt from tax under section 10(10AA)(i) [see para 3.1-3]
Leave encashment at the time of retirement/leaving job	Non-Government employee	It is fully or partly exempt from tax in some cases under section 10(10AA)(ii) [see para 3.1-4]

3.1-3 Government Employees getting leave encashment at the time of retirement [Sec. 10(10AA)(i)]†

In the case of a Central/State Government employee, any amount received as cash equivalent of leave salary in respect of period of earned leave at his credit at the time of his retirement (whether on superannuation or otherwise), is exempt from tax.

3.1-4 Non-Government Employees getting leave encashment at the time of retirement [Sec. 10(10AA)(ii)]†

In the case of a non-Government employee (including an employee of a local authority or public sector undertaking), leave salary is exempt from tax on the basis of least of the following—

1.	Period of earned leave (in number of months) to the credit of the employee at the time of his retirement or leaving the job [see Note 1] × Average monthly salary [see Note 2]
2.	10 × Average monthly salary
3.	The amount specified by the Government [i.e., Rs. 3,00,000 applicable from April 1, 1998; for earlier period this amount was different]
4.	Leave encashment actually received at the time of retirement.

Notes :

1. How to find out leave standing to the credit of an employee at the time of retirement or leaving the job –

It will be calculated as follows—

Step (a) – Find out duration of service in number of years (ignore any fraction of year).

Step (b) – Find out rate of earned leave entitlement from the service rules — how many days leave is credited for each year of service (earned leave entitlements cannot exceed 30 days for every year of actual service rendered for the employer from whose service he has retired). For instance, if earned leave is credited at the rate of 40 days leave for each year of service, for Step (b) calculation shall be made at the rate of 30 days leave for each year of service. If, however, earned leave is credited at the rate of 25 days leave for each year of service, for Step (b) calculation shall be made at the rate of 25 days leave for each year of service.

Step (c) – Find out earned leave actually taken or encashed (in number of days) during the service time.

The computation shall be made as follows—

[Step (a) × Step (b) minus Step (c)] ÷ 30

2. How to find out average monthly salary– Salary, for this purpose, means basic salary and includes dearness allowance if terms of employment so provide.* It also includes commission based upon fixed percentage of turnover achieved by an employee. “Average salary” for the aforesaid purpose is to be calculated on the basis of average salary drawn during the period of 10 months immediately preceding the retirement [seeproblem 41.1-P3].

• • When earned leave encashment is received from two or more employers – Where leave salary or leave encashment is received by a non-Government employee from two or more employers (may be in the same year or different years), the maximum amount of exemption under section 10(10AA)(ii) during the lifetime of the concerned employee cannot exceed Rs. 3,00,000.

3.1-5 Other Points

The following other points should also be kept in view :

• • Even if there is any voluntary retirement from service by way of resignation, the provisions of section 10(10AA) would apply.
  • Relief under section 89 would be admissible in respect of encashment of leave salary by an employee when in service.
  • Salary paid to the legal heirs of the deceased employee in respect of privilege leave standing to the credit of such employee at the time of his/her death is not taxable as salary.
  • Sum equivalent of leave salary received by the family of a Government servant who died in harness, is not taxable in the hands of recipient.

Problems

3.1-P1 X, an employee of the Himachal Pradesh Government, retires on January 3, 2022 and receives Rs. 11,60,000 as cash equivalent of earned leave to his credit. Is Rs. 11,60,000 fully exempt from tax?

Solution: Since X is a Government employee, leave salary of Rs. 11,60,000 is fully exempt from tax in view of section 10(10AA). Exemption under section 10(10AA) is available even if X opts for the alternative tax regime under section 115BAC.

3.1-P2 X was employed by PQR Ltd. up to March 15, 1988. At the time of leaving PQR Ltd., he was paid Rs. 3,50,000 as leave salary out of which Rs. 57,000 was exempt from tax under section 10(10AA)(ii). Thereafter he joined ABC (P.) Ltd. and received Rs. 4,12,200 as leave salary at the time of his retirement on December 31, 2021. Determine the amount of taxable leave salary from the following information :

