How to Calculate Taxable Salary

Calculation of Taxable Salary is important for individuals earning a salary from their employer. But still many of them do not know how to calculate the taxable salary for income tax purpose.

In this article, we try to explain the basics of the taxable salary and its various components. 

Let us start !!!!!!

As per the Income Tax Act, the sources of income of a person has divided into five heads. They are


(1) Salary income
(2) Income from house property
(3) Profit or gain from business or profession
(4) Capital Gain
(5) Income from other sources


What is meant by Salary

Salary means the consideration or remuneration paid by the employer or master to the employee or servant in return of the service or labour rendered or supplied.


The remuneration must be paid by an employer and there should be an employer-employee relationship between the payer and payee.

Clarification of Employee-Employer Relationship for Taxable Salary

Usually, an income considered as salary if the payment is made by the employer to the employee and the relationship between these two parties should be of employer and employee.


The employer can ask or direct and control the employee as to what to do and how to do. If a person working as an agent for a business and earns a commission, the same is not considered a Salary.


It means if we are receiving any payment from a person other than the employer, it will not form part of our salary.

Definition of Salary as per Income Tax Act

Section 17(a) of the Income Tax Act,1961, defines the Salary as given below
Salary includes the following

(1) Wages;

(2) Any annuity or pension;


(3) Any Gratuity;


(4) Any fee, commission, perquisite or profit in lieu of or in addition to any  salary or wages;


(5) Any advance of salary;


(6) Any payment received in respect of any period of leave not availed for by the assesses;


(7) The portion of the annual accretion in any previous year to the balance at the credit of an employee, participating  in recognized provident fund, to the extent it is taxable; 


(8) Transferred balance in a Recognized Provident Fund to the extent it is taxable.


(9) The contribution made by the employer in the previous year, to the account of an employee under a pension scheme, referred to in sec. 80CCD [National Pension Scheme and Atal Pension Yojana]

From the above definition, it is clear that there is no difference between Wages and Salary. An employer pays any sum of money, in the hands of the employee, it is taxable.

Some cases, we may receive a salary from more than one employer during the same previous year. Example a Doctor is working for two hospitals and receives salary from both the hospitals . in that case, both the salary is taxable as Salary Income. 

There are some cases that the persons receive a pension from the previous employer and the same person is working with another employer, in this case, both pension and salary from the present employer are treating as Salary Income

Taxability of Surrender of Salary

Salary should not be taxable if you surrender your salary to the Central Government. This surrender is opting under section 2 of Voluntary Surrender of Salaries (Exemption from Taxation) Act,1961. Our surrender of salary as per this section, shall not be taxed

Taxability of Forgoing of Salary

Forgoing of salary means the waiver of salary by the employer. This happens after the completion of the work and salary accrued.
Eg: Once the salary is accrued, and the work performed for the current month, the employee asking the employer to contribute the salary for social activities or charitable trust.
Salary is taxable in the hands of the employee under the head salaries, its taxability on accrual or receipt basis, whichever come first.

Due basis or Receipt basis

Income under the head salaries is taxable on due basis or receipt basis, whichever is earlier. Taxable salary includes areas of salary, advance salary and outstanding salary.

In case the employee receives the Areas of Salary.

For example, there are situations where the employees get salary increment with retrospective effect or without retrospective effect.
When the increment is granted, the increment with retrospective effect will be taxed this year. The reason is that this salary is not taxed in the past years.

In case the employee receives the Advance Salary

When an employee receives the salary in advance, it is taxable in the year of receipt. It will not be taxed when it is due.

In case the Outstanding Salary

When the salary is due, it is taxable under the head salaries. The same salary should not be added to the taxable salary when the employee receives this outstanding salary.

Relationship between Place of Accrual of Salary and Residential Status

Read: Residential Status of an Individual for Income Tax

Place of accrual means the place where the service rendered. Suppose, the service rendered in India and the salary received outside India, this salary is said to accrue or arise in India.

Suppose an employee is Ordinarily Resident in India,  irrespective of the type of employer, place of service and the place where the salary received, salary  is taxable 

In the case of Not Ordinarily Resident, if the place where the service rendered and salary received outside India, irrespective of the type of employer it is taxable.

In the case of Non-Resident, if the place where the service rendered and salary received outside India, irrespective of the type of employer,  it is not taxable.

Suppose the employee as an Indian citizen, the employer is a Government and the service rendered is outside India. In this case, irrespective of the place where the salary received, it is Taxable.

