Introduction to Taxation Law

Taxation is a fundamental pillar of governance, serving as the backbone of any government’s revenue system and enabling it to fulfil its obligations toward the welfare and development of society. Through the mechanism of taxation, governments mobilize resources essential for maintaining law and order, building infrastructure, providing healthcare and education, and fostering economic growth. It is not merely a tool for revenue collection but also a powerful instrument for achieving equity and social justice. At its core, taxation reflects the principle of collective responsibility, where individuals and businesses contribute a portion of their income or wealth to fund public expenditures. This system ensures that the burden of supporting a nation’s development is shared equitably among its citizens, promoting a sense of unity and accountability within society.

In India, taxation has evolved into a well-defined and structured system governed by comprehensive legal frameworks. Among these, the Income Tax Act, 1961, stands out as a cornerstone of direct taxation. Enacted on April 1, 1962, this legislation provides a detailed framework for the levy, collection, and administration of income tax[1]. The Act applies to the entire country, including Jammu and Kashmir, and has been periodically amended to address the dynamic needs of a growing economy. The Income Tax Act, 1961, outlines various provisions to ensure transparency, equity, and efficiency in the taxation process. It defines critical concepts such as income, assessment, residential status, and the obligations of taxpayers. By categorizing income into distinct heads—such as salaries, house property, business profits, capital gains, and other sources—the Act ensures a systematic approach to taxation. Furthermore, it specifies the rates of tax, exemptions, deductions, and penalties, ensuring clarity and compliance.

Taxation law in India also plays a pivotal role in redistributing wealth and fostering socio-economic balance. Through progressive tax structures, higher earners contribute a larger share of their income to the government, enabling the state to channel resources toward poverty alleviation, public health, education, and rural development. Moreover, tax incentives and deductions promote investments in priority sectors, driving innovation and economic expansion. In addition to its economic significance, taxation serves as a policy tool for regulating behaviours and fostering environmental and social objectives. For instance, the government imposes higher taxes on activities that harm the environment, such as carbon emissions, while offering tax benefits for renewable energy investments. Similarly, exemptions and rebates are granted to encourage savings, home ownership, and education.

Overall, taxation law is integral to the functioning of a state, shaping its fiscal policies and ensuring the equitable distribution of resources. By aligning its taxation policies with national and global priorities, India has established a robust system that not only drives economic growth but also upholds the principles of fairness and inclusivity. As the global economy evolves, so too does the Indian taxation framework, reflecting the dynamic interplay of domestic and international influences.

History of Taxation in India

The history of taxation in India is deeply rooted in its ancient civilization, evolving significantly over centuries. Taxation has always been a crucial tool for governance, used to fund public welfare, defence, and administrative functions. From the voluntary contributions of the Vedic era to the modern, well-regulated system, taxation in India has transformed in structure and intent.

In the ancient period, references to taxation can be found as early as the Vedic era, where taxes were voluntary contributions to the king, often paid as a share of agricultural produce called Bali. The Mauryan Empire under Chandragupta Maurya introduced a more systematic approach to taxation. Kautilya’s Arthashastra, written during this period, categorized taxes into Bhaga (a share of agricultural produce), Kara (tax on trade and commerce), and Shulka (custom duties). The Arthashastra emphasized equitable tax collection and warned against excessive taxation to avoid public discontent.[2]

In the medieval period, during the Delhi Sultanate, taxes such as Jizya (a tax on non-Muslims) and Zakat (a religious tax for Muslims) were introduced. The primary source of state revenue was Kharaj, a land revenue tax collected in cash or kind.[3] Under the Mughal Empire, taxation became highly organized. Raja Todar Mal, Akbar’s finance minister, implemented the Dahsala system in 1580, which assessed land revenue based on a decade’s average production and prices. This system ensured fairness and efficiency in tax collection.[4]

The colonial period saw significant changes with the advent of the British East India Company. The Permanent Settlement of Bengal (1793) under Lord Cornwallis created a class of landlords (Zamindars) who were responsible for collecting fixed land revenues. In southern India, the Ryotwari system was implemented, collecting taxes directly from farmers. During British Crown rule, the first Income Tax Act was introduced in 1860 by Sir James Wilson to recover losses from the Revolt of 1857[5]. This Act marked the beginning of modern taxation in India, with subsequent refinements through the Income Tax Acts of 1886, 1918, and 1922.

Post-independence, India retained the 1922 Income Tax Act, but numerous amendments were made to suit the needs of a newly independent nation. Taxation was established as a central subject under the Constitution of India, with clear demarcations between direct taxes (e.g., income tax) and indirect taxes (e.g., excise duty). The landmark Income Tax Act, 1961, enacted on April 1, 1962, replaced the 1922 legislation, providing a comprehensive framework for assessing and collecting taxes. This Act remains the cornerstone of India’s taxation system.