Salary at the time of retirement (per month)	Rs. 22,900
Average salary received during 10 months ending on December 31, 2021
– From March 1, 2021 to July 31, 2021 (per month)	Rs. 22,600
– From August 1, 2021 to December 31, 2021 (per month)	Rs. 22,900
Duration of service (a)	14¾ years
Leave entitlement for every year of service (b)	45 days
Leave availed while in service (c)	90 days
Leave at the credit of employee at the time of retirement [(14 × 45 – 90) ÷ 30]	18 months
Leave salary paid at the time of retirement at the rate of Rs. 22,900 per month (i.e., Rs. 22,900 × 18)	Rs. 4,12,200

Solution: The amount of exemption under section 10(10AA) will be computed as under :

Step (a) – Length of service [14.75 years, rounded off]	14 years
Step (b) – Rate of leave entitlement [actual rate is 45 days for each year of service, it cannot exceed 30 days leave for each year of service]	30 days for each year
Step (c) – Leave availed while in service	90 days
Leave to the credit of the employee at the time of retirement [(14 × 30 – 90) ÷ 30]	11 months
	Rs.
Average monthly salary (for 10 months ending on December 31, 2021) [i.e., (Rs. 22,600 × 5 + Rs. 22,900 × 5) ÷ 10]	22,750
a. Period of earned leave to the credit of the employee at the time of retirement × Average monthly salary (i.e., Rs. 22,750 per month × 11 months)	2,50,250
b. 10 months × average monthly salary (i.e., Rs. 22,750 × 10)	2,27,500
c. Maximum amount not taxable [Rs. 3,00,000 less amount exempted earlier]	2,43,000
d. Amount received from the employer	4,12,200
Amount not taxable under section 10(10AA) [i.e., the least of (a), (b), (c) or (d)]	2,27,500
Amount taxable for the assessment year 2022-23	1,84,700

Notes :

1. While computing completed years of service, any fraction of the year shall be ignored.
2. If a non-Government employee is entitled to receive leave salary at a rate higher than 30 days’ salary for every completed year of service, the amount shown at (a) above has to be calculated with reference to 30 days’ salary for every completed year of service.
3. X can claim relief under section 89 in respect of Rs. 1,84,700.
4. The aforesaid exemption of Rs. 2,27,500 is available, even if X opts for the alternative tax regime under section 115BAC.

3.1-P3 X retires on March 16, 2022 from a private sector company. According to the service rule, he is entitled to 24 days leave for each year of completed service. The following information is available from the records of the employer-company —

Duration of service	32 years
Gross leave entitlement (32 yrs. × 24)	768 days
Less : Leave actually availed while in service	108 days
Balance	660 days
Less : Leave encashment taken during 2000-01	390 days
Balance	270 days
Less : Leave encashment paid on May 10, 2021 [@ Rs. 15,000 per month]	60 days
Leave standing to the credit of X at the time of retirement	210 days

Salary and dearness allowance paid to X prior to retirement are as follows—

	Basic salary per month Rs.	Dearness allowance per month [62 per cent is part of salary for determining retirement benefits] Rs.
January 1, 2021 to October 31, 2021	14,000	1,000
November 1, 2021 to March 16, 2022	15,000	1,250

Accordingly, he has been paid Rs. 1,13,750 (i.e., Rs. 16,250 × 210/30) at the time of retirement on March 16, 2022. Find out the amount of leave salary chargeable to tax for the assessment year 2022-23 taking into consideration the following points raised by X —

1. “Average salary” for the purpose of section 10(10AA) should be calculated on the basis of salary drawn during 10 months immediately preceding the retirement.
2. The word “month” has not been defined in the Act. As per section 3(35) of the General Clauses Act, 1897, “month” shall mean a month reckoned according to the British calendar. Consequently, in this case (according to X), average salary should be calculated on the basis of salary drawn during 10 months ending on February 28, 2022 (i.e., from May 1, 2021 to February 28, 2022).

Solution: The opinion of X, given in the problem, is not legally tenable because of the following reasons —

1. The General Clauses Act defines the word “month” as a month “reckoned” according to the British calendar.
2. The word “reckoned” according to the Shorter Oxford English Dictionarymeans “to count, to make calculation; to ascertain by counting”. For instance, the period commencing on April 24, 2021 and ending on May 23, 2021 is one month according to the British calendar. The definition of “month” as given in the General Clauses Act does not state that the word “month” always means a period commencing on the first day of the month and ending on the last day of the month.
3. Accordingly, if a person retires on March 16, 2022, “average salary” shall be determined on the basis of salary drawn during ten months ending on the date of retirement (i.e.,May 17, 2021 to March 16, 2022).

