Table of Contents

Introduction..................................................................................................... 2

Heads of Income.............................................................................................. 2

Meaning of Salary............................................................................................ 3

Place of Accrual Salary.................................................................................... 4

Salary u/s 17(1) of Income Tax Act, 1961........................................................4

Profit in lieu of Salary [Sec- 17(3)]...................................................................5

Income forming part of salary.........................................................................5

Basis of Charge............................................................................................... 9

Advance Salary.............................................................................................. 10

Arrear of Salary............................................................................................. 10

Annuity.......................................................................................................... 10

Gratuity [Section 10(10)]............................................................................... 10

Pension [Section 17(1)(ii)].............................................................................11

Provident Fund............................................................................................... 13

HOUSE RENT ALLOWANCE [Sec. 10(13A) Rule 2A]........................................14

Bibliography.................................................................................................. 15

 Introduction
Income means a receipt in the form of money or moneys worth which is
derived from definite source with some sort of regularity or expected
regularity. These definite sources of income are salaries, house property,
business or profession, capital gains and any other source. If an income is
not derived from any of these sources, it is not taxable under the Income
Tax Act, 1961 (hereinafter referred as Act). For example, if a person finds
a purse containing Rs.1000 on road, it is not treated as income since it is
not received from any definite source.
The scope of total income is determined with reference to residential
status of a person i.e. total income of each person is based on his
residential status. Once we know what incomes of a person are taxable,
then we need to know how to compute total taxable income according to
the provisions of Income Tax Act.
The project work starts with the classification of incomes into various
heads. This project is devoted to the first and most important head of
income Salaries. The lesson is divided into various sections. First we
define the concept of salary income i.e. what are the characteristics, which
make an income fall under this head. Then, incomes falling under this
head are enumerated, followed by the detailed descriptions of income tax
provisions regarding three of these incomes.

Heads of Income
Income of a person is classified into 5 categories. Thus, income belonging
to a particular category is taxed under a separate head of income
pertaining to that category. Section 14 of the Act, has classified five
different heads of income for the purpose of computation of total income.
The five heads of income are:
i. Income under the head salaries (Section 15 17)
ii.
Income from house property (Section 22 27)
iii.
Profits and gains from business or profession (Section 28 44)
iv.
Capital gains (Section 45 55)
v. Income from other sources (Section 56 59)
It may be noted here that an income belonging to a specific head must be
computed under that head only. If an income cannot be placed under any
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of the first four heads, it will be taxed under the head Income from other
sources. Certain expenses incurred in earning incomes under each head
are allowed to be deducted from its gross income according to the
provisions applicable to that specific head. Then, the net income under
various heads is aggregated together to compute gross total income of the
person. After making certain deductions which are allowed from gross total
income (relating to certain expenses incurred or payments made or certain
incomes earned) we arrive at the figure of total income for taxation
purpose.

Meaning of Salary
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 taxed under business or profession head. In order to
understand what is included in salary, let us discuss few characteristics of
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).
Section 15, 16 and 17 of the Income Tax Act deal with the computation of
income under the head Salaries.
(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.
(2) Full-time or part-time employment:
It does not matter whether the employee is a fulltime employee or a parttime 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 or Sacrificing 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.
(4) Surrender of salary:
However, if an employee surrenders his salary to the Central Government
u/s 2 of the Voluntary Surrender of Salaries (Exemption from Taxation) Act,
1961, the salary so surrendered would be exempt while computing his
taxable income.
(6) Voluntary payments:
Whether the payment from an employer is based on a contract or not, it
constitutes salary in the hands of the employee. However, many
employers give personal gifts and testimonials to the employees. For
example, employees who complete 20 years of service may be given a
wrist watch. The question arises whether the value of the watch can be
taxed in the hands of the employee. Courts have taken the view that such
gifts are not taxable. However, in these cases it is important that such
gifts must be given to employees pursuant to a scheme applicable to
employees in general. If gifts are given purely on a selective basis they will
become chargeable in the hands of the recipient. However, due to the levy
of Fringe Benefit Tax, these gifts will now be exempt in the hands of the
recipient, but will be taxable in the hands of the employer.

Place of Accrual Salary

The place of accrual of salary is the place of employment. Under section
9(1)(ii), salary earned 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.

Salary u/s 17(1) of Income Tax Act, 1961

Salary under section 17(1), includes the following:
I.
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, (v) any advance of salary,

V.

any payment received in respect of any period of leave not availed

VI.

by him i.e. leave salary or leave encashment,

the portion of the annual accretion in any previous year to the
balance at the credit of an employee participating in a recognised

VII.

provident fund to the extent it is taxable and

transferred balance in recognized provident fund to the extent it is

VIII.

taxable,
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 80CCD.

