DR.

RAM MANOHAR LOHIA

NATIONAL LAW UNIVERSITY, LUCKNOW
Academic Session
2016-2017

INCOME TAX LAW

PROJECT
ON
"Exemptions to Salary Heads (allowances) under Section 10
of Income Tax Act, 1961"

Submitted for the Project Work undertaken in the partial fulfillment Of B.A. L.L.B (Hons.) course at
Dr. Ram Manohar Lohia National Law University, Lucknow.

SUBMITTED TO: SUBMITTED BY:

Mr. ANIL SAIN JAY VIKRAM SINGH

Income Tax Law Roll no.64 Section A
DR. RMLNLU, Lucknow B.A LL.B (HONS) Semester VII
 Income Tax Law 2016

ACKNOWLEDGEMENT

I would like to take this opportunity to extend a word of my gratitude to my esteemed

‘Income Tax Law’ teacher Mr. Anil Sain, who had been a constant source of inspiration
for me in the pursuance of this project. Sir has been gracious enough to guide me on the
right path which has enabled me to strengthen my efforts. I may also take this opportunity
to wish the reader of my project a knowledgeable experience. The project has been made
with utmost care & with utmost finesse to see that the information mentioned is to the best
of the accuracy and correctness.

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 Income Tax Law 2016

CONTENTS

INTRODUCTION.................................................................................................................................................................................. 4
CONCEPT OF SALARY....................................................................................................................................................................... 6
IMPORTANT PROVISIONS OF THE IT ACT............................................................................................................................ 10
EXEMPTIONS FROM SALARY INCOME................................................................................................................................... 11
i) Death cum retirement gratuity or any other gratuity: Exempt to the extent specified u/s
10(10).............................................................................................................................................................................................. 11
ii) Commutation of pension - Exempt to the extent as provided in sec. 10(10A)..........................................12
iii) Leave encashment - Exempt to the extent provided in sec. 10(AA)...............................................................13
iv) Retrenchment Compensation - exempt to the extent provided by section 10(10B)..............................13
v) Compensation on voluntary retirement - Exempt to the extent provided by sec. 10(10C).................13
vi) Payment from approved superannuation fund - Exempt under section 10(13)......................................13
vii) House Rent Allowance under Section 10(13A) read with rule 2A.............................................................14
viii) Exemption of pension/family pension to awardees of PVC, MVC and VC under Section
10(18).............................................................................................................................................................................................. 14
CONCLUSION..................................................................................................................................................................................... 15
BIBLIOGRAPHY................................................................................................................................................................................. 16

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 Income Tax Law 2016

INTRODUCTION
Income means a receipt in the form of money or money’s 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 source1.
Income tax is an annual tax on income. The Indian Income Tax Act (Section 4) provides that in respect of
the total income of the previous year of every person, income tax shall be charged for the corresponding
assessment year at the rates laid down by the Finance Act for that assessment year. Section 14 of the
Income tax Act further provides that for the purpose of charge of income tax and computation of total
income all income shall be classified under the following heads of income:
A. Salaries
B. Income from house property
C. Profits and gains of business or profession.
D. Capital gains
E. Income from other sources.
The total income from all the above heads of income is calculated in accordance with the provisions of
the Act as they stand on the first day of April of any assessment year.

Salary, as commonly understood, means a fixed payment made periodically as compensation for regular
services rendered. It covers wages paid for manual work, salary paid for clerical jobs and remuneration
paid to executives and managers.
Salary is determined by market pay rates for people doing similar work in similar industries in the same
region. Salary is also determined by the pay rates and salary ranges established by an individual
employer. Salary is also affected by the number of people available to perform the specific job in the
employer's employment locale.
 The following are the essential conditions for income to be treated as salary income:-
there must be relation of employer and employee between the payer of income and receiver of
income.

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 Income Tax Law 2016

 Salary may be from more than one employer.

 Salary may be received from not just the present employer but also a prospective employer and in
some cases even from a former employer for example pension received from a former employer.
 Salary income must be real and not fictitious there must an intention to pay and receive salary.
 Forgoing of salary ie if an employee surrenders his salary to the central government, then the
salary so surrendered will not be treated as taxable income of the employee.
 Salary paid tax free - tax free salary means the salary on which income tax is borne not by the
employee but by the employer. Tax free salary is also taxable in the hands of the employee.