Computation of exemption

		Basic salary	62% of dearness allowance
		Rs.	Rs.
Salary from May 17, 2021 to October 31, 2021 (5 months and 14 days)		76,534	3,389
Salary from November 1, 2021 to March 16, 2022 (4 months and 16 days)		68,000	3,513
Total of ten months (Rs. 1,51,436)		1,44,534	6,902

 

	Rs.
Average monthly salary (Rs. 1,51,436/10)	15,143.60
a. Leave to the credit of X on the date of retirement × Average monthly salary (i.e., Rs. 15,143.60 × 210/30)	1,06,005
b. 10 months × salary (i.e., Rs. 15,143.60 × 10)	1,51,436
c. Amount notified by the Government	3,00,000
d. Amount received	1,13,750

Rs. 1,06,005 is the amount exempt from tax under section 10(10AA)† and the amount taxable for the assessment year 2022-23 is Rs. 7,745. Besides, Rs. 30,000, being the leave encashment taken on May 10, 2021, is taxable for the assessment year 2022-23. Therefore, the amount taxable for the assessment year 2022-23 is Rs. 37,745 which is subject to relief under section 89.

3.2 Gratuity [Sec. 10(10)]†

Gratuity is a retirement benefit. It is generally payable at the time of cessation of employment and on the basis of duration of service. Tax treatment of gratuity is given below :

Status of employee	Whether gratuity is taxable
Government employee	It is fully exempt from tax under section 10(10)(i)†
Non-Government employee covered by the Payment	It is fully or partly exempt from tax under section10(10)(ii)† of Gratuity Act, 1972 [see para 3.2-2]
Non-Government employee not covered by the Payment of Gratuity Act, 1972	It is fully or partly exempt from tax under section10(10)(iii)† [see para 3.2-3]

3.2-1 In the Case of Government Employees

Any death-cum-retirement gratuity received by Government employees (i.e., Central Government employees, State Government employees, employees of local authority but not employees of a statutory corporation) is wholly exempt from tax under section 10(10)(i)†.

Problems

3.2-1P1 X, an employee of the Central Government, receives Rs. 7,86,000 as gratuity at the time of his retirement on September 30, 2021. Is gratuity fully exempt from tax?

Solution: Gratuity received by him will be fully exempt from tax under section 10(10)(i)†.

3.2-2 In the case of employees covered by the payment of gratuity act, 1972 [Sec. 10(1)(ii)]† – Any gratuity received by an employee, covered by the Payment of Gratuity Act, 1972**, is exempt from tax on the following basis—

1.	15 days’ salary (7 days’ salary in the case of employees of a seasonal establishment) based on salary last drawn for each year of service (i.e., 15 days’ salary × Length of service).
2.	Rs. 20,00,000†.
3.	Gratuity actually received.

• What is exempt from tax – The least of the above three is exempt from tax. Gratuity in excess of the aforesaid limits is taxable in the hands of the assessee. However, the assessee can claim relief under section 89.
• How to find out length of service – If the period of service is 6 months or less than 6 months, it shall be ignored for this purpose. Conversely, if the period of the service is more than 6 months, it shall be taken as one full year. Consider the following cases—

	The difference between date of retirement and date of joining	Length of service for the purpose of section 10(10)(ii)
Case 1	26 years, 5 months and 29 days	26 years
Case 2	26 years and 6 months	26 years
Case 3	26 years, 6 months and 1 day	27 years
Case 4	26 years, 11 months and 29 days	27 years

• What is salary – “Salary” for the purpose of the aforesaid limits means salary last drawn by an employee and includes dearness allowance but does not include any bonus, commission, house rent allowance, overtime wages and any other allowance.
• How to determine 15 days’ salary – Salary of 15 days is calculated by dividing salary last drawn by 26, i.e., maximum number of working days in a month. For instance, if monthly salary at the time of retirement is Rs. 2,500, 15 days’ salary would come to Rs. 1,442.31 [i.e., Rs. 2,500 × 15÷26].
• How to determine 15 days’ salary for each year of service in the case of a piece-rated employee – In the case of a piece-rated employee, daily wages shall be computed on the average of the total wages received by him for a period of three months immediately preceding the retirement. For this purpose, the wages paid for any overtime work shall not be taken into account.