In the modern era, the introduction of the Goods and Services Tax (GST) on July 1, 2017, marked a significant reform in India’s indirect taxation system. GST replaced multiple indirect taxes like VAT, excise duty, and service tax, creating a unified and transparent tax structure across the country.

What is Tax?

A tax is a compulsory financial charge or levy imposed by the government on individuals, businesses, or transactions. Unlike a fee or charge for a specific service, taxes represent a broader societal obligation to support the functioning and development of a state. Taxes enable governments to fund public goods such as infrastructure, healthcare, education, and national security, promoting social and economic stability.

Taxation is not voluntary; its payment is legally enforceable, with non-compliance leading to penalties. Taxes may be levied on various bases, including income, consumption, property, and transactions, ensuring the government has adequate resources for its responsibilities.

Definitions under the Income Tax Act, 1961

The Income Tax Act, 1961, provides well-defined terms to ensure clarity in tax law application. Some of the key definitions are:

• Assessment Year – Section 2(9)

Section 2(9) defines an “Assessment year” as “the period of twelve months starting from the first day of April every year.” An assessment year begins on 1st April every year and ends on 31st March of the next year. For example, Assessment year 2012–13 means the period of one year beginning on 1st April, 2011, and ending on 31st March, 2012. In an assessment year, income of the assessee during the previous year is taxed at the rates prescribed by the relevant Finance Act. It is therefore also called as the “Tax Year.”

• Previous Year – Sections 2(34) & 3

Section 3 defines “Previous year” as “the financial year immediately preceding the assessment year.” Income earned in one financial year is taxed in the next financial year. The year in which income is earned is called the “previous year”, and the year in which it is taxed is called the “assessment year.”

Common previous year for all sources of income:
A person may earn income from more than one source, but the previous year will always be common for all the sources of income. This will be so even if a person maintains records or books of accounts separately for different sources of income. Total income of a person from all the sources of income will be taken together and considered in the previous year or the financial year immediately preceding the assessment year.

• Person – Section 2(31)

The term “person” includes:
a. An individual;
b. A Hindu Undivided Family (HUF);
c. A company;
d. A firm;
e. An Association of Persons (AOP) or a Body of Individuals (BOI), whether incorporated or not;
f. A local authority; and
g. Every artificial juridical person not falling within any of the preceding categories.

These are seven categories of persons chargeable to tax under the Act. The aforesaid definition is inclusive and not exhaustive. Therefore, any person not falling in the abovementioned seven categories may still fall within the four corners of the term “person” and accordingly may be liable to tax.

• Assessee – Section 2(7)

U/s 2(7), “Assessee” means a person by whom income tax or any other sum of money is payable under the Act, and it includes:
a. Every person in respect of whom any proceeding under the Act has been taken for the assessment of his income or loss or the amount of refund due to him.
b. A person who is assessable in respect of income or loss of another person or who is deemed to be an assessee.
c. An assessee in default under any provision of the Act.

A minor child is treated as a separate assessee in respect of any income generated out of activities performed by him, like singing in radio jingles, acting in films, tuition income, delivering newspapers, etc. However, income from investments, capital gains on securities held by a minor child, etc., would be taxable in the hands of the parent having the higher income (mostly the father), unless such assets have been acquired from the minor’s sources of income.

• Income – Section 2(24)

Although income tax is a tax on income, the Act does not provide any exhaustive definition of the term “Income.” Instead, the term is defined inclusively, covering both its natural and specified meanings.

Broadly, the term “Income” includes the following:
i. Profits and gains.
ii. Dividends.
iii. Voluntary contributions received by certain institutions.
iv. Receipts by employees in the form of benefits or perquisites, whether convertible into money or not.
v. Incomes from business (Section 28).
vi. Any capital gains chargeable under Section 45.
vii. Any sum earlier allowed as deduction and chargeable to income-tax under Section 59.
viii. Any winnings from lotteries, crossword puzzles, races, including horse races, card games, and other games of any sort, or from gambling or betting of any form or nature whatsoever.
ix. Any contribution received from employees towards any provident fund, superannuation fund, or Employees’ State Insurance Act, 1948, or any other fund for the welfare of such employees.
x. Any sum received under a Keyman insurance policy, including the sum allocated by way of bonus on such policy.
xi. Any sum of money or value of property received as a gift (Section 56(2)).

Types of Tax

Taxes are broadly classified into Direct Taxes and Indirect Taxes[6], based on how they are levied and who bears the ultimate burden of the tax.