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 Income Tax Law 2016

CONCEPT OF SALARY

 WHAT IS “SALARY”?
Salary is the remuneration received by or accruing to an individual, periodically, for service rendered as a
result of an express or implied contract. The actual receipt of salary in the previous year is not material as
far as its taxability is concerned. The existence of employer-employee relationship is the sine-qua-non for
taxing a particular receipt under the head “salaries”. For instance, the salary received by a partner from
his partnership firm carrying on a business is not chargeable as “Salaries” but as “Profits & Gains from
Business or Profession”. Similarly, salary received by a person as MP or MLA is taxable as “ Income
from other sources”, but if a person received salary as Minister of State/ Central Government, the same
shall be charged to tax under the head “Salaries”. Pension received by an assessee from his former
employer is taxable as “Salaries” whereas pension received on his death by members of his family
(Family Pension) is taxed as “Income from other sources”.

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.

Characteristics of Salary
1. 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.
2. 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.
3. Salary received from employer, whether one or more than one is included in this head.
4. 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.

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 Income Tax Law 2016

5. 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.
The statute enjoins every employer to estimate the liability of tax deductible at source and to deduct tax at
an average rate. For this the employer is required to determine the salary payable to the employee and
accordingly compute the tax liability.
The employer must estimate this tax liability at the very beginning of the financial year in accordance
with the following sequence of steps:
(1) The employer should first compute the gross salary payable to the employee during the year taking
into account any salary received/receivable by the employee from any other employer/former employer.
(2) The gross salary is to be reduced by those payments which are exempt from taxation.
(3) Deductions u/s 16 are to be reduced from the above amount to arrive at the net salary payable.
(4) Income chargeable under any other head as reported by the employee is to be added and accordingly
the gross total income (GTI) is to be computed.
(5) Deduction under Chapter VI-A for which the employee is eligible is to be reduced from gross total
income and thus the total income is to be computed.
(6) On the basis of the rates in force, the tax liability on the total income of the employee is to be
computed.
(7) The tax liability so computed is to be increased by the surcharge payable (if any) and education cess
payable at prescribed rate, to arrive at the total tax payable. 1/12th of this total tax payable is to be
deducted every month by the employer.

 WHAT DOES “SALARY” INCLUDE

Section 17(1) of the Income tax Act gives an inclusive and not exhaustive definition of “Salaries”
including therein
(i) Wages
(ii) Annuity or pension
(iii) Gratuity
(iv) Fees, Commission, perquisites or profits in lieu of salary
(v) Advance of Salary
(vi) Amount transferred from unrecognized provident fund to recognized provident fund
(vii) Contribution of employer to a Recognized Provident Fund in excess of the prescribed limit
(viii) Leave Encashment
(ix) Compensation as a result of variation in Service contract etc.
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 Income Tax Law 2016

(x) Contribution made by the Central 16 Government to the account of an employee under a notified
pension scheme

Meaning of the terms:

 Leave encashment is the salary received by an individual for leave period. It is a chargeable
income whether he is a government employee or not. Under section 10(10AA) (i) there is also a
provision of exemption in case of leave encashment depending upon whether he is a government
employee or other employees.
 Annuity: It is an annual income received by the employee from his employer. It may be paid by
the employer as voluntarily or on account of contractual agreement. It is not taxable until the right
to receive the same arises. Under section 56, Income Tax Act, 1961 other annuities come under a
will or granted by a life insurance company or accruing as a result of contract which comes as
income under from other sources.
 Gratuity: It is salary received by an individual paid by the employee at the time of his retirement
or by his legal heir in the case of death of the employee.
 Allowance: It is the amount received by an individual paid by his/her employer in addition to
salary. Under section 15 of the Income Tax Act, 1961 these allowance are taxable excluding few
condition where they are entitled of deduction/ exemptions2.

Salary is taxable in the year of receipt or in the year of earning of the salary income, whichever is
earlier. i.e. if the salary has been received first, then it will be taxable in the year of receipt. If it has
been earned first but not yet received then it will be taxable in the year of earning. Salary income is
taxable in the hands of individuals only. no other type of person such as a firm or HUF, companies
can earn salary income.