For instance, X is a piece-rated employee. He retires on June 20, 2022. During the period March 21, 2022 to June 20, 2022, he has been paid total wages of Rs. 32,780 which includes overtime payment of Rs. 8,200. 15 days’ salary shall be determined as follows—

	Rs.
Wages of 3 months ending on the date of retirement	32,780
Less: Payment for overtime	8,200
Balance	24,580
One month’s salary (1/3 of Rs. 24,580)	8,193
15 days’ salary (15/26 of Rs. 8,193)	4,727

Problems

3.2-2P1 X, an employee of PQ Co. Ltd., receives Rs. 78,000 as gratuity. He is covered by the Payment of Gratuity Act, 1972. He retires on December 12, 2021 after rendering service of 38 years and 8 months. At the time of retirement his monthly basic salary and dearness allowance was Rs. 2,400 and Rs. 800, respectively. Is the entire amount of gratuity exempt from tax ?

Solution: In this case, 39 years will be taken as completed years of service. 15 days’ salary is Rs. 1,846.15 (i.e., Rs. 3,200 × 15÷26, being the number of working days in a month).

Out of Rs. 78,000 received as gratuity, the least of the following will be exempt from tax :

(a) Rs. 72,000 (being 15 days’ salary for each completed year of service, i.e.,Rs. 1,846.15 × 39) ;
(b) Rs. 20,00,000 ; or
(c) Rs. 78,000 (being gratuity actually received).

Hence Rs. 72,000 is exempt from tax under section 10(10)(ii) and the balance of Rs. 6,000 is taxable for the assessment year 2022-23 which is subject to relief under section 89. Exemption of Rs. 72,000 is available even if X opts for the alternative tax regime under section 115BAC.

4. Different types of allowances

4.1 City compensatory allowance

Fully taxable under section 15.

4.2 House rent allowance

Exempt from tax to the extent of the least of the following:

a. 50% of salary in Delhi, Bombay, Calcutta, Madras or 40% of salary in other cases;
b. house rent allowance ; or
c. the excess of rent paid over 10% of salary.

4.3 Entertainment allowance

This allowance is first included in salary and thereafter a deduction is allowed. In the case of Government employees, least of the following is deductible:

a. Rs. 5,000;
b. 20% of salary; or
c. entertainment allowance.

4.4 Children education allowance in India

It is exempt from tax to the extent it does not exceed Rs. 100 per month per child for a maximum of two children (actual expenditure is not taken into consideration).
Hostel expenditure allowance in India It is exempt from tax to the extent it does not exceed Rs. 300 per month per child for a maximum of two children (actual expenditure is not taken into consideration). Exemption is in addition to the exemption available in the case of children education allowance.

4.5 Transport allowance

It is given to an employee to meet his expenditure for the purpose of commuting between office and residence. It is exempt up Rs. 3,200 per month in the case of an employee who is blind or dumb and deaf or orthopaedically handicapped.

4.6 Allowance for transport employee

It is given to employees of transport undertaking to meet their personal expenditure during duty performed in the course of running of such transport from one place to another place. The amount is exempt to the extent it does not exceed

(a) 70 per cent of the allowance or

(b) Rs. 10,000 per month, whichever is lower (actual expenditure is not taken into consideration).

4.7 Tribal area allowance

Exempt up to Rs. 200 per month in some cases

4.8 Travelling allowance, conveyance allowance

These allowances are given to meet specific expenditure in performance of duties of an office. Exemption is available to the extent the amount is utilized for the specific purpose for which the allowance is given.

4.9 Helper allowance, research allowance, uniform allowance

These allowances are given to meet specific expenditure in performance of duties of an office. Exemption is available to the extent the amount is utilized for the specific purpose for which the allowance is given.

4.10 Transfer allowance

It is exempt from tax to the extent expenditure is incurred in connection with transfer, packing and transportation of personal effects on transfer from one place to another place.

4.11 Foreign allowance

Exempt from tax if paid outside India by the Government to an Indian citizen for rendering service outside India.

4.12 Tiffin allowance

Taxable.

4.13 Fixed medical allowance

Taxable.

4.14 Allowance received by a teacher/researcher from a SAARC member State

Not taxable up to 2 years.

