Income under the head of Salaries :

Meaning of Salary :

• Leave Salary
• What is Annuity?
• Bonus, fees and commission
• Gratuity
• Pension

Income under the head 'Salary' covers all remuneration due to or paid to an individual for service rendered by him under an expressed or implied contract of employment. The relationship of employer employee is essential.

Salary is chargeable to tax in the following circumstances :-

• When due from the former employer or present employer in the previous year, whether paid or not.
• When paid or allowed in the previous year, by or on behalf of a former employer or present employer, though not due or before it becomes due.
• When arrears of salary is paid in the previous year by or on behalf of a former employer or present employer, if not charged to tax in the period to which it relates.

Salary under the Income Tax Act is not specifically defined but as per Section 17 of the Income Tax Act it includes the following :

• Wages
• Any annuity or pension
• any gratuity
• Any fees, commission, perquisite or profit in lieu of or in addition to any salary or wages
• Any advance of salary
• Any payment received by an employee in respect of any period of leave not availed by him
• The annual accretion to the balance at the credit of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax
• The aggregate of all sums that are comprised in the transferred balance of an employee participating in a recognised provident fund to the extent to which it is chargeable to tax.

Leave Salary

• Encashment of leave during tenure of service:
• Leave encashment to an employee, while he continues to be in service with the same employer, is fully taxable irrespective of whether he is a Government or a Non-Government employee.
• Encashment of accumulated earned leave at the time of retirement [Section 10 (10AA)]: For the purpose of exemption of accumulated leave encashment, employees are divided into two categories.
  • Government Employees ( Central and State Government Employees only) [Section 10(10AA)(i)]: Leave encashment of accumulated earned leave at the time of retirement, whether on superannuation or otherwise, received by a Government employee, is fully exempt from tax. Since full leave encashment is exempt, nothing is to be included in gross salary.
  • Other Employees [Section 10(10AA)(ii)] : Leave encashment of accumulated leave at the time of retirement whether on superannuation or otherwise received by other employees (including employees of local authority and public sector undertakings) is exempt to the extent of the minimum of the following four amounts:
    • Leave encashment actually received
    • 8 months' 'average salary'
    • Cash equivalent of unavailed leave calculated on the basis of maximum 30 days leave for every completed year of service, The cash equivalent is to be calculated on the basis of the average salary.
    • Amount specified by the Government which is given in the table below:

Average salary is to be calculated on the basis of average salary drawn by the employee during the period of 10 months immediately preceding his retirement.

What is Annuity?

Annuity is an annual grant received by the employee from his employer and is covered under the definition of salary. It may be paid by the employer voluntarily or on account of contractual agreement. A deferred annuity is not taxable until the right to receive the same arises. Other form for annuities made under a will or granted by a life insurance company or accruing as a result of contract come under the head "Income from Other Sources" and are assessed u/s 56 of the I.T. Act.

Bonus, fees and commission:

Bonus is taxable on receipt basis and is included in the gross salary in the year in which the bonus is received. Any fees or commission received by the employee or receivable by the employee is fully taxable and has to be included in gross salary. Commission may be a fixed amount per annum or may be a percentage of turnover or net profit. However, the same is taxable under the head "Salaries" when it is received or receivable by the employee.

Gratuity:

Gratuity can be received by the employee at the time of his retirement or by his legal heir in the event of death of the employee. Gratuity received by an employee on his retirement is taxable under the head "Salary" and gratuity received by the legal heir is taxable under the head" Income from Other Sources".

In both the above situations gratuity upto a specified limit is exempt under the provisions of sec.10(10) of the Income Tax Act, 1961.

For the purpose of exemption of gratuity under sec.10(10) the employees are divided under three categories:

1. Govt. employees - In the case of govt. employees the entire amount of death-cum-retirement gratuity is exempt from tax and nothing is therefore taxable under the head Salaries.

2. Employees covered under the Payment of Gratuity Act, 1972 - The employees covered under the Gratuity Act who receive gratuity have been given exemption which is the minimum of the following amounts. Gratuity received in excess of the minimum of the amounts mentioned below is included in the gross salary for the purposes of taxation.

• The amount of gratuity actually received.
• Fifteen days' salary (7 days in the case of seasonal employment) for every completed year of service provided the employment is more than six months.
• The gratuity payable or paid is Rs.3,50,000/-. This limit is applicable w.e.f. 24.9.97.

3. Other employees - In the case of other employees the gratuity received or receivable on his retirement or on his becoming incapacited prior to such retirement or termination of his employment or any gratuity received by his heirs is exempt to the extent of the minimum of the following amounts. The amount received in excess of the sums mentioned below is included in the gross salary of the employee for the purposes of taxation.

• Actual amount of gratuity received.
• Half month's average salary for every completed year of service. (Average salary means the average of the salary drawn by the employee for 10 months immediately preceding the month in which he retires)
• Rs. 2,50,000/-

Pension:

• Pension is normally paid to retired employees on a monthly basis. However, certain employers allow the pension to be fully or partly commuted i.e. a lumpsum payment is made to the employees. The treatment of the commuted pension and the periodical monthly pension received is as under.
• The periodical monthly pension is fully taxable in the hands of all the employees irrespective of the fact that the employee is a government employee or a non-government employee.
• Commuted pension in the case of government employee is fully exempt under sec. 10A of the Income Tax Act. Hence, no part of the commuted pension is includible under the head "Income from Salary."
• Commuted pension in the case of non-government employees is exempt under sec.10A to the following extent. This exemption is linked to the receipt of gratuity.
• In the case of non-government employees if the employees receive gratuity the commuted value of 1/3 rd of the entitled pension is exempt from tax. Any amount received over and above the exempted pension is taxable and hence included in gross salary for the purposes of taxation.
• In the case of non-government employees if the employee does not receive any gratuity which is exempt from tax, commuted value of one half of such pension is not taxable.
• Any payment in commutation of pension received from an approved fund of the LIC of India set up after 1.8.96