1. Direct Taxes
2. These are taxes levied directly on an individual or entity and cannot be transferred to others.
3. The burden of payment lies on the taxpayer, who is legally responsible for paying the tax to the government.
4. Examples include Income Tax, Corporate Tax, Wealth Tax, and Property Tax.
5. Direct taxes are progressive in nature, meaning they increase with the income or wealth of the taxpayer, promoting social equity by ensuring higher earners pay more.
6. Indirect Taxes
7. These are taxes levied on goods and services and are ultimately paid by consumers.
8. The burden of the tax is transferred from businesses or service providers to the end-users, as it is included in the price of goods or services.
9. Examples include Goods and Services Tax (GST), Excise Duty, Customs Duty, and Value Added Tax (VAT).
10. Indirect taxes are regressive in nature, as they are applied uniformly regardless of the buyer’s income, potentially affecting lower-income groups more.

While direct taxes focus on income and wealth, indirect taxes target consumption, making both types complementary in achieving fiscal objectives.

Applicability of Direct Taxes Under Different Heads

Direct taxes are typically levied under the following heads:

1. Income from Salary

• Applicable to income earned as salaries, pensions, and gratuities.
• Includes perquisites (e.g., company-provided housing or cars) and allowances (e.g., travel, house rent, or dearness allowances).
• Employers deduct Tax Deducted at Source (TDS) on salaries before payment.

2. Income from House Property

• Tax is levied on income derived from owning property, such as rental income.
• Owners are allowed deductions for municipal taxes paid and a standard deduction for maintenance expenses.
• Even vacant properties may be taxed if deemed “self-occupied” beyond a permissible limit.

3. Income from Business or Profession

• Applies to profits earned by individuals, partnerships, or corporations engaged in trade, business, or professions.
• Taxable income is calculated after deducting allowable expenses, such as salaries, rent, and operational costs.
• Includes presumptive taxation schemes for small businesses under certain thresholds.

4. Income from Capital Gains

• Taxable on profits earned from the sale of capital assets like property, stocks, or gold.
• Classified as short-term or long-term, depending on the holding period of the asset.
• Tax rates differ for short-term and long-term gains, with indexation benefits available for long-term gains.

5. Income from Other Sources

• A residual category covering income not included under other heads.
• Includes dividends, lottery winnings, gifts (above specified limits), and interest earned on savings or fixed deposits.

Income from salary
Income from Salary is one of the five major heads of income under the Income Tax Act, 1961, governed primarily by Sections 15 to 17[7]. It represents the monetary and non-monetary compensation received by an individual from an employer for services rendered under an employment contract. This head of income plays a pivotal role in the taxation framework due to its structured nature and significant contribution to government revenue.

Salary income is taxable on a receipt basis or due basis, whichever is earlier. This provision ensures that tax is levied not only on payments received during the financial year but also on any salary due but not yet received[8]. Such an approach prevents any potential deferment of tax liability and brings greater transparency and accountability to the tax system. This dual basis of chargeability also underscores the obligation of employees to report income accurately in the year it becomes assessable.

The definition of salary under the Income Tax Act is broad and encompasses a variety of payments, including basic salary, allowances, perquisites, bonuses, gratuity, pension, and other forms of remuneration. This comprehensive scope ensures that all forms of income derived from employment are brought within the ambit of taxation, leaving little room for tax evasion.

From the perspective of the government, taxation of salary income is a significant and stable source of revenue. Salaried individuals are typically taxed at source through the Tax Deducted at Source (TDS) mechanism, which ensures regular inflow of funds into the government treasury. For taxpayers, it provides clarity in computing tax liability as salary income is well-documented through Form 16 and payroll records, minimizing disputes.

Furthermore, income from salary highlights the progressive nature of the Indian tax system, where higher income levels attract higher rates of taxation, thereby contributing to economic equity. The comprehensive rules and provisions related to salary income, coupled with specific exemptions and deductions, aim to balance the interests of the government and taxpayers, promoting compliance while providing relief for legitimate expenses.

Definition of Salary (Section 17(1))

The term Salary under the Income Tax Act, 1961, is defined comprehensively in Section 17(1).[9] It includes various forms of monetary and non-monetary payments made by an employer to an employee. The scope of salary under this section is broad, ensuring that most forms of compensation received during the employment relationship are brought under the purview of taxation.

