August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

Deduction On Salary & Some Exemptions

Project submitted

to
Mr. Rana Navneet Roy
(Faculty: Principles of Taxation)

Project submitted

by

Hiten Joshi

(Roll no.-79)

(Section-C, Sem-V)

Submitted On:

21.08.2017

HIDAYATULLAH NATIONAL LAW UNIVERSITY

RAIPUR, C.G.

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 August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

Table of Contents

TOPICS PAGES

Acknowledgements ............................................................................................................. 03

Introduction ...................................................................................................... 04

Objectives ........................................................................................................................... 05

Research Methodology ....................................................................................................... 05

Meaning of Salary .............................................................................................................. 06

Characteristics of Salary ...................................................................................... 06

Deduction allowed from salary ........................................................................................... 11

Deduction on Salary and Its Exemptions .......................................................................... 12

Conclusion .......................................................................................................................... 15

References ........................................................................................................................... 16

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 August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

Acknowledgements

At the outset, I would like to express my heartfelt gratitude and thank my teacher, Mr. Rana
Navneet Roy for putting his trust in me and giving me a project topic “Deduction on Salary
and exemptions” such as this and for having the faith in me to deliver.

My gratitude also goes out to the staff and administration of HNLU for the infrastructure in
the form of our library and IT Lab that was a source of great help for the completion of this
project.

Name –Hiten Joshi

Roll no.- 79

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 August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

Introduction
Among the five heads of income listed by S.14, “Salaries” is the first and most important
head of income. The concept of “Salaries” is very wide and includes not only the salary in
common parlance but also various other receipts, gifts, perquisites and benefits.
“Salary” includes :
(i) Wages or Salary: ‘Salary’ is generally used in respect of payment for services of a higher
class, whereas ‘wages’ is confined to the earnings of labourers. However, for income-tax
purposes there is no difference between salary and wages.
(ii) Annuity is annual grant made by the employer to the employee.
(iii) Pension is a periodical payment for past services.
(iv) Gratuity is a lump sum payment for past services.
(v) Fees and Commission: It is a remuneration to encourage employees.
(vi) Perquisites: These include all benefits and amenities provided by the employer to the
employee, either in cash or kind.
(vii) Profit in lieu of or in addition to salary or wages.
(viii) Advance of Salary.
(ix) Any payment received by an employee in respect of any period of leave not availed of by
him.
(x) Taxable portion of annual accretion: Where the employee is a member of a Recognised
Provident Fund, the amount contributed by the employer in this fund in excess of 12 per cent
of the salary of the employee and interest credited on the amount of the fund in excess of the
prescribed rate of interest is to be included in the salary income.

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 August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

Objectives

 To understand the significance and meaning of the term “ Salary” and study
its application in the tax legislations.
 To study how tax is deducted from salary and its exemptions.

Research Methodology

The project is descriptive in nature. Data have been collected on the basis of
secondary resources. This includes books, literature, articles, journals, web pages,
etc. Books and other reference as guided by Faculty of Law of Taxation have been
primarily helpful in giving this project a firm structure. Websites and articles have
also been referred.

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 August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

Meaning of salary

The relationship of payer and payee must be of employer and employee for an income to be
categorized as salary income. For example: Salary income of a Member of Parliament cannot
be specified as salary, since it is received from Government of India which is not his
employer.
Salary, in simple words, means remuneration of a person, which he has received from his
employer for rendering services to him. But receipts for all kinds of services rendered cannot
be taxed as salary. The remuneration received by professionals like doctors, architects,
lawyers etc. cannot be covered under salary since it is not received from their employers but
from their clients. So, it is tax under business or profession head. In order to understand what
is included in salary, let us discuss few characteristics of salary.1

Characteristics of Salary

1. The Act makes no distinction between salary and wages, though generally salary is paid
for non-manual work and wages are paid for manual work.

2. Salary received from employer, whether one or more than one is included in this head.

3. Salary is taxable either on due basis or receipt basis which ever matures earlier:
i) Due basis – when it is earned even if it is not received in the previous year.
ii) Receipt basis – when it is received even if it is not earned in the previous year.
iii) Arrears of salary- which were not due and received earlier are taxable when due or
received, which ever is earlier.

4. Compulsory deduction from salary such as employees’ contribution to provident fund,

deduction on account of medical scheme or staff welfare scheme etc. are examples of
instances of application of income. In these cases, for computing total income, these
deductions have to be added back.