In case, the place of service is in India, irrespective of the residential status of the employer and employer, Salary is taxable

In case the salary received in India, the salary is taxable in the hands of employees

Calculation of Taxable Salary

ParticularsDetailsAmount
Basic Salary
Fee
Commission
Bonus
Gratuity
Leave Encashment
Pension
Retrenchment Compensation
Compensation Received under VRS
Allowances :
Dearness Allowances
HRA
Children Education Allowance
Children Hostel Allowance
Entertainment Allowance
Medical Allowance
Conveyance Allowance
City Compensatory Allowance
Uniform Allowance
Professional Development Allowance
Transport Allowance
Other Allowance
Perquisites u/s 17(2) :
Any Obligation of Employee paid by Employer
Accommodation
Shares and securities issued under ESOP
Employer’s Contribution to Superannuation Fund
Gas, Electricity & Water
Medical Facility
Other Fringe benefits
Leave Travel Concession
Contribution of Employer to Provident Fund
Interest on Recognised Provident Fund
Any other item
Gross Salary
Less: Deduction u/s 16
(ia) Standard Deduction
(ii) Entertainment Allowance
(iii) Tax on employment / Professional tax
Taxable Salary

Basic Salary–  It is the remuneration paid by the employer to employee


Fee – Apart from the salary, some employers may give remuneration for doing something extra under the terms of employment, it is called fee

Commission – Commission is calculated as a percentage of profit or sale.

Bonus – Bonus is a payment by the company to its employees to thank their dedication and achievement

Gratuity – Companies pays the gratuity its employees by considering their years of services.

Read: How to Calculate Taxable Gratuity

Leave encashment – employees are allowed to take certain days as leave with pay. This is granting on a yearly basis. If the employee not taking these leaves, it will accumulate and subsequently encash by the employees.

Read: How to Calculate Taxable Leave Salary Encashment

Pension – This payment is received by the employee after the retirement

Retrenchment Compensation – This is a payment received by the employee at the time of cancellation of the contract.

The compensation received under VRS – This compensation is received by the employees when they accept to retire voluntarily

DA – It is a payment to employees to overcome the impact of inflation

HRA – This expense is to meet the payment of rent for housing 

Children’s Educational Allowance – It is meant for the education of the children

Children Hostel Allowance – This is for covering the hostel allowance of children

Entertainment Allowances – This payment is to meet the entertainment expenses of employees

Medical Allowances – This allowance is a fixed monthly payment to employees for covering their medical expenses

Conveyance Allowances – If companies are not providing any transportation, the employer may give an allowance for conveyance

City compensatory allowances – This allowance is to meet the increased expenses in metropolitan cities

Uniform allowances – This allowance is to cover the expenditure on purchasing the uniform to wear in the office

Professional Development  Allowance – As the name indicates, it for the development of the profession

These are the main components of the taxable salary. All the details of the income tax Act are changing from time to time. So for updated information, you can also visit the website

FAQ – Taxable Salary

Salary received by a Partner

If a partner receive salary from his firm, it will not be treated as salary . The reason is that there is no employee-employer relationship between the partner and his firm. This salary will be taxable under the head of " Profit & Gain of business or Profession"

Salary Received by Proprietor

A proprietor and his business is the same only. So it will not be considered as Salary.

Remuneration to Directors of the Company

If the director is an employee of the company, then the salary is treated as Salary. If the director is not an employee of the company, then the remuneration is treated as "Income from Other sources"

Remuneration to Judges

Judge's remuneration is taxable under the head "Salaries".

Remuneration to Judges

Judge's remuneration is taxable under the head "Salaries".

Widow's Pension or Pension received by Legal Heir of Deceased Employee

This pension is not taxable as Salary . There is no employee -employer relationship between payer and payee. This pension will be taxed as "Income From Other Sources" in the hand of payee.

What is Pay Scale

Pay Scale is  a system of salary payment . In this system, the increment scale and the basic salary are informed the employee in advance.

E.g. Basic Salary is mentioned in the offer letter as 10,000 - 2,000 - 18,000 - 4,000 - 30,000 . 

As per this pay scale , the employee will get a 10,000 as basic salary with an annual increment of 2,000 till the salary  reach 18,000. From the year when the salary reach 18,000. the yearly increment will be 4,000 and it will continue till it reach 30,000 .

 

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