Here’s a detailed breakdown of the components included under salary:

1. Wages: The basic compensation paid to an employee for the work performed. This includes fixed amounts agreed upon as part of the employment contract.
2. Pension: A periodic payment made to retired employees as a form of sustenance.
3. Gratuity: A lump-sum payment made to employees as a token of gratitude for their service, typically upon retirement or resignation. Exemption under Section 10(10) is available subject to limits for non-government employees.
4. Advance Salary: Salary received in advance for services yet to be rendered. Taxable in the year of receipt, regardless of the period it pertains to. Relief under Section 89 may be claimed for tax smoothing.
5. Arrears of Salary: Salary received in a financial year for services rendered in a prior year. Fully taxable in the year of receipt. Relief under Section 89 is available to reduce additional tax burden.
6. Fees, Commissions, and Bonuses: Includes additional payments such as incentives, performance bonuses, or any fees received in relation to employment. Fully taxable in the hands of the employee.
7. Allowances: Financial benefits provided to employees to meet specific expenses, such as House Rent Allowance (HRA), Dearness Allowance (DA), etc. Taxability depends on the nature of the allowance; some are fully taxable, some partially exempt, and others fully exempt.
8. Perquisites: Non-monetary benefits provided by an employer, such as rent-free accommodation, company car, or club memberships. Taxability varies: some are fully taxable; others are partially exempt or exempt entirely under specific provisions.

Basis of Charge in Income from Salary

Under Section 15, the following incomes are chargeable to Income-tax under the head ‘Salaries’;

• any salary due from an employer or a former employer to an assessee in the previous year whether paid or not;
• 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 becomes due to him;
• 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.[10]

Allowances under Income Tax Act

Allowances are fixed monetary benefits provided by employers to employees to meet specific expenses. These allowances can be fully taxable, partially exempt, or fully exempt under the Income Tax Act, 1961, depending on their nature and purpose[11]. Below is a detailed explanation:

1. Fully Taxable Allowances

These allowances are included entirely in the gross salary and are fully taxable:

1. Dearness Allowance (DA): Paid to employees to offset the impact of inflation and the rising cost of living. If DA is included in salary for retirement benefits like gratuity or pension, it also impacts calculations under those heads.
2. City Compensatory Allowance (CCA): Paid to employees working in high-cost urban areas to compensate for the higher cost of living.
3. Overtime Allowance: Paid for work performed beyond normal working hours.
4. Fixed Medical Allowance: Paid to cover routine medical expenses. Fully taxable, as opposed to reimbursement of medical expenses, which may be exempt.
5. Other Fully Taxable Allowances: Entertainment allowance (except for government employees, who can claim a deduction under Section 16(ii)).

2. Partially Exempt Allowances (Section 10)

These allowances are partly exempt under specific conditions or limits.

(a) House Rent Allowance (HRA) [Section 10(13A)]:

HRA is provided to employees to meet rental housing expenses.

• Exemption: The least of the following is exempt from tax:
• Actual HRA received.
• 50% of salary (for metro cities) or 40% of salary (for non-metro cities).
• Rent paid minus 10% of salary.

Notes:

• Salary includes basic salary + DA (if part of retirement benefits) + commission (if based on fixed percentage).
  • If the employee resides in their own house or does not pay rent, no exemption is allowed.

(b) Special Allowances [Section 10(14)]:

These allowances are granted for specific official purposes.

Examples:

1. Travel allowance for official tours.
2. Uniform allowance for purchasing and maintaining uniforms.
3. Research allowance for academic or professional research.

Taxability: Exempt to the extent they are used for the intended purpose.

3. Fully Exempt Allowances

These allowances are completely exempt from tax:

1. Allowances to Supreme Court/High Court Judges:
   • Specific allowances provided to judges of the Supreme Court and High Courts are fully exempt under the Act.
2. Allowances to UNO Employees:
   • Allowances paid to employees of the United Nations Organization (UNO) are fully exempt from tax, as per special provisions.
3. Foreign Service Allowance:
   • Paid to government employees serving abroad to meet their expenses in foreign countries.
4. Practical Example of HRA Exemption

Suppose an employee receives the following:

• Basic Salary: ₹30,000/month
• DA (forming part of retirement benefits): ₹5,000/month
• HRA: ₹12,000/month
• Rent Paid: ₹15,000/month

Exemption Calculation:

1. Actual HRA received: ₹12,000/month = ₹1,44,000/year.
2. 50% of salary (metro city): ₹17,500/month = ₹2,10,000/year.
3. Rent paid minus 10% of salary: ₹15,000 – ₹3,500 = ₹11,500/month = ₹1,38,000/year.

Least of the above: ₹1,38,000 is exempt, and ₹6,000 (₹1,44,000 – ₹1,38,000) is taxable.

This detailed structure helps taxpayers optimize their tax liabilities while remaining compliant with the Income Tax Act.