4.15 Sumptuary allowance to High Court/Supreme Court Judge, Chief Election Commissioner or other Election Commissioner

Not taxable

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5. Perquisites

5.1 Rent-free unfurnished house

1. In the case of Government employee (i.e., Central Government employee, State Government employee or a Government employee on deputation to a public sector undertaking if house is allotted by the Government): Taxable value is the license fees of the house as per house allotment scheme of the Government.

2. In the case of non-Government employees:

• • If the house is owned by employer: Taxable value is 15 per cent of salary of employee of the relevant period (7.5 per cent if population is 10 lakh or less or 10 per cent if population is above 10 lakh but not more than 25 lakh).
  • If the house is taken on lease by employer: Taxable value is either 15 per cent of the salary or lease rent, whichever is lower.

5.2 Rent-free furnished house

Value of “furniture” will be added to the value of rent-free unfurnished house as computed above. Value of furniture is 10 per cent per annum of cost of furniture to the employer or rent paid/payable of the furniture by the employer, as the case may be.

5.3 Concession in rent

Value of the perquisite in respect of rent-free furnished/unfurnished house will be calculated as given above. From the amount so calculated, rent charged by employer shall be deducted. The balance (if it is positive) is taxable value of the perquisite in respect of concession in rent.

5.4 Rent-free/ concessional furnished/ unfurnished house in special cases

• • Not chargeable to tax if provided in a “remote area”.
  • Hotel accommodation/guest house accommodation provided to an employee is taxable at the rate of 24 per cent of salary of the relevant period or hotel tariff, whichever is lower.
  • Hotel accommodation for 15 days (in aggregate in a previous year) can be provided immediately after transfer at the new location as a tax-free perquisite. Further, if an employee is transferred and housing facility is provided to him at the new location (he has yet to vacate a house given at the old location), for a period of 90 days immediately after transfer only one house (at the option of the employee at the old location or new location) is chargeable to tax.
  • Rent-free house is not taxable if it is provided to a High Court Judge, Supreme Court Judge, Union Minister, Chief Election Commissioner/other Election Commissioners, Leader of Opposition in Parliament, and an Official in Parliament.

5.5 Free domestic servants

Actual expenditure of the employer as reduced by any amount paid by the employee is a taxable perquisite in the hands of an employee.

5.6 Gas, electricity or water supplied after purchasing from outside agency

Actual amount spent by the employer as reduced by any amount recovered from the employee is a taxable perquisite in the hands of an employee.

5.7 Free education facility

Expenditure relating to providing training to employees is not taxable. If education facility is provided to the family members of employee, expenditure incurred by the employer is the taxable value of perquisite. If education facility is provided to the family members in an educational institute owned or maintained by the employer, then reasonable cost of education in a similar institute in or near the locality is taxable. Up to Rs. 1,000 per month per child is not taxable if the employer provides education facility to the children of an employee in an educational institution owned/maintained by the employer.

5.8 Leave travel concession (LTC)

Only 2 journeys in a block of 4 years is exempt (however, carry over concession is available). Exemption is based upon actual expenditure relating to travel fare only in respect of the shortest route from the place of origin to farthest point.

5.9 Employee’s obligation met by employer

Taxable in all cases.

5.10 Interest-free/ concessional loan

Find out the maximum outstanding balance on the last day of each month. It shall be multiplied by SBI landing rate on the first day of the previous year. Amount recovered from the employee on account of interest is deductible. Perquisite is not taxable if the aggregate amount of original loan does not exceed Rs. 20,000. Moreover, if loan is given by employer for medical treatment (given in rule 3A) of the employee or his family members, it is not chargeable to tax.

5.11 Use of employer’s movable asset

10 per cent per annum of actual cost of asset to the employer or hire charges as reduced by any amount recovered from the employee is a taxable perquisite in the hands of an employee. Nothing is, however, taxable in the case of computer/laptop.

5.12 Sale of movable assets

Actual cost to the employer minus normal wear and tear minus sale consideration paid by the employee, is taxable (normal wear and tear for each year of use is calculated as follows – computer/electronic items: 50 per cent p.a. by reducing instalment method; car: 20 per cent p.a. by reducing instalment method; any other asset: 10 per cent p.a. of cost).

