Definitions: Salary, Allowances, Perquisites and Profits in Lieu of Salary, Provident Fund, Retirement Benefits, Gratuity, Pension and Leave Salary
by Under the Income Tax Act, salary includes various forms of monetary and non monetary benefits received by an employee from an employer. Salary income is not limited to basic pay. It may include allowances, perquisites, retirement benefits, gratuity, pension, leave salary and profits in lieu of salary. Understanding these terms is important for determining the taxable income of an individual under the Head Salaries.
1. Salary
Salary means the remuneration received by an employee from an employer or former employer for services rendered. Under Section 17(1), salary includes basic salary, wages, pension, gratuity, fees, commission, bonus, taxable allowances, perquisites and certain profits in lieu of salary. Salary is generally taxable under the Head Salaries when there exists an employer and employee relationship. It may be paid monthly, annually or at other intervals. Salary can be received in cash or, in certain cases, through benefits having monetary value. For income tax purposes, salary is taxable on the basis of the provisions relating to accrual and receipt. Various deductions and exemptions may be available while calculating taxable salary income.
2. Allowances
Allowances are fixed amounts paid by an employer to an employee in addition to basic salary to meet particular expenses or provide additional compensation. Examples include Dearness Allowance, House Rent Allowance, Transport Allowance and Special Allowance. Allowances may be fully taxable, partly exempt or fully exempt depending upon their nature and the conditions prescribed under the Income Tax Act. House Rent Allowance may receive exemption subject to prescribed conditions. Some allowances are provided specifically for official duties, while others are paid as part of regular remuneration. For income tax purposes, the treatment of an allowance depends upon the relevant provision of law and the circumstances under which it is received by the employee.
3. Perquisites
Perquisites are benefits or facilities provided by an employer to an employee in addition to normal salary. They may be provided in cash, kind or through the use of facilities. Examples include rent free accommodation, motor car facility, concessional loans, free education and certain employer provided benefits. Under Section 17(2), specified benefits and facilities are treated as perquisites for income tax purposes. The taxable value of a perquisite is generally determined according to prescribed rules. Some perquisites may be exempt or may have special valuation provisions. Perquisites are important because they increase the employee’s taxable salary even though the employee may not receive the benefit directly as cash.
4. Profits in Lieu of Salary
Profits in lieu of salary are amounts or benefits received by an employee or former employee that are connected with employment but are not ordinary salary payments. Under Section 17(3), they include certain amounts received from an employer or former employer in connection with termination or modification of employment. They may also include certain payments received under specified arrangements relating to employment. Examples can include compensation received on termination of employment and certain payments received before or after employment under prescribed conditions. Such receipts are generally taxable under the Head Salaries, subject to applicable exemptions and deductions. The purpose of this provision is to ensure that employment related compensation cannot escape taxation merely because it is not called salary.
5. Provident Fund
A Provident Fund is a retirement savings arrangement under which contributions are made by the employee and, in applicable cases, by the employer. The amount accumulated in the fund, together with applicable interest, is generally intended to provide financial security after retirement or on specified occasions. Different types include Statutory Provident Fund, Recognised Provident Fund, Unrecognised Provident Fund and Public Provident Fund. Their income tax treatment differs according to the applicable rules. Employer contributions, interest and withdrawals may be taxable or exempt depending upon the type of fund and prescribed conditions. Therefore, while calculating salary income, it is necessary to identify the nature of the provident fund and apply the relevant provisions governing contributions, interest and final withdrawal.
6. Retirement Benefits
Retirement benefits are amounts or facilities received by an employee because of retirement, resignation, termination or completion of service. They are designed to provide financial security after employment. Important retirement benefits include gratuity, pension, provident fund, leave encashment and certain retirement compensation. The tax treatment of these benefits depends upon the nature of the benefit, the employee’s status and the conditions prescribed under the Income Tax Act. Some retirement benefits may be fully exempt, while others may be partly taxable subject to specified limits. For salary taxation, retirement benefits must therefore be separately examined and the applicable exemption or deduction must be considered before determining the employee’s final taxable salary income.
7. Gratuity
Gratuity is a retirement benefit paid by an employer to an employee as recognition of services rendered during employment. It is generally payable on events such as retirement, resignation, death or disablement, subject to the applicable rules. Gratuity received by employees may be governed by the Payment of Gratuity Act or other applicable employment provisions. Under Section 10(10), gratuity may be fully or partly exempt from income tax depending upon the category of employee and prescribed conditions and limits. Any amount exceeding the applicable exemption is generally taxable under the Head Salaries. Gratuity is therefore an important retirement benefit that must be considered while calculating taxable salary income.
8. Pension
Pension is a regular payment received by an employee after retirement as a benefit for services rendered during employment. It may be received from the employer, government or an approved pension arrangement, depending upon the employment and pension scheme. Pension may be uncommuted or commuted. Uncommuted pension is generally received periodically and is taxable according to the applicable provisions. Commuted pension, which represents a lump sum received by surrendering part of the future pension, may be fully or partly exempt under Section 10(10A), depending upon the circumstances. Pension is treated as salary for income tax purposes when received by an employee or former employee and is therefore considered while determining taxable income under the Head Salaries.
9. Leave Salary
Leave salary refers to the amount received by an employee in respect of accumulated leave, particularly when leave is not actually taken. The payment is commonly known as leave encashment. It may be received during employment or at the time of retirement, resignation or termination. Leave encashment received during employment is generally taxable, subject to applicable provisions. Under Section 10(10AA), leave encashment received on retirement by certain employees may be fully or partly exempt, subject to prescribed conditions and limits. The treatment differs for Government employees and other employees. Therefore, while computing taxable salary, the nature and timing of leave salary received by the employee must be examined before determining the taxable amount.