Leave Encashment (Section 10(10AA))

Leave encashment is the payment an employee receives when they are unable to avail of their leave (whether casual or earned leave) and the leave is converted into cash. Under the Income Tax Act, 1961, the taxability of leave encashment varies based on whether the employee is a Government or Non-Government employee.[12]

Tax Treatment of Leave Encashment (Section 10(10AA))

1. For Government Employees:
   • Fully Exempt: Leave encashment received by government employees is completely exempt from tax. This exemption is available under Section 10(10AA) of the Income Tax Act, irrespective of the amount of leave encashed or the duration of service. This exemption applies to all government employees, including central and state government employees, as well as employees of local authorities.
2. For Non-Government Employees:
   • Exemption for Non-Government Employees: Leave encashment is partially exempt from tax for non-government employees. The exempt portion is the least of the following:
     1. ₹3,00,000: The maximum amount of leave encashment that can be exempted for non-government employees is ₹3,00,000. This is the upper limit for exemption under Section 10(10AA).
     2. Actual Leave Encashment Received: The actual amount of leave encashment received by the employee during the financial year. However, this is subject to the maximum exemption limit of ₹3,00,000.
     3. 10 Months’ Average Salary: This is calculated by taking the average of the salary (basic salary + dearness allowance, if part of retirement benefits) for the last 10 months immediately preceding the date of retirement or cessation of employment.
     4. Cash Equivalent of Leave (Based on 30 Days per Year of Service): This refers to the number of days of leave that the employee has accumulated (subject to a maximum of 30 days per year of service) and the cash value of those days based on the average monthly salary.

Advance Salary

Advance salary refers to the salary that an employee receives before the due date or before it has been earned. Advance salary is taxable in the year it is actually received, regardless of whether the salary pertains to that year or a future year[13]. For example, if an employee receives salary in advance for the next year, the entire amount will be included in the taxable income of the year in which the advance is received. Section 89 provides relief for income that is received in advance, which could otherwise cause a higher tax burden due to a lump sum being taxed in a single year. Under this section, an employee can request tax relief by spreading the advance salary over the years to which it pertains, thereby reducing the overall tax burden by bringing the salary into the relevant tax periods. To claim relief under Section 89, the employee must file a Form 10E to disclose the income received in advance and the relief calculation.

Arrears of Salary

Arrears of salary are payments made for a salary that was due in a previous year but paid in the current year. These arrears are typically received due to delayed salary payments, promotions, or pay revisions. Arrears of salary are taxable in the year in which they are received, even though they pertain to previous years. This means that if salary for a past year is paid in a subsequent year, it will be included in the taxable income for the year of receipt. If an employee receives arrears of salary in a year, it may result in higher taxation due to a large sum being added to the income in that particular year. To mitigate this, Section 89 provides relief to the taxpayer. The employee can request relief by spreading the arrears over the years to which they relate, so that they are taxed in smaller chunks rather than in one go, thus reducing the total tax payable. To avail of this relief, the employee must file Form 10E and calculate the tax impact, which is then adjusted through the income tax return.

Example:
An employee received ₹1,00,000 as arrears for salary in 2024 that pertains to 2023. The employee will be taxed in 2024, but they can claim relief under Section 89 to spread the ₹1,00,000 over the two years, potentially reducing the tax liability.

Profits in Lieu of Salary (Section 17(3))

Profits in lieu of salary under Section 17(3) include any monetary benefits an employee receives that are related to their employment but are not categorized directly as salary. These are typically lump-sum payments or other forms of compensation related to the cessation of employment or benefits due to employment.[14]

Profits in lieu of salary include:

1. Compensation for Termination of Employment: This refers to the payment made by the employer to the employee as compensation for the termination of employment. This may include severance pay, redundancy payments, or any settlement made due to the termination. Such compensation is fully taxable under the head Income from Salary. The taxability of such payments depends on whether they are specifically excluded under any other provisions (for example, payments under specific labor laws or severance schemes may have different tax treatments).
2. Payments Received under Keyman Insurance Policies: A Keyman insurance policy is a policy taken by a company on the life of an important employee or director. The company is the beneficiary of the policy in the event of the key employee’s death or disability. The payments received from such policies (including the sum received on the death of the insured employee) are considered profits in lieu of salary and are taxable under Section 17(3). [15]The premiums paid by the employer for such policies are not deductible as salary expenses for tax purposes, and the payment received under the policy is considered part of salary income.
3. Any Amount Received in Connection with Employment: Any other sum received by an employee in connection with their employment, which does not fall under the specific categories of salary or allowances, but is essentially a benefit or profit derived from employment, will also be included as profits in lieu of salary.

Perquisites (Section 17(2))

Perquisites refer to benefits or privileges provided by the employer to the employee, in addition to the regular salary. These are non-monetary benefits that enhance an employee’s overall compensation package.[16] Under Section 17(2) of the Income Tax Act, 1961, perquisites are categorized into taxable and exempt perquisites.