Profit in lieu of Salary [Sec- 17(3)]

It includes the following:
(i) The amount of any compensation due to or received by an assessee
from his employer or former employer at or in connection with the
termination of his employment.
(ii) The amount of any compensation due to or received by an assessee
from his employer or former employer at or in connection with the
modification of the terms and conditions of employment. Usually, such
compensation is treated as a capital receipt. However, by virtue of this
provision, the same is treated as a revenue receipt and is chargeable as
salary.
NOTE- It is to be noted that merely because a payment is made by an
employer to a person who is his employee does not automatically fall
within the scope of the above provisions. The payment must be arising
due to master-servant relationship between the payer and the payee. If it
is not on that account, but due to considerations totally unconnected
with employment, such payment is not profit in lieu of salary.
(iii) Any payment due to or received by an assessee from his employer or
former employer from a provident or other fund, to the extent to which it
does not consist of employees contributions or interest on such
contributions.
(iv) Any sum received by an assessee under a Keyman Insurance policy
including the sum allocated by way of bonus on such policy.
(v) Any amount, whether in lump sum or otherwise, due to the assessee
or received by him, from any person (a) before joining employment with that person, or
(b) after cessation of his employment with that person.
(vi) Any other sum received by the employee from the employer.

 Income forming part of salary

Section 17 of the Act gives an inclusive definition of salary. Broadly, it
includes:
i.
Basic Salary
All employees are entitled to a basic salary which is fixed as per
their respective terms of employment either as a fixed amount or
at a graded system of salary. Under this graded system, apart from
the basic salary at which the employee will start, annual
increments to be given to the employee are pre fixed in the grade.
For example, if a person is employed on 1st May, 2004 in the grade
of 12000 300 15000, this means that he will start at a basic
salary of Rs.12000 from 1st May, 2004. He will get an annual
increment of Rs.300 w.e.f. 1st May, 2005 and onwards every year
on the same date till his basic salary reaches Rs.15, 000. No further
increment is given thereafter till he is promoted and placed in other
ii.

grade.
Fees, Commission & Bonus
Any fees or commission paid or payable to an employee is fully
taxable and is included in salary. Commission payable may be at a
fixed amount or a fixed percentage of turnovers. In both the cases,
it is taxable as salary only when it is paid or payable by the
employer to the employee. When commission is based on fixed
percentage of turnover achieved by employee, it is included in
basic salary for the purpose of grant of retirement benefits and for

iii.

computing certain exemptions that we will discuss later on.

Taxable Value of Allowance
Allowance is a fixed monetary amount paid by the employer to the
employee (over and above basic salary) for meeting certain
expenses, whether personal or for the performance of his duties.
These allowances are generally taxable and are to be included in
gross salary unless specific exemption is provided in respect of
such allowance. For the purpose of tax treatment, we divide these
allowances into 3 categories:
Fully Taxable Allowances
This category includes all the allowances, which are fully taxable.
So, if an allowance is not partially exempt or fully exempt, it gets

included in this category. The main allowances under this

category are enumerated below: (i) Dearness Allowance and
Dearness PayAs is clear by its name, this allowance is paid to compensate the
employee against the rise in price level in the economy. Although
it is a compensatory allowance against high prices, the whole of it
is taxable. When a part of Dearness Allowance is converted into
Dearness Pay, it becomes part of basic salary for the grant of
retirement benefits and is assumed to be given under the terms
of employment.
(ii) City Compensatory Allowance
This allowance is paid to employees who are posted in big cities.
The purpose is to compensate the high cost of living in cities like
Delhi, Mumbai etc. However, it is fully taxable.
(iii) Tiffin / Lunch Allowance
It is fully taxable. It is given for lunch to the employees.
(iv) Non practicing Allowance
This is normally given to those professionals (like medical
doctors, chartered accountants etc.) who are in government
service and are banned from doing private practice. It is to
compensate them for this ban. It is fully taxable.
(v) Warden or Proctor Allowance
These allowances are given in educational institutions for working
as a Warden of the hostel or as a Proctor in the institution. They
are fully taxable.
(vi) Deputation Allowance
When an employee is sent from his permanent place of service to
some place or institute on deputation for a temporary period, he
is given this allowance. It is fully taxable.
(vii) Overtime Allowance
When an employee works for extra hours over and above his
normal hours of duty, he is given overtime allowance as extra
wages. It is fully taxable.
(viii) Fixed Medical Allowance
Medical allowance is fully taxable even if some expenditure has
actually been incurred for medical treatment of employee or
family.
(ix) Servant Allowance
It is fully taxable whether or not servants have been employed by
the employee.
(x) Other allowances
There may be several other allowances like family allowance,
project allowance, marriage allowance, education allowance, and
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holiday allowance etc. which are not covered under specifically