1
Mahesh Chandra & D.C. Shukla;- “Income-tax Law and Practice”, Pragati Publications

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 August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

Salary

The meaning of the term ‘salary’ for purposes of income tax is much wider than what is
normally understood. Every payment made by an employer to his employee for service
rendered would be chargeable to tax as income from salaries. The term ‘salary’ for the
purposes of Income-tax Act, 1961 will include both monetary payments (e.g. basic salary,
bonus, commission, allowances etc.) as well as non-monetary facilities (e.g. housing
accommodation, medical facility, interest free loans etc).

(1) Employer-employee relationship : Before an income can become chargeable under

the head ‘salaries’, it is vital that there should exist between the payer and the payee, the
relationship of an employer and an employee. Consider the following examples:

(a) Sujatha, an actress, is employed in Chopra Films, where she is paid a monthly
remuneration of 2 lakh. She acts in various films produced by various producers. The
remuneration for acting in such films is directly paid to Chopra Films by the different
producers. In this case, 2 lakh will constitute salary in the hands of Sujatha, since the
relationship of employer and employee exists between Chopra Films and Sujatha.

(b) In the above example, if Sujatha acts in various films and gets fees from different
producers, the same income will be chargeable as income from profession since the
relationship of employer and employee does not exist between Sujatha and the film
producers.

(c) Commission received by a Director from a company is salary if the Director is an

employee of the company. If, however, the Director is not an employee of the company, the
said commission cannot be charged as salary but has to be charged either as income from
business or as income from other sources depending upon the facts.
Where the employee is a resident and ordinarily resident in india and rendering services in
india salary shall be deemed to accrue or arise in india even if the employer who is non-
resident pays some amount being part of salary outside india.2
(d) Salary paid to a partner by a firm is nothing but an appropriation of profits. Any salary,
bonus, commission or remuneration by whatever name called due to or received by partner of

2
[CIT v Eli Lilly and co.(india) Pvt. Ltd. (2009) 312 ITR 225 (SC)]

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 August 21, 2017 DEDUCTION ON SALARY & EXEMPTIONS

a firm shall not be regarded as salary. The same is to be charged as income from profits and
gains of business or profession. This is primarily because the relationship between the firm
and its partners is not that of an employer and employee.

(2) Full-time or part-time employment: It does not matter whether the employee is a full
time employee or a part-time one. Once the relationship of employer and employee exists, the
income is to be charged under the head salaries”. If, for example, an employee works with
more than one employer, salaries received from all the employers should be clubbed and
brought to charge for the relevant previous years.

(3) Foregoing of salary: Once salary accrues. the subsequent waiver by the employee does
not absolve him from liability to income-tax. Such waiver is only an application and hence,
chargeable to tax.

Example: Mr. A, an employee instructs his employer that he is not interested ¡n receiving the
salary for April 2012 and the same might be donated to a charitable institution. In this case,
Mr. A cannot claim that he cannot be charged in respect of the salary for April 2012. It is
only due to his instruction that the donation was made to a charitable institution by his
employer. It is only an application of income. Hence, the salary for the month of April 2012
will be taxable in the hands of Mr. A. He is however, entitled to claim a deduction under
section 80G for the amount donated to the institution.

(4) Surrender of salary: However, if an employee surrenders his salary to the Central
Government under section 2 of the Voluntary Surrender of Salaries (Exemption from
Taxation)Act, 1961, the salary so surrendered would be exempt while computing his taxable
income.

(5) Salary paid tax-free: This, in other words, means that the employer bears the burden of
the tax on the salary of the employee. In such a case, the income from salaries in the hands of
the employee will consist of his salary income and also the tax on this salary paid by the
employer.

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Definition of Salary
The term ‘salary’ has been defined differently for different purposes in the Act. The
definition as to what constitute salary is verý wide. As already discussed earlier, it ¡s an
inclusive definition and includes monetary as well as non-monetary items. There are different
definitions of salary’ say for calculating exemption in respect of gratuity, house rent
allowance etc.
‘Salary’ under section 17(1), includes the following:
wages,
(ii) any annuity or pension,

(iii) any gratuity,

(iv) any fees, commission, perquisite or profits in lieu of or in addition to any salary or
wages,

(y) any advance of salary,

(vi) any payment received in respect of any period of leave not availed by him i.e. leave
salary or leave encashment,

(vii) 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 and

(viii) transferred balance in recognized provident fund to the extent it is taxable,

(ix) the contribution made by the Central Government or any other employer in the previous
year to the account of an employee under a pension scheme referred to in section
8000D.