5.13 Medical facilities

1. Medical facility provided in a hospital owned or maintained by the employer is not chargeable to tax.
2. Medical facility provided by an employer in a Government hospital, approved hospital (if a few conditions are satisfied) or a private hospital (if such private hospital is recommended by the Government for the medical treatment of Government employees) or medical expenditure incurred by employer pertaining to Covid-19 (subject to notified conditions), is not chargeable to tax.
3. Medical insurance premium paid or reimbursed by the employer is not chargeable to tax.
4. Any other expenditure incurred or reimbursed by the employer for providing medical facility in India is chargeable to tax.
5. Expenditure on medical treatment outside India is not chargeable to tax, if a few conditions are satisfied.
6. Further, the perquisite in respect of medical facility is not taxable if the employee is a non-specified employee

5.14 Motor car

Car owned or hired by employer, expenses incurred by employer and used for partly official and partly personal purposes – Rs. 1,800 per month (1600 cc or less)/Rs. 2,400 per month (above 1600 cc) for car and Rs. 900 per month for driver. Expenditure recovered from employee is not deductible.

Car owned or hired by employer, expenses incurred by employer and used wholly for personal purposes – Entire expenditure incurred by employer including depreciation at the rate of 10 per cent per annum of actual cost of the car, is taxable in the hands of employee. Expenses recovered from employee are deductible.

Car owned or hired by employer, used for partly official and partly personal purposes, expenses for private purposes incurred by employee – Rs. 600 per month (1600 cc or less)/Rs. 900 per month (above 1600 cc) for car and Rs. 900 per month for driver. Expenditure recovered from employee is not deductible.

Car owned by employee, expenses incurred by employer and used for partly official and partly personal purposes – Actual expenditure incurred by employer minus expenditure pertaining to official use minus anything recovered from employee, is taxable in the hands of employee. Expenditure pertaining to official use can be calculated as per logbook of the car. Alternatively, expenditure pertaining to official use can be calculated at the rate of Rs. 1,800 per month (1600 cc or less)/Rs. 2,400 per month (above 1600 cc) for car and Rs. 900 per month for driver.

• • Conveyance facility when not taxable – Conveyance facility between office and residence is not chargeable to tax in the case of any employee of any organization. Moreover, conveyance facility to High Court judges, Supreme Court judges, Chief Election Commissioner/other Election Commissioners is not chargeable to tax.

5.15 Free transport

Taxable as a perquisite in the hands of an employee on the basis of value at which the employer offers such benefit to the public as reduced by any amount recovered from the employee (tax free perquisite in the hands of employees of railways/airlines).

5.16 Lunch, refreshment, etc.

• • Food and non-alcoholic beverages are provided in working hours in remote area or in an off shore installation: Fully exempt from tax.
  • Lunch/refreshment is provided in working hours at any other place: Cost to the employer in excess of Rs. 50 per meal (as reduced by the amount recovered from the employee) is the taxable value of perquisite in the hands of the employee (tea and snacks in working hours is tax-free perquisite).

5.17 Travelling, touring, accommodation

• • When such facility is available uniformly to all employees: Taxable as a perquisite in the hands of an employee on the basis of actual expenditure of the employer as reduced by any amount recovered from the employee.
  • When such facility is not available uniformly to all employees: Taxable as a perquisite in the hands of an employee on the basis of value at which such facilities are offered by other agencies to the public as reduced by any amount recovered from the employee.

5.18 Gift, voucher or token

Taxable as a perquisite in the hands of an employee on the basis of actual expenditure of the employer (gift may be made either to employee or any member of his household. Gift-in-kind up to Rs. 5,000 per annum is exempt‡).

5.19 Credit card

Expenditure incurred by the employer minus expenditure pertaining to official use minus anything recovered from the employee, is taxable.

5.20 Club

Expenditure incurred (including annual or periodical fees) by the employer minus expenditure pertaining to official use minus anything recovered from the employee, is taxable. Health club/sports club facility given uniformly to all employees in employer’s premises, is not taxable. The initial one time deposits or fees for corporate or institutional membership, where benefit does not remain with particular employee after cessation of employment, are exempt.

5.21 Specified security or sweat equity shares or ESOP

Amount taxable is the fair market value of shares/securities on the date on which option is exercised by the employee. Amount, if any, recovered from the employee is deductible.†

5.22 Employer’s contribution towards recognised provident fund, NPS and superannuation fund and annual accretion to these funds

Not chargeable to tax up to Rs. 7.5 lakh per year. Employer contribution towards these funds (in excess of Rs. 7.5 lakh per annum) is chargeable to tax. Even annual accretion pertaining to such excess amount (as per rule 3B) is chargeable to tax.