exempt category, so are fully taxable.
Partial Exempt Allowance
This category includes allowances which are exempt upto certain
limit. For certain allowances, exemption is dependent on amount
of allowance spent for the purpose for which it was received and
for other allowances, there is a fixed limit of exemption.
(i) House Rent Allowance (H.R.A.)
An allowance granted to a person by his employer to meet
expenditure incurred on payment of rent in respect of residential
accommodation occupied by him is exempt from tax to the extent
of least of the following three amounts:
a) House Rent Allowance actually received by the assessee
b) Excess of rent paid by the assessee over 10% of salary due to
him
c) An amount equal to 50% of salary due to assessee (If
accommodation is situated in Mumbai, Kolkata, Delhi, Chennai)
Or an amount equal to 40% of salary (if accommodation is
situated in any other place).
Salary for this purpose includes Basic Salary, Dearness Allowance
(if it forms part of salary for the purpose of retirement benefits),
Commission based on fixed percentage of turnover achieved by
the employee.
(ii) Entertainment Allowance
This allowance is first included in gross salary under allowances
and then deduction is given to only central and state government
employees under Section 16(ii).
(iii) Special Allowances for meeting official expenditure
38 Certain allowances are given to the employees to meet
expenses incurred exclusively in performance of official duties
and hence are exempt to the extent actually incurred for the
purpose for which it is given. These include travelling allowance,
daily

allowance,

conveyance

allowance,

helper

allowance,

research allowance and uniform allowance.

(iv) Special Allowances to meet personal expenses
There are certain allowances given to the employees for specific
personal purposes and the amount of exemption is fixed i.e. not
dependent on actual expenditure incurred in this regard. These
allowances include:
a) Children Education Allowance

This allowance is exempt to the extent of Rs.100 per month per

child for maximum of 2 children (grand children are not
considered).
b) Children Hostel Allowance
Any allowance granted to an employee to meet the hostel
expenditure on his child is exempt to the extent of Rs.300 per
month per child for maximum of 2 children.
c) Transport Allowance
This allowance is generally given to government employees to
compensate the cost incurred in commuting between place of
residence and place of work. An amount uptoRs.800 per month
paid is exempt. However, in case of blind and orthopaedically
handicapped persons, it is exempt up to Rs. 1600p.m.
d) Out of station allowance
An allowance granted to an employee working in a transport
system to meet his personal expenses in performance of his duty
in the course of running of such transport from one place to
another is exempt upto 70% of such allowance or Rs.6000 per
month, whichever is less.
Fully Exempt Allowances
(i) Foreign allowance
This allowance is usually paid by the government to its
employees being Indian citizen posted out of India for rendering
services abroad. It is fully exempt from tax.
(ii) Allowance to High Court and Supreme
Court Judges of whatever nature are exempt from tax.
(iii) Allowances from UNO organisation to its employees are fully
exempt from tax.

Basis of Charge
1. Section 15 deals with the basis of charge. Salary is chargeable to tax
either on due basis or on receipt basis, whichever is earlier.
2. However, where any salary, paid in advance, is assessed in the year of
payment, it cannot be subsequently brought to tax in the year in which it
becomes due.
3. If the salary paid in arrears has already been assessed on due basis,
the same cannot be taxed again when it is paid.

Advance Salary
Advance salary is taxable when it is received by the employee
irrespective of the fact whether it is due or not. It may so happen that
when advance salary is included and charged in a particular previous
year, the rate of tax at which the employee is assessed may be higher
than the normal rate of tax to which he would have been assessed.
Section 89(1) provides for relief in these types of cases.

Arrear of Salary
Normally speaking, salary arrears must be charged on due basis.
However, there are circumstances when it may not be possible to bring
the same to charge on due basis. For example if the Pay Commission is
appointed by the Central Government and it recommends revision of
salaries of employees, the arrears received in that connection will be
charged on receipt basis. Here, also relief under section 89(1) is
available.

Annuity
1. As per the definition, annuity is treated as salary. Annuity is a sum
payable in respect of a particular year. It is a yearly grant. If a person
invests some money entitling him to series of equal annual sums, such
annual sums are annuities in the hands of the investor.
2. Annuity received by a present employer is to be taxed as salary. It
does not matter whether it is paid in pursuance of a contractual
obligation or voluntarily.
3. Annuity received from a past employer is taxable as profit in lieu of
salary.
4. Annuity received from person other than an employer is taxable as
income from other sources.

Gratuity [Section 10(10)]

Gratuity is a voluntary payment made by an employer in appreciation of
services rendered by the employee. Now-a-days gratuity has become a
normal payment applicable to all employees. In fact, Payment of Gratuity
Act, 1972 is a statutory recognition of the concept of gratuity. Almost all
employers enter into an agreement with employees to pay gratuity.