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What is “salary”-
Salary is said to be the remuneration received by or accruing to an individual for service
rendered aa result of an express or implied contract. The statute, gives an inclusive but not
exhaustive definition of salary. Salary includes therein3
(i) Wages (ii) Annuity or pension (iii) Gratuity (iv) fees, commission, perquisites or
profits in lieu of salary (v) Advance salary (vi) Receipt from provident fund (vii)
Contribution of employer to a recongnised provident fund in excess of prescribed
limit (viii) Leave encashment (ix) compensation as a result of variation of service
contract etc. (x) Government contribution to a pension scheme.4

Exceptions to salary income:

The existence of an‘employer-employee’ relationship is a must for a payment to be taxed
under the head salaries. Accordingly, the following classes of payments do not fall under the
purview of the head ‘salary’

(i) Salary received by a partner from his partnership firm carrying on business - This
income is taxable under the head “profits and gains of business and profession”.

(ii) Salary received by a person as MP or MLA- This income is taxable under the head
“income from other sources”. However, the salary received by a person as a Minister of
Central Government/State Government is chargeable under the head salaries.

(iii) Family pension that is pension received by the members of the family of an
employee subsequent to his death - This is taxable under the head “income from other
sources”. However the pension received by an employee from his former employer is taxable
under the head salaries.

3
Section 17(1),Exemption from Taxation) Act, 1961.
4
H.C. Mehrotra- “Income-tax Law and Accounts” , 27th edition (2006).

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Deduction allowed from salary –

The following amounts shall be deducted in order to arrive at the chargeable income under
the head ‘Salaries’.
(A) Standard deduction: Omitted by Financial Act, 2005 w.e.f. 1.4.2006. – Section 16(i)
(B) Entertainment allowance : Where the employee is in receipt of entertainment
allowance, the amount so received shall first be included in the salary income and thereafter
the following deduction shall be made - Section 16(ii) :
16(ii). A deduction in respect of any allowance in the nature of an entertainment allowance
specifically granted by an employer to the assessee who is in receipt of a salary from the
Government, a sum equal to one fifth of his salary (exclusive of any allowance, benefit or
other perquisite) or five thousand rupees, whichever is less.
W.e.f. April 1, 2002 entertainment allowance will be allowed in computing income from
salary only in case of employees of the Government and will cease to be allowable for
persons other than those employed in Government i.e. entertainment allowance deduction
will not be allowed to other employees.
For this purpose ‘Salary’ excludes any allowance, benefit or other perquisites:
Where an employee, not entitled to claim deduction under this clause, spends some money on
the entertainment of customers of the concern, the amount so spent cannot be deducted from
the salary income. The condition makes exemption well-nigh impossible for the employees of
private sector. For them, the better course would be to get the entertainment expenses
reimbursed.
(C) Tax on employment or Professional Tax: From the assessment year 1990-91, deduction
shall be allowed in respect of any sum paid by the assessee on account of a tax on
employment within the meaning of clause (2) of article 276 of the Constitution, leviable by a
State under any law passed by its legislature. Where Professional/Employment tax is paid by
the employer on behalf of the employee, it will first be included in his gross salary as a
perquisite, being a monetary obligation of the employee discharged by the employer.
Thereafter, a deduction on account of such professional tax shall be allowed to the employee
from his gross salary. Professional tax due but not paid shall not be allowed as deduction.

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Income Tax Exemptions for Salaried Employees

The various Income Tax Exemptions for Salaried Employees have been mentioned below.
These Income Tax Exemptions for Salaried Employees are highly advisable to everyone as
they help in saving tax legally thereby reducing the tax burden on the Salaried Employee.

For a detailed view on each Income Tax Exemption for Salaried Employees, kindly refer the
link attached in the following points.

1. HRA Exemption for Salaried Employees

Many employers give House Rent Allowance (HRA) to their employees for them to reside at
a good place. A portion of the House Rent Allowance given by an employer to an employee
is exempted from the levy of the Income Tax and Income Tax is only levied on the remaining
part.

HRA Exemption is one of the most useful income tax exemptions for Salaried Employees as
it can be easily claimed and the amount of exemption allowed is also large.

2. Income Tax Exemption on Leave Travel Allowance

Many employers also give allowances to their employees to go on a vacation with their
respective families. The amount given by the employer to an employee to go on a vacation is
exempted from the levy of tax to a certain extent provided that the amount given was for a
vacation in India only.

Leave Travel Allowance is also an effective income tax exemption for Salaried Employees.
However, this amount can only be claimed if the employee actually goes on a vacation as
bills for the same would be required to be furnished.