5.23 Perquisite received by a teacher/researcher from a SAARC member State

Not taxable up to 2 years.

5.24 Telephone/mobile phone

Not taxable

5.25 Any other facility (not being telephone/mobile phone and not being reimbursement of expenditure on books for office purpose)

Taxable as a perquisite in the hands of an employee on the basis of actual expenditure of the employer as reduced by any amount paid by the employee.

6. Employee’s provident fund

Statutory provident fund – Deduction under section 80C on employee’s contribution is available. All other contributions/interest/lump sum payment exempt from tax.

Recognized provident fund – Deduction under section 80C on employee’s contribution is available. Excess of employer’s contribution over 12% of salary is taxable (exempt up to 12% of salary). Excess of interest over 9.5% is taxable. Lump sum payment at the time of retirement, exempt in certain cases.

Unrecognized provident fund – Deduction under section 80C on employee’s contribution is not available. Employer’s contribution and interest are exempt from tax. Lump sum payment (except employee’s contribution) at the time of retirement is taxable.

7. Deduction under section 80C

Up to Rs. 1,50,000.

8. Meaning of “salary” for different calculations

• • For the purpose of calculating (a) house rent allowance, (b) gratuity (not being gratuity under the Payment of Gratuity Act), (c) leave encashment at the time of retirement, (d) NPS contribution and (e) employer’s contribution towards recognized provident fund, not chargeable to tax – For these purposes, “salary” means basic salary, dearness allowance*/pay if part of salary for computing retirement benefits and commission (if paid as a percentage of turnover achieved by an employee).
  • For the purpose of calculating gratuity received under the Payment of Gratuity Act, 1972, not chargeable to tax – For this purpose, “salary” means basic salary and dearness allowance whenever dearness allowance is paid. The same rule is applicable in the case of retrenchment compensation.
  • For the purpose of calculating perquisite value of rent-free/concessional house – For this purpose, “salary” means basic salary, dearness allowance/pay if part of salary for computing retirement benefits, bonus, commission, fees, taxable allowances and any monetary benefit otherwise chargeable to tax. However, “salary” does not include tax-free allowances, value of a perquisite and employer’s contribution towards provident fund and lump-sum payments received at the time of termination of service or superannuation or voluntary retirement, like gratuity, severance pay, leave encashment, voluntary retrenchment benefits, commutation of pension and similar payments.
  • For the purpose of entertainment allowance, not chargeable to tax – For this purpose, “salary” means basic salary.

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1. Taxable by virtue of section 9(1)(iii)

2. Not taxable by virtue of section 10(7)

†When compensation is paid under any scheme approved by the Central Government, these limits are not applicable and the entire amount is exempt.

†Exemption under section 10(10AA) is available even if the assessee opts for the alternative tax regime under section 115BAC.

*Dearness allowance/pay shall be considered only when it is part of salary for computing all retirement benefits (like provident fund, pension, leave encashment, gratuity, etc.). If dearness allowance/pay is part of salary for computing only some (not all) of the retirement benefits, then it is not taken into consideration for this purpose.

*The number given in brackets represents a similar solved Problem No. of another book entitled “Students’ Guide to Income-tax – Problems & Solutions”, June 2022 edition. This book includes many more solved problems focusing on contemporary issues.

*The number given in brackets represents a similar solved Problem No. of another book entitled “Students’ Guide to Income-tax – Problems & Solutions”, June 2022 edition. This book includes many more solved problems focusing on contemporary issues.

**The Payment of Gratuity Act, 1972, is applicable in the case of every shop/establishment (employing 10 or more persons) and every factory, mine, oilfield, plantation, port, etc.

†The exemption under section 10(10) or section 10(10AA) is available even if the assessee opts for the alternative tax regime under section 115BAC.

*The number given in brackets represents a similar solved Problem No. of another book entitled “Students’ Guide to Income-tax – Problems & Solutions”, June 2022 edition. This book includes many more solved problems focusing on contemporary issues.

† Prior to March 29, 2018, this limit was Rs. 10,00,000.

Also Read: TDS on Salary-Deductions, TDS Calculation