• Taxable Perquisites

The following perquisites are fully taxable and included in the employee’s taxable income:

1. Rent-free Accommodation: Rent-free accommodation is provided by the employer to the employee, typically in the form of a residence, without the employee having to pay rent. If the accommodation is provided for residential purposes, it is considered a perquisite. The value of this benefit is determined based on the rules specified under the Income Tax Rules. It is generally calculated as either a percentage of the salary or the actual rent paid by the employer, subject to certain conditions. The value is taxable under the head Income from Salary.
2. Motor Car for Personal Use: A motor car provided by the employer for personal use of the employee is considered a perquisite. The perquisite value of a motor car depends on factors such as whether the car is used for official or personal purposes. If the motor car is used for personal purposes, the employer must calculate the perquisite value, which includes expenses such as fuel, maintenance, insurance, etc. The value of the perquisite is taxable under the head Income from Salary.
3. Employer-paid Club Memberships: Employer-paid memberships to clubs, including social or health clubs, are considered perquisites if the cost of membership is borne by the employer. The cost paid by the employer for club memberships is taxable under the head Income from Salary. This includes membership fees for clubs that offer recreational or health facilities to employees, which are provided as part of the employment perks.
4. Exempt Perquisites

Certain perquisites are exempt from tax under specific conditions, as detailed below:

1. Medical Facilities Provided by the Employer in Specified Hospitals: If the employer provides medical facilities to the employee in hospitals or dispensaries recognized by the government, these facilities are exempt from tax.
   • Exemption Conditions: The exemption applies if the medical treatment is provided in specified hospitals (those recognized by the government or prescribed in the rules). Medical treatment for the employee’s family members is also eligible for exemption if the facilities are provided in the same manner.

This benefit is fully exempt as long as the medical treatment is provided in government-recognized facilities.

2. Education Facilities for Children in Employer-run Schools: If the employer provides education facilities for the children of employees in employer-run schools, the benefit is partially exempt. The exemption is limited to ₹1,000 per month per child for up to two children. If the amount exceeds ₹1,000 per month per child, the excess amount will be taxable as a perquisite.

exemption applies only for children studying in schools run by the employer, and only for two children per employee. If the employer pays for the education of more than two children, the excess amount is subject to tax.

• Tax Treatment of Perquisites
• Calculation of Perquisites: For each perquisite, the employer is required to determine its fair market value, and this value is added to the employee’s total income for tax purposes. Tax on perquisites is calculated based on the applicable tax slab rates, which vary depending on the employee’s total income.
• Form 12BA: Employers must provide a Form 12BA to the employee, detailing all the perquisites provided during the year, along with their value for tax purposes.

Gratuity (Section 10(10))

Gratuity is a lump sum payment made by an employer to an employee in recognition of long-term service. It is typically paid upon retirement, resignation, or in the event of the employee’s death or disability. Gratuity is provided as a reward for an employee’s services to the employer and serves as a form of financial security after retirement.[17]

• Gratuity for Government Employees: For government employees, the entire gratuity amount received is fully exempt from tax. There is no upper limit on the amount of gratuity received by government employees. Section 10(10) of the Income Tax Act, 1961, applies, and the full gratuity amount is excluded from taxable income.
• Gratuity for Non-Government Employees (Covered Under the Gratuity Act): For non-government employees who are covered under the Payment of Gratuity Act, 1972, the exemption is subject to certain conditions.

 The gratuity received by such employees is taxable, but only the least of the following amounts is exempt from tax:

1. ₹20,00,000:
   The maximum exemption limit is ₹20,00,000 for non-government employees. If the gratuity amount exceeds this limit, the excess amount will be taxable. This limit applies irrespective of the employee’s years of service.
2. Actual Gratuity Received:
   The actual amount of gratuity received by the employee will be exempt from tax, but only if it is within the exemption limits specified under the law.
3. 15 Days’ Salary for Each Year of Service:
   The exempt gratuity is also calculated as 15 days’ salary for each year of service, where:
   • Salary is taken to mean basic salary (including dearness allowance, if applicable) for the purpose of calculating the per-day salary.
   • The number of years of service is calculated in full years (i.e., a fraction of the year is ignored).

• Taxability:
  • The amount that exceeds the exempt limit (whichever is the least of the three amounts) will be taxable as income under the head “Income from Salary”.
  • The taxability of gratuity depends on whether the employee is covered under the Payment of Gratuity Act. For employees not covered under this act, the exemption limits are different, and the gratuity received may be fully taxable.