3. Exemption on Encashment of Leaves for Salaried Employees

Most employers give all their employees a certain no. of days which can be claimed as
leaves. However, in case a person does not claim these leaves, many employers also give
their employees the option for en-cashing these leaves i.e. the employers pays extra to the
employees for the leaves which were allowed to be taken but were not taken.

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This amount received as Leave Encashment is also allowed to be claimed as an exemption up

to a certain extent.

4. Tax Exemption from Pension Income for Salaried Employees

On retirement of an employee, many employers pay a pension to their employees.
Sometimes, the employer pays pension from his own pocket and in some cases, the employer
purchases an annuity and then the pension is being paid by the organisation from whom the
annuity has been purchased.

The Pension can be of 2 types i.e. Commuted and Uncommuted. In commuted pension, the
whole amount of pension is received in lump-sum whereas in Uncommuted Pension, the
amount is paid in instalments at regular intervals.

Irrespective of the type of Pension, Income Tax Exemption is given in both types of pensions
up to a certain limit.

5. Income Tax Exemption on Gratuity for Salaried Employees

Gratuity is a gift made by the employer to his employee in appreciation of the past services
rendered by the employee. Gratuity can either be received by:-

1. The employee himself at the time of his retirement

2. The legal heir at the time of the death of the employee

For the purpose of computing Income Tax Exemptions for Salaried Employees who have
received gratuity, the employees can be segregated into 3 parts and then the exemption is
allowed depending on the category they are into:-

1. Govt. Employees and employees of Local Authorities

2. Employees covered under the Payment of Gratuity Act, 1972
3. Employees not covered in any of the 2 above.

6. Income Tax Exemption on VRS Received

Many employees opt for Voluntary Retirement before the actual age of retirement (i.e. 60
years). In such cases, the employer sometimes gives some money to the employee on his
voluntary retirement.

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The amount received or receivable by the employee on voluntary retirement under the golden
handshake scheme is exempted under Section 10(10C).

7. Income Tax Exemption for Perquisites

Some employers also give their employees various perquisites/facilities like Car, Mobile
phones, Rent Free accommodation.

Such perquisites are not fully tax free. A specific value of such facilities is allowed as an
exemption and value of the balance facilities allowed is allowed as an exemption.

8. Exemption of Various Allowances

Various other allowances like Transport Allowance, Children Education Allowance are also
allowed as Income Tax Exemptions to Salaried Employees but only up to a certain limit.

Relevant Points regarding Income Tax Exemptions for Salaried Employees

1. The above stated 8 Income Tax Exemptions for Salaried Employees are the most
useful exemptions. However, there are various other exemptions as well but are not
commonly used.
2. The above stated income tax exemptions are only available to Employees.

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CONCLUSION
“The art of dodging tax without breaking the law is tax avoidance.”

- Justice C. Reddy

Among the five heads of income listed by S.14, “Salaries” is the first and most important
head of income. The concept of“ Salaries” is very wide and includes not only the salary in
common parlance but also various other receipts, gifts, perquisites and benefits. The lesson is
divided into various sections dealing with the concept of salary income and its characteristics,
which define as to what constitutes “salaries” followed by the incomes falling under this head
the computation of basic salary, types of allowances and perquisites, valuation of the
perquisites, various income tax provisions for computing taxable value of allowances etc and
their detailed descriptions along with the applicable legal provisions of income tax.
Tax, though an essential element of the fiscal and revenue system of a government has to be
used judiciously and smartly in order to ensure that it falls proportionately on people
according to their spending habits and earning capacity. Tax 5methods must also be of such a
nature as to ensure that no loopholes are present so as make avoidance a cake walk.

People are however the micro subjects of tax policies. Taxation must be aimed at the bigger
fish and the larger picture is what must be taken into consideration. Companies, firms and
other corporations must be subject to higher tax owing to their larger earning capacity as well
as the nature of their function.

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http://www.charteredclub.com/income-tax-exemptions-for-salaried-employees/

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Bibliography
Direct taxes: Law and Practice by Dr.Girish Ahuja and Dr. Ravi Gupta, 4th
Edition, Bharat Publishers (2012)
Student Guide to Income Tax by Dr.Vinod Singhania and Dr. Monica
Singhania, Taxmann’s (2013)

Webliography
Manupatra, www.manupatra.com
https://doresearch.stanford.edu/research.../major.../allocation-expenses
www.taxmann.com/bookstore/

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