Points to consider:
a) Salary income is chargeable to tax on “due basis” or “receipt basis” whichever is earlier.
b) Existence of relationship of employer and employee is must between the payer and payee to tax the
income under this head.
c) Income from salary taxable during the year shall consists of following:
i. Salary due from employer (including former employer) to taxpayer during the previous year, whether
paid or not;

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 Income Tax Law 2016

ii. Salary paid by employer (including former employer) to taxpayer during the previous year before it
became due;
iii. Arrear of salary paid by the employer (including former employer) to taxpayer during the previous
year, if not charged to tax in any earlier year;
Exceptions – Remuneration, bonus or commission received by a partner from the firm is not taxable
under the head Salaries rather it would be taxable under the head business or profession.

Place of accrual of salary:

a) Salary accrues where the services are rendered even if it is paid outside India;
b) Salary paid by the Foreign Government to his employee serving in India is taxable under the head
Salaries;
c) Leave salary paid abroad in respect of leave earned in India shall be deemed to accrue or arise in India.
Exceptions – If a Citizen of India render services outside India, and receives salary from Government of
India, it would be taxable as salary deemed to have accrued in India3.

IMPORTANT PROVISIONS OF THE INCOME TAX ACT

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 Income Tax Law 2016

 Sec 17 of the act says that basic salary, dearness allowance and bonus, fees or commission is fully
taxable under the act.
 Sec 10 talks about allowances, which is taxable with a few exemptions.
 Section 17 talks about perquisites that are chargeable to income tax.
 Section 16 talks about the deduction from salary.
 The act also talks about retirement benefits, retrenchment compensation, gratuity, pension,
voluntary retirement, provident fund, and other benefits.

Section 192 of the I.T.Act, 1961 provides that every person responsible for paying any income which is
chargeable under the head ‘salary’, shall deduct income tax on the estimated income of the assessee under
the head salaries. The tax is required to be calculated at the average rate of income tax as computed on
the basis of the rates in force. The deduction is to be made at the time of the actual payment. However, no
tax is required to be deducted at source, unless the estimated salary income exceeds the maximum
amount not chargeable to tax applicable in case of an individual during the relevant financial year4.

The statute requires deduction of tax at source from the income under the head salary. As such the
existence of “employer-employee” relationship is the “sine-qua-non” for taxing a particular receipt under
the head salaries. Such a relationship is said to exist when the employee not only works under the direct
control and supervision of his employer but also is subject to the right of the employer to control the
manner in which he carries out the instructions. Thus the law essentially requires the deduction of tax
when;
(a) Payment is made by the employer to the employee.
(b) The payment is in the nature of salary and
(c) The income under the head salaries is above the maximum amount not chargeable to tax.

EXEMPTIONS FROM SALARY INCOME

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 Income Tax Law 2016

Section 10 of the I.T. Act provides for certain categories of payments to be exempt from taxation, either
wholly or partly. Such payments are not to be included under the head ‘salary’ for computing the tax
deductible.
i) Death cum retirement gratuity or any other gratuity: Exempt to the extent specified u/s
10(10).
Any death cum retirement gratuity received by Central and State Govt. employees, Defense
employees and employees in Local authority shall be fully exempt.
Any gratuity received by persons covered under the Payment of Gratuity Act, 1972 shall be
exempt subject to following limits:-
For every completed year of service or part thereof, gratuity shall be paid at the rate of 15
days' salary based on the salary last drawn by the concerned employee. Salary for this purpose
will include basic salary and dearness allowance only. 15 days salary is to be computed by the
formula

Section 10 of the Income Tax defines gratuity as follows:

(i) any death-cum-retirement gratuity received under the revised Pension Rules of the Central
Government or, as the case may be, the Central Civil Services (Pension) Rules, 1972, or under
any similar scheme applicable to the members of the civil services of the Union or holders of
posts connected with defence or of civil posts under the Union (such members or holders being
persons not governed by the said Rules) or to the members of the all-India services or to the
members of the civil services of a State or holders of civil posts under a State or to the employees
of a local authority or any payment of retiring gratuity received under the Pension Code or
Regulations applicable to the members of the defence services ;
(ii) any gratuity received under the Payment of Gratuity Act, 1972 (39 of 1972), to the extent it
does not exceed an amount calculated in accordance with the provisions of sub-sections (2) and
(3) of section 466 of that Act ;
(iii) any other gratuity received by an employee on his retirement or on his becoming
incapacitated prior to such retirement or on termination of his employment, or any gratuity
received by his widow, children or dependants on his death, to the extent it does not, in either
case, exceed one-half month's salary for each year of completed service, [calculated on the basis
of the average salary for the ten months immediately preceding the month in which any such
event occurs, subject to such limit as the Central Government may, by notification in the Official
Gazette, specify in this behalf having regard to the limit applicable in this behalf to the
employees of that Government] :
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Provided that where any gratuities referred to in this clause are received by an employee from
more than one employer in the same previous year, the aggregate amount exempt from income-
tax under this clause [shall not exceed the limit so specified]:
Provided further that where any such gratuity or gratuities was or were received in any one or
more earlier previous years also and the whole or any part of the amount of such gratuity or
gratuities was not included in the total income of the assessee of such previous year or years, the
amount exempt from income-tax under this clause [shall not exceed the limit so specified] as
reduced by the amount or, as the case may be, the aggregate amount not included in the total
income of any such previous year or years.
Thereby it can be referred as:
a) Any Death-cum-Retirement gratuity to Govt. Employees Wholly exempt.
b) Any gratuity received by the employees covered under Payment of Gratuity Act, 1972. Least
of the following is exempt:-
– 15 days salary (7 days in case of seasonal employment) for each completed year of service or
part in excess of 6 months.
– Rs. 3,50,000
– Amount of gratuity actually received
c) Any other gratuity, (not covered under (a) or (b)): Least of the followings is exempt:-
– Rs 3,50,000
– Half month’s salary for each completed year of service
– Amount of gratuity actually received.

ii) Commutation of pension - Exempt to the extent as provided in sec. 10(10A)

In case of employees of Central & State Govt., Local Authority, Defense Services and
corporations established under Central or State Acts, the entire commuted value of pension is
exempt.
In case of any other employee:
a. If the employee receives gratuity, one third of full value of commuted pension will be
exempt from tax under section 10(10A)(ii).
b. If the employee does not receive gratuity, one half of full value of commuted pension will
be exempt from tax under section 10(10A)(iii).

iii) Leave encashment - Exempt to the extent provided in sec. 10(AA).

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 Income Tax Law 2016

Payment by way of leave encashment received by Central & State Govt. employees at the time of
retirement in respect of the period of earned leave at credit is fully exempt.
In case of other employees, the exemption is to be limited to a maximum of 10 months of leave
encashment, based on last 10 months average salary. This is further subject to a limit of Rs.
3,00,000/-.
Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to
the credit of such employee at the time of death is not taxable.
Provided that where any such payments are received by an employee from more than one
employer in the same previous year, the aggregate amount exempt from income-tax under sub-
clause 42 shall not exceed the specified limit i.e. Rs. 300000/-.

iv) Retrenchment Compensation - exempt to the extent provided by section 10(10B).

Retrenchment compensation received by a workman under the Industrial Dispute Act 1947 or
any other Act or Rules is exempt subject to following limits:
a. Compensation calculated @ fifteen days average pay for every completed year of
continuous service or part there of in excess of 6 months.
b. The above is further subject to an overall limit of Rs. 5,00,000/- for retrenchment on or
after 1.1.1997.

v) Compensation on voluntary retirement - Exempt to the extent provided by sec. 10(10C)

Least of the following is exempt from tax:
a. Actual amount received as per the guidelines i.e. least of the following:
3 months salary for each completed year of services
b. Salary at the time of retirement X No. of months of services left for retirement; or
Rs. 5,00,000.
vi) Payment from approved superannuation fund - Exempt under section 10(13).
Approved superannuation fund means superannuation fund which is approved by the
Commissioner of Income-tax. With effect from assessment year 2010-11, employer's
contribution to an approved superannuation fund in excess of Rs. 1,00,000 is charged to tax as
perquisite.
Employee's contribution will qualify for deduction under section 80C and interest on
accumulated balance is not liable to tax. Payments in following cases will be exempt from tax
under section 10(13):

