Income from Salary (Part I) View Second Part >>

The salaried class of taxpayers forms the bulk of taxpayers in India and they pay tax mostly through TDS deducted and deposited by their employer. The employer deducts tax and issues them Form 16 which contains details of incomes of various kinds, tax deductions, taxes due, and taxes paid. For most of the taxpayers, this Form 16 forms the basis for filing I-T Return. There is nothing wrong with that. However, it may be true that Form 16 may not always give the correct picture of your incomes and deductions. The taxbuddy.com has found that often the salaried taxpayers overstate their income in Form 16 and understate their deductions and end up paying more tax than due. But by asking more questions and scrutinizing in detail, the TaxBuddy has saved more taxes for salaried taxpayers. In order to do that, you must be thoroughly aware of the categories of incomes that salaried taxpayer earns, the different kinds of exemptions that are available to him, and the tax deductions that can be claimed by him.

What is meant by Salary income?
The salary is the remuneration received by an individual against the services to his employer as per the terms of service (letter of appointment). It is important to remember that even if a receipt in the hands of an individual is named as salary or remuneration, the same may not be qualified as ‘salary income’ within the meaning of the Income Tax Act. There must exist a relationship of employer-employee or master-servant between the payer and payee of the remuneration.

Components of Salary Income
The payslip issued by your employer to you is evidence that you are paid salary income by the employer. You must have seen that the payslip does not contain only a single entry like ‘Salary for this month: xxxxx’. However, it contains a detailed break-up of the salary income into different components like basic salary, dearness allowance, transport allowance, house rent allowance, etc. These are well-recognized components and the taxability of different components of salary income is different. The taxability of a salary component means how many portions of it is taxable and what are the eligibility conditions to claim a certain portion as tax-free.

Basic Salary
This is the wages for the work done or services rendered by an employee to an employer through an employer-employee relationship. This is mentioned in the payslip of an employee as a basic salary. This is fully taxable as Income from salary. Sometimes, the basic salary is received as an advanced salary. This amount of advance salary is taxed on the receipt basis however, sometimes the basic salary is received for the services rendered by the employee in past. Such a salary is called as ‘arrear salary’. This is fully taxable in the year in which it is received on receipt basis if it is not taxed in the year when it was due. However, the taxpayer can claim tax rates relief under section 89 of the IT Act.

Dearness Allowance (DA)
The cost of living increases during a period and such an increase is called ‘inflation’. In order to offset the effects of inflation, the employer pays Dearness Allowance (DA) to the employees. The DA is paid generally paid by the Government to its employees and the employees in public sector units. The DA is computed as a percentage of basic salary. The Dearness Allowance is fully taxable as a part of the basic salary.The amount of basic salary and DA is often needed for computation of various allowances under the head of income from salaries.

House Rent Allowance
The salaried employees who live in rented accommodation tend to receive House Rent Allowance from their employer to meet the expenses on rent for accommodation. Such an allowance is a part of salary and is indicated separately in the salary slip. The total amount of HRA received in one year or the period of the year with a particular employer (if employment is for a part of the year with a particular employer) is mentioned separately in Form No. 16. The entire amount of HRA is not taxable in all cases. For TDS to be done by your employer, you must provide the correct amount of taxable HRA to the employer for inclusion in the taxable salary on which TDS is deducted. The tax-free amount of HRA shall be least of the following:

  • The amount of HRA received by the employee
  • 50% salary (Basic salary + DA) if an employee is staying in any of the Metropolitan Cities of Mumbai, Delhi, Chennai, and Kolkata
  • 40% salary (Basic salary + DA) if an employee is staying in any city other than these four cities
  • Rent paid by you minus 10% of the salary (Basic salary + DA)

The least of the amounts determined above shall be tax-free and the rest of the amount will be taxable.

Other Common Allowances

Sr. No. Allowance granted by an employer Amount exempt from tax
1. Children education allowance Up to ₹100 per month per child up to a maximum of 2 children is exempt
2 Transport allowance granted to an employee to meet expenditure on commuting between place of residence and place of duty for the blind persons and persons with disability ₹3200 per month for blind and handicapped employees is exempt
3 Conveyance allowance granted to meet the expenditure on conveyance in performance of duties of an office Exempt to the extent of expenditure incurred for official purposes
4 Traveling allowance to meet the cost of travel on tour or on transfer
5 Daily allowance to meet the ordinary daily charges incurred by an employee because of absence from his normal place of duty
6 Helper/Assistant allowance
7 Research allowance granted for encouraging the academic research and other professional pursuits
8 Uniform allowance
9 Any allowance or perquisite paid or allowed by Government to its employees (an Indian citizen) posted outside India Fully Exempt
10 Allowances paid by the UNO to its employees Fully Exempt
11 Special compensatory Allowance (Hilly Areas) (Subject to certain conditions and locations) The amount exempt from tax varies from ₹300 to ₹7,000 per month.
12 Border area, Remote Locality or Disturbed Area or Difficult Area Allowance (Subject to certain conditions and locations) The amount exempt from tax varies from ₹200 to ₹1,300 per month.
13 Tribal area allowance in (a) Madhya Pradesh (b) Tamil Nadu (c) Uttar Pradesh (d) Karnataka (e) Tripura (f) Assam (g) West Bengal (h) Bihar (i) Orissa Up to ₹200 per month is exempt
14 Compensatory Field Area Allowance. If this exemption is taken, the employee cannot claim any exemption in respect of border area allowance (Subject to certain conditions and locations) Up to ₹2,600 per month is exempt
15 Compensatory Modified Area Allowance. If this exemption is taken, an employee cannot claim any exemption in respect of border area allowance (Subject to certain conditions and locations) Up to ₹1,000 per month is exempt
16 Counter Insurgency Allowance granted to members of Armed Forces operating in areas away from their permanent locations. If this exemption is taken, the employee cannot claim any exemption in respect of border area allowance (Subject to certain conditions and locations) Up to ₹3,900 per month is exempt
17 Underground Allowance to employees working in uncongenial, unnatural climate in underground mines Up to ₹800 per month is exempt
18 High Altitude Allowance granted to armed forces operating in high altitude areas (Subject to certain conditions and locations) a) Up to ₹1,060 per month (for altitude of 9,000 to 15,000 feet) is exempt
19 High Altitude Allowance granted to armed forces operating in high altitude areas (Subject to certain conditions and locations)

Highly active field area allowance granted to members of armed forces (Subject to certain conditions and locations)

b) Up to ₹1,600 per month (for altitude above 15,000 feet) is exempt
20 High Altitude Allowance granted to armed forces operating in high altitude areas (Subject to certain conditions and locations) Up to ₹4,200 per month is exempt
21 Island Duty Allowance granted to members of armed forces in Andaman and Nicobar and Lakshadweep group of Island (Subject to certain conditions and locations) Up to ₹3,250 per month is exempt
22 Island Duty Allowance granted to members of armed forces in Andaman and Nicobar and Lakshadweep group of Island (Subject to certain conditions and locations)

Action Points:
While negotiating your salary package with your employer, you may keep the tax efficiency of the package in mind. The allowances which are partly taxable or tax-free may be increased in the package and the allowances which are fully taxable may be reduced in the package so that the tax outgo may be minimized to the possible extent.