Introduction – Income from Salary
Income from Salary is one of the most important heads under the Income Tax Act, 1961. For most taxpayers, it forms the largest portion of taxable income, and therefore, understanding its scope, components, exemptions, and computation mechanism is essential. Under Section 15 of the Act, income is chargeable to tax under the head “Salaries” when it is due, paid, or earned—whichever is earlier. Salary is not merely the monthly payment received by an employee; rather, it is a comprehensive legal concept that includes various monetary and non-monetary benefits provided by the employer.
Courts have repeatedly clarified the legal nature of the employer–employee relationship. In CIT v. L.W. Russel, the Supreme Court held that the existence of a master–servant relationship is essential for income to be taxed under Salaries. Similarly, in Manmohan Das v. CIT, the Court stated that remuneration paid without such a relationship cannot be taxed as salary but may instead fall under other heads such as “Profits and Gains of Business or Profession” or “Income from Other Sources.”
Understanding this relationship is the foundation of the entire chapter, as salary income arises only when there is a contract of employment. A consultant, freelancer, or independent professional is not covered under this head.
Meaning and Scope of Salary
Salary includes wages, annuity, pension, gratuity, fees, commission, perquisites, allowances, advance salary, leave encashment, and even contributions by employers to certain funds. Under Section 17(1), the definition is inclusive and therefore broad enough to cover both fixed and variable payments.
The Supreme Court in Gestetner Duplicators Pvt. Ltd. v. CIT held that even payments dependent on work performance (like commission) qualify as salary as long as they emanate from employment. Thus, the legal focus is always on the source of payment rather than its form.
“Tip: Always identify whether the payment flows from a contract of employment. If yes, it is taxable as salary.”
Allowances, perquisites, and retirement benefits are significant components examined extensively under case law and statutory provisions.
Allowances
Allowances are fixed monetary amounts paid to employees to meet specific expenses. They are generally taxable unless specifically exempt under Sections 10(14) and 10(13A). The nature of each allowance must be examined individually.
House Rent Allowance (HRA)
HRA is one of the most common allowances. Exemption under Section 10(13A) is based on actual rent paid, salary, and the city of residence. In CIT v. Justice S.C. Mittal, the court emphasized that exemption is conditional and the burden of proof lies on the employee to demonstrate rent payment.
Dearness Allowance (DA)
DA is paid to offset inflation. It is fully taxable. Further, DA may form part of retirement benefits if included in employment terms.
Transport, Medical, and Other Allowances
Most allowances such as transport allowance (except for specific cases), city compensatory allowance, and overtime allowance are fully taxable unless specifically exempted.
“Tip: Every allowance is taxable unless the law expressly provides an exemption—never assume.”
Perquisites
Perquisites are non-monetary benefits enjoyed by the employee due to employment. Section 17(2) defines perquisites broadly to include rent-free accommodation, employer-paid taxes, use of employer’s assets, and ESOP benefits.
In Oberoi Hotels (India) Pvt. Ltd. v. CIT, the Court clarified that perquisites need not be convertible into money; even benefits in kind are taxable if provided by the employer.
Major taxable perquisites include:
- Rent-Free or concessional accommodation
- Use of employer’s car for personal use
- Interest-free or concessional loans
- Employer’s contribution to provident fund exceeding statutory limits
- Employer payment of taxes on behalf of the employee
Some perquisites, however, are exempt under rules, such as laptops and mobile phones used for official purposes.
Profits in Lieu of Salary
Section 17(3) includes compensation payments received at or before termination of employment. These include:
- Compensation upon resignation
- Payments received from unrecognized provident funds
- Key-man insurance policy receipts
The Supreme Court in CIT v. E.D. Sheppard held that any payment received due to cessation of employment is taxable unless specifically exempt.
“Tip: Any lump-sum payment linked to joining, continuing, or leaving a job generally falls under ‘profits in lieu of salary.’”
Retirement Benefits
Gratuity
Regulated under the Payment of Gratuity Act, gratuity is partly or fully exempt depending on the employee category. Section 10(10) governs this exemption. In Indian Hume Pipe Co. Ltd. v. CIT, the Supreme Court emphasized that gratuity is a reward for long service and may be exempt only under statutory provisions.
Pension
Pension (periodic payment) is taxable as salary. However, commuted pension is exempt for government employees and partly exempt for non-government employees under Section 10(10A).
Leave Encashment
Leave encashment at the time of retirement is exempt under Section 10(10AA) subject to specified limits. Encashment during service is fully taxable.
Provident Fund
Employer’s contribution exceeding prescribed limits becomes taxable. Interest credited beyond statutory rates is also taxable.
Salary Paid in Advance or in Arrears
Section 15 clarifies that advance salary is taxable in the year of receipt, while arrears are taxable in the year of receipt unless eligible for relief under Section 89. The Supreme Court in CIT v. L.W. Russel held that even voluntary payments made early or late may still be taxed as salary if arising from employment.
Deductions from Salary
Under Section 16, employees are eligible for specific deductions such as:
- Standard deduction
- Entertainment allowance (Govt employees only)
- Professional tax
These deductions simplify computation and provide relief to salaried individuals.
“Tip: Salary has very limited deductions—memorize Section 16 carefully.”
Computation of Income from Salary
The computation mechanism follows a structured formula:
- Gross Salary (including all taxable allowances, perquisites, and profits in lieu)
- Less: Exemptions under Section 10
- Less: Deductions under Section 16
- Taxable Salary
This systematic approach is crucial in examinations and practical application.
In CIT v. L.W. Russel, the Court reiterated the importance of examining each element of salary independently before final computation.
Conclusion
Income from Salary under the Income Tax Act, 1961 forms a comprehensive legal category covering monetary and non-monetary payments flowing from an employment relationship. Its interpretation is governed by statutory provisions, judicial decisions, and administrative rules. Understanding allowances, perquisites, retirement benefits, exemptions, and computation mechanisms is essential for any student of taxation law. With numerous case laws and statutory nuances, this head of income requires thorough conceptual clarity.
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