Example of Gratuity Calculation:

Let’s assume an employee with the following details:

• Basic Salary: ₹50,000 per month
• Years of Service: 20 years
• Gratuity Received: ₹10,00,000

To calculate the exempt gratuity:

1. 15 Days’ Salary for Each Year of Service:
   • 15 days’ salary per year = ₹50,00030×15\frac{₹50,000}{30} \times 1530₹50,000​×15 = ₹25,000
   • Total for 20 years = ₹25,000 × 20 = ₹5,00,000
   • The exempt gratuity based on this calculation is ₹5,00,000.
2. Maximum Exemption Limit: ₹20,00,000
   Since the gratuity received (₹10,00,000) is less than ₹20,00,000, this condition does not restrict the exemption.
3. Actual Gratuity Received: ₹10,00,000
   The actual amount received by the employee is ₹10,00,000, which is also less than ₹20,00,000.

• Exempt Gratuity: The least of the three amounts is ₹5,00,000, so the exempt gratuity will be ₹5,00,000.
• Taxable Gratuity: The remaining amount, ₹10,00,000 – ₹5,00,000 = ₹5,00,000, will be taxable under the head Income from Salary.

Gratuity for Non-Government Employees Not Covered Under the Gratuity Act:

For non-government employees not covered under the Gratuity Act, the entire gratuity amount received is taxable unless it qualifies under other exemptions or limits. In such cases, the employee cannot claim the exemption under Section 10(10) and will be taxed on the full gratuity amount.

Gratuity on Death or Disablement:

• Exemption:
  In case of death or disablement of the employee, the gratuity received by the employee’s family members or the employee (in case of disablement) is fully exempt from tax, irrespective of the amount.
• This exemption applies to both government and non-government employees.

11. Leave Travel Concession (LTC) [Section 10(5)]

Leave Travel Concession (LTC) is a benefit provided by employers to their employees to cover travel expenses for personal trips within India. This benefit is partially or fully exempt under Section 10(5) of the Income Tax Act, subject to specific conditions and limitations.

Eligibility Criteria

• The exemption applies only to travel within India.
• Covers expenses for travel by the shortest route to the destination.
• Includes travel for the employee and their family (spouse, children, and dependent parents or siblings).

Conditions for Exemption

1. Frequency of Claims:
   Exemption is available for two journeys in a block of four years. The blocks are predefined by the government, such as 2022-2025.
2. Mode of Travel:
   • Travel by air: Exemption is limited to the economy class fare of a national carrier for the shortest route.
   • Travel by train: Exemption is limited to the first-class fare for the shortest route.
   • Travel by any other mode: Exemption is capped based on equivalent train or air fare for the same distance.
3. Amount of Exemption:
   The exemption is limited to the actual cost of travel, i.e., tickets, excluding other expenses like food, accommodation, or sightseeing.

Unutilized Claims

If an employee does not utilize LTC for one journey during a block, they can carry it forward to the first year of the next block.

Illustration

• An employee travels with their family (spouse and two children) by air for a vacation within India.
  • Actual ticket cost: ₹40,000.
  • Eligible exemption: ₹40,000 (as it falls within the defined limits for air travel).
• If the ticket cost exceeds the specified fare limits, the excess amount will be taxable.

12. Deductions from Salary

Deductions from Salary under Section 16 are specific allowances or payments that are subtracted from the total income under the head “Income from Salary” to arrive at the taxable income. The following deductions are available:

1. Standard Deduction [Section 16(ia)]: A flat deduction allowed to all salaried individuals to cover general employment-related expenses. Amount ₹50,000 (or the actual salary, whichever is lower). The standard deduction replaces earlier exemptions like conveyance allowance and medical reimbursement. It simplifies compliance and reduces the tax burden for employees.If the gross salary of an employee is ₹6,00,000, the standard deduction will reduce the taxable salary to ₹5,50,000.[18]

2. Entertainment Allowance [Section 16(ii)]: Entertainment allowance refers to a payment made by the employer to meet entertainment-related expenses for official purposes.This deduction is available only to government employees.

Amount of Deduction:
The least of the following is allowed as a deduction:

1. ₹5,000.
   1. 20% of basic salary (excluding allowances, perquisites, and other benefits).
   1. Actual entertainment allowance received.

• Taxability for Non-Government Employees:
  Entertainment allowance received by non-government employees is fully taxable, and no deduction is allowed.

Example:

• Basic salary: ₹2,40,000.
• Entertainment allowance received: ₹8,000.
• Deduction:
  • ₹5,000 (least of ₹5,000, ₹48,000 [20% of ₹2,40,000], and ₹8,000).
• Taxable allowance: ₹3,000 (₹8,000 – ₹5,000).