10

Exemption when Gratuity Received Under the Payment of Gratuity Act,

1972Gratuity act 1972 is applicable to an establishment where 10 or more
employees are employed during the financial year. If on a single day, an
establishment has employed more than 10 or more employees then this
gratuity act will be applicable to them. Once gratuity act 1972 is
applicable it will continue to be applicable even though numbers of
employees are reduced below 10. In case the employee is covered under
gratuity act 1972, the least of the followings will be exempted and
gratuity in excess of the exemption limit will be taxable in the hands of
employee.
1. Gratuity actually received
2. Rs. 10, 00,000
3. 15 days of salary for every completed year of service or part there of
in excess of 6 months (15/26 * last drawn salary * length of service).
Exemption when Employee is not covered under payment of Gratuity Act
In other cases, where the employee receive gratuity due to his
retirement, death, termination, resignation or being incapacitated prior to
his death then the least of the followings will be exempted
1. 10, 00,000
2. Half months average salary for each completed year of service
3. Gratuity actually received After the above exemption if anything left
out then that amount will be taxable under the head salary in the hand of
employee who received it.

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Pension [Section 17(1)(ii)]

Concise Oxford Dictionary defines pension as a periodic payment made
especially by Government or a company or other employers to the
employee in consideration of past service payable after his retirement.
Commuted pension: Commutation means inter-change. Many persons
convert their future right to receive pension into a lump sum amount
receivable immediately. For example, suppose a person is entitled to
receive a pension of say ` 2000 p.m. for the rest of his life. He may
commute th i.e. 25% of this amount and get a lump sum of say `
30,000. After commutation, his pension will now be the balance 75% of `
2,000 p.m. = ` 1,500 p.m.
i.
Commuted pension received by employee of local authority,
Government organisation or statutory corporation under Civil
Pensions (Commutation) rules of the Central Government or under
any other similar scheme is wholly exempted from tax as per
Section 10(10A). Also in following cases pension is exempted from
Tax.
Pension received from UNO by employee or his/her family
members.
Judges of High Court and Supreme Court
Family pension received by family members of armed forces.
ii.
Commuted pension received by any other employee:
Employee receives Gratuity also: In case employee receive
gratuity along with pension, commuted value of one-third of
pension which normally he/she is entitled to receive is exempt
from tax.
Employee doesnt receive Gratuity: Commuted value of one-half
of such pension is exempt from tax.
When pension amount received by employee exceed exemption limit
as mentioned above, such exceed amount is liable to tax when it is
due or paid. Family pension received by family members of employee
is taxable in the hands of recipients under head Income from other
Sources and not under head Income from Salary.

12

Provident Fund
Provident fund scheme is a scheme intended to give substantial
benefits to an employee at the time of his retirement. Under this
scheme, a specified sum is deducted from the salary of the employee as
his contribution towards the fund. The employer also generally
contributes the same amount out of his pocket, to the fund. The
contribution of the employer and the employee are invested in
approved securities. Interest earned thereon is also credited to the
account of the employee. Thus, the credit balance in a provident fund
account of an employee consists of the following:
(i) employees contribution
(ii) interest on employees contribution
(iii) employers contribution
(iv) interest on employers contribution.
The accumulated balance is paid to the employee at the time of his
retirement or resignation. In the case of death of the employee, the same
is paid to his legal heirs. The provident fund represents an important
source of small savings available to the Government. Hence, the Income13

tax Act, 1961 gives certain deductions on savings in a provident fund

account. There are four types of provident funds:
(i) Statutory Provident Fund (SPF)
(ii) Recognised Provident Fund (RPF)
(iii) Unrecognised Provident Fund (URPF)
(iv) Public Provident Fund (PPF)

House Rent Allowance [Sec. 10(13a) Rule 2a]

Conditions for claiming exemption:
1. Assessee is in receipt of HRA
2. Pays rent
3. Rent paid is more than 10% of salary.
Very Important:
1. The exemption shall be calculated on the basis of where the
accommodation is situated.
2. If the place of employment is the same for the whole year, then
exemption shall be calculated for the whole year.
3. If there is a change in place during the previous year, then it will be
calculated on a monthly basis.
4. Exemption should be calculated in respect of the period during which
rental accommodation is occupied by the employee during the previous
year.
5. Salary for the period during which rental accommodation is not
occupied shall not be considered.

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15

 Bibliography
1. Dr. Girish Ahuja & Dr. Ravi Gupta, Taxation Laws, Third Edition,
2014.
2. http://www.managementparadise.com/forums/taxation-financialservices/22811-income-under-head-salaries.html
3. http://taxguru.in/income-tax/tax-treatment-income-salary.html
4. http://www.icaiknowledgegateway.org/littledms/folder1/chapter-4income-from-salaries.pdf

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