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 Income Tax Law 2016

 Payment on death of beneficiary; or

 Payment to an employee in lieu of, or in commutation of an annuity on his retirement at or after
the specified age or on his becoming incapable prior to such retirement; or
 Refund of contribution to an employee on leaving the service (otherwise than above mentioned
reason) to the extent to which such payment does not exceed the contribution made prior to April
1, 1962.
 By way of refund of contributions on the death of a beneficiary

vii) House Rent Allowance under Section 10(13A) read with rule 2A
a. Persons living in rented house
Any amount of house rent allowance received by the employee from his employer is exempted
upto
 Excess of actual rent paid over 10% of salary,
 An amount eaual to 50% of salary where such accommodation is situated in any one of the
following places, namely Mumbai, Calcutta, Delhi and Madras and 40% of salary in other
places; or
 Actual amount of House Rent Allowance received.
b. Persons living in their own houses or not paying any rent but getting HRA
Full HRA received is taxable. No exemption under this provision.

viii) Exemption of pension/family pension to awardees of PVC, MVC and VC under Section
10(18)
Clause (18) of section 10 provides for exemption of any income by way of pension received by
an individual or family pension received by any member of the family of an individual who has
been in the service of the Central Government or State Government and has been awarded
“Param Vir Chakra” or “Maha Vir Chakra” or “Vir Chakra” or such other gallantry award as may
be specifically notified by the Central Government.5

Thus these are the allowances that are provided under Income Tax Act for salaried individuals.

CONCLUSION
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 Income Tax Law 2016

This project gives a clear idea regarding what constitutes a part of salary. Salary, as commonly
understood, means a fixed payment made periodically as compensation for regular services rendered. It
covers wages paid for manual work, salary paid for clerical jobs and remuneration paid to executives and
managers. Compensation for regular services rendered. It covers wages paid for manual work, salary paid
for clerical jobs and remuneration paid to executives and managers. This project also talks about what
constitutes a salary under this act and how the provisions impose tax liability.
Eventually the project also dwells upon the allowances provided to salaried employees under the Income
Tax Act. It clearly gives out the heads or allowances that are granted under section 10 of the aforesaid
ACT. Apart from enumerating the allowances, a brief understanding and application has also been
discussed about so as to get acquainted with the benefits of the same. It can be seen that the allowances
are useful to salaried employees and certainly essential in many cases. These allowances apart from being
tax saver, are also very huge relief to the individual who has a fix amount of monthly income as sole
source of income.
Therefore the project successfully covers the allowances to salary head specifically in section 10 of the
Act. Also the benefits and effects of the same have talked and discussed.

BIBLIOGRAPHY
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 Income Tax Law 2016

BOOKS REFERRED
 Taxman’s Master Guide to Income Tax Act, Taxman Publications Pvt. Ltd., 19th edn. 2009, New
Delhi.
 Shah Pradeep S., Kadakia Rajesh S., Taxman’s Master Guide to Income Tax Act, (1990), Taxman
Publications Private Ltd., New Delhi.
 Vyas Dinesh, The Law and Practice of Income Tax, (9th Edn. Vol. II 2004), Lexis Nexis
Butterworths, New Delhi.
 Kanga, Palkhivala and Vyas: The Law and Practice of INCOME TAX- Volume-II Ninth Edition
Lexis Nexis Butterworths, New Delhi.
BARE ACTS
 The Income Tax Act, 1961
 The Constitution of India
WEB SOURCES
 http://taxguru.in/income-tax/valuation-of-perquisites-under-the-income-tax-act-and-rules-for-the-
salaried-employees-for-a-y-2010-2011.html
 http://www.sitcinfo.com/content/directTaxes/decisions/displayNamDetails.asp?
rCase=V+K+Prasad+%40+Ors.+Vs.+Union+of+India+
%40+Ors.&GoToRec=1&Scroll=Move
 http://www.incometaxindia.gov.in/booklets%20%20pamphlets/tds-on-salaries.pdf
 http://taxguru.in/income-tax/tax-treatment-income-salary.html
 http://www.citehr.com/140841-salary-vs-income-tax-employer-employee.html
 http://www.slideshare.net/drishtirai/taxability-of-salary?from_action=save
 http://yourfinancebook.com/how-salary-is-defined-under-income-tax-act-1961/
 http://www.surfindia.com/finance/income-tax/salary-income-tax.html
 http://taxguru.in/income-tax/salary-income-exempt-allowance-section-1014.html
 http://www.charteredclub.com/allowances-exempt-under-section-10/
 http://incometaxmanagement.com/Pages/Tax-Ready-Reckoner/Exempted-Incomes/Exempted-
Incomes-Under-Section-10.html
 http://cawinners.com/income-under-head-salary/
 http://finotax.com/income-tax/info/retirement-benefit

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