3. Tax on Employment [Section 16(iii)] : Tax on employment, also known as professional tax, is a state-level tax levied on individuals earning income through employment or profession. The amount of professional tax actually paid by the employee during the financial year is allowed as a deduction from their gross salary. Limit for the professional tax cannot exceed ₹2,500 per annum, as prescribed by state laws. If an employee pays ₹2,400 as professional tax in a year, the same amount will be deducted from their gross salary.

Conclusion
In conclusion, the income under the “Salary” head forms a critical component of an individual’s taxable income under the Income Tax Act, 1961. It encompasses all monetary benefits, allowances, perquisites, and other payments received by an employee from their employer in consideration of services rendered. Accurate computation of salary income requires a thorough understanding of the inclusions, exclusions, and specific provisions, such as exemptions under Section 10, standard deduction under Section 16, and the tax treatment of allowances and perquisites.

Employees must ensure compliance with tax regulations while leveraging permissible deductions and exemptions to minimize their tax liability. Simultaneously, employers bear the responsibility of accurately withholding taxes under the Tax Deducted at Source (TDS) mechanism to avoid penalties.

By comprehending the legal framework governing salary income, taxpayers can ensure proper planning, compliance, and optimized financial management within the boundaries of the law.

[1] Income Tax Act, 1961, ClearTax, https://cleartax.in/s/income-tax-act-1961 (last visited Jan. 4, 2025).

[2] Taxation System (North India till 600 CE), ePG Pathshala, https://epgp.inflibnet.ac.in/epgpdata/uploads/epgp_content/S000829IC/P001771/M024008/ET/1507700873P10-M06-TaxationSystem(NorthIndiatill600CE-ET.pdf (last visited Jan. 4, 2025).

[3] https://unacademy.com/content/upsc/study-material/medieval-india/firuz-tughluq/ (last visited Jan. 4, 2025).

[4] Dahsala System of Mughal Empire of Akbar – Medieval India History Notes, Prepp, https://prepp.in/news/e-492-dahsala-system-of-mughal-empire-of-akbar-medieval-india-history-notes (last visited Jan. 4, 2025).

[5] , https://law.uok.edu.in/Files/5ce6c765-c013-446c-b6ac-b9de496f8751/Custom/unit_1_of_income_tax.pdf (last visited Jan. 4, 2025).

[6] Types of Taxes in India: Direct and Indirect Tax, ClearTax, https://cleartax.in/s/types-of-taxes-in-india-direct-and-indirect-tax (last visited Jan. 4, 2025).

[7] Heads of Income: What Are the Different Heads of Income Under Income Tax?, TaxBuddy, https://www.taxbuddy.com/blog/heads-of-income-what-are-the-different-heads-of-income-under-income-tax#:~:text=Income%20from%20Salaries,-Amongst%20the%205&text=Section%2015%20to%20Section%2017,the%20employee%20while%20on%20employment. (last visited Jan. 4, 2025).

[8] Section 17(1): Definition of Salary Under the Income Tax Act, ClearTax, https://cleartax.in/s/section-171-definition-of-salary-under-the-income-tax-act (last visited Jan. 4, 2025).

[9] ibid

[10] Income Under the Head Salary,  https://www.hostbooks.com/in/hb/income-under-the-head-salary/#:~:text=Basis%20of%20charge%20(Section%2015)&text=Salary%20is%20chargeable%20to%20tax,in%20which%20it%20becomes%20due. (last visited Jan. 4, 2025).

[11] Taxable, Non-Taxable, and Partially Taxable Components of Salary in India, Webtel, https://webtel.in/Blog/Taxable-Non-taxable-and-Partially-Taxable-Components-of-Salary-in-India/3384 (last visited Jan. 4, 2025).

[12] Leave Encashment, Zoho Payroll, https://www.zoho.com/in/payroll/academy/payroll-administration/leave-encashment.html (last visited Jan. 4, 2025).

[13] Advance Tax, ClearTax, https://cleartax.in/s/advance-tax (last visited Jan. 4, 2025).

[14] Profits in Lieu of Salary (Section 17(3)), Vakilsearch, https://vakilsearch.com/blog/profits-in-lieu-of-salary-section-173/ (last visited Jan. 4, 2025).

[15] Section 17(3) of Income Tax Act, Tax2Win, https://tax2win.in/guide/section-17-3-of-income-tax-act (last visited Jan. 4, 2025).

[16] Perquisites in Income Tax, ClearTax, https://cleartax.in/s/perquisites-in-income-tax (last visited Jan. 4, 2025).

[17] Gratuity, BankBazaar, https://www.bankbazaar.com/tax/gratuity.html (last visited Jan. 4, 2025).

[18] Standard Deduction on Salary, ClearTax, https://cleartax.in/s/standard-deduction-salary (last visited Jan. 4, 2025).

By Lexosphere