Salary : Other Provisions (Part 4)

Covering remaining provisions applicable for computation under the head salary (Updated upto A.Y. 2018-19)

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In the earlier post, we have discussed about valuation of perquisite (Computation of income under the head Salary – Part 3: Valuation of Perquisites). Now, in the last part of 4 part series, we will discussed remaining provision applicable for computation under the head salary like tax treatment regarding contribution to provident fund, deduction available u/s 16, etc.

Provident Fund

Provident fund scheme is a saving device in the hands of salaried class. It is a retirement benefit scheme. Under this scheme, a stipulated sum is regularly deducted from the salary of the employee as his contribution towards the fund. The employer also, generally, contributes a similar amount out of his pocket to the fund. The employer’s and employee’s contribution are together invested in such fund. Interest earned thereon is also credited to the fund of the employee. Thus, provident fund scheme is a great media to initiate and mobilise small savings to a large scale. On termination of service or retirement, employee receives the whole accumulated fund, subject to certain conditions. Hence, provident fund has four components i.e. Employer’s contribution; Employee’s contribution; Interest on employer’s contribution; and Interest on employee’s contribution.
Provident fund is of four types, viz:

  1. Statutory Provident Fund (SPF): Statutory provident fund is set up under the provisions of the Provident Funds Act, 1925. Government and Semi-Government organisations, local authorities, railways, Universities and recognised educational institutions maintain Statutory Provident Fund.
  2. Recognised Provident Fund (RPF): The provident fund scheme is framed under the Employee’s Provident Fund and Miscellaneous Provisions Act, 1952 (hereinafter referred as PF Act). The PF Act covers any establishment employing 20 or more persons. However, any establishment employing less than 20 persons can also join the scheme provided employer and employee both agree to do so. Further, if an employer creates his own scheme for provident fund then he can do so subject to recognition from the Commissioner of Income tax.
  3. Unrecognised Provident Fund (URPF): If a provident fund scheme is created by an employer, which is not recognised by the Commissioner of Income tax, then such fund is known as Unrecognised provident fund.
  4. Public Provident Fund (PPF): The Central Government has established a fund for the benefit of public to mobilise personal savings. Any member of the public, whether salaried or self-employed, can contribute to the fund by opening a provident fund account at any branch of the State Bank of India or its subsidiaries or other nationalised bank. Even a salaried employee can simultaneously become a member of employee’s provident fund (whether statutory, recognised or unrecognized) and public provident fund. Any amount in multiple of ₹ 5 (subject to minimum of ₹ 500 and maximum of ₹ 1,50,000 p.a.) may be deposited in this account. Interest is credited every year but payable only at the time of maturity. Interest earned on this fund is exempt from tax u/s 10(11)
Also Read  Standard Deduction of ₹ 40,000: Actual Benefit or Eye Wash?
Tax Treatment

Tax treatment of contribution (or otherwise) of various type provident fund are as under:

ParticularsTreatment

Statutory Provident Fund

Employer’s ContributionNot taxable
Employee’s ContributionEligible for deduction u/s 80C
InterestNot Taxable
Lump Sum withdrawalNot Taxable

Recognised Provident Fund

Employer’s ContributionExempted up to 12% of Salary (here, salary means Basic + DA1 + Commission as a fixed percentage on turnover
Employee’s ContributionEligible for deduction u/s 80C
InterestExempted @ 9.5% p.a. (Interest rate), any excess interest will be taxable as salary.
Lump Sum withdrawalNot Taxable (subject to Note 2)

Unrecognised Provident Fund

Employer’s ContributionNot taxable
Employee’s ContributionNot eligible for deduction u/s 80C
InterestNot Taxable
Lump Sum withdrawalTaxable (See Note 1)

Public Provident Fund

Employer’s ContributionNot Applicable
Employee’s ContributionEligible for deduction u/s 80C
InterestNot Taxable
Lump Sum withdrawalNot Taxable
  1. Lump sum amount withdrawn from URPF

    ParticularsTax treatment
    Accumulated employer’s contributionFully taxable under the head Salaries
    Accumulated employee’s contributionNot taxable
    Accumulated interest on employer’s contributionFully taxable under the head Salaries
    Accumulated interest on employee’s contributionFully taxable as income from other sources
  2. Lump sum amount withdrawn from RPF

    1. Amount withdrawn from RPF is not taxable, if:
      1. Employee retires or terminates job after 5 years of continuous service; or
      2. Employee has resigned before completion of 5 years and joins another organization (who also maintains recognized provident fund and his fund balance with current employer is transferred to the new employer).
      3. The entire balance standing to the credit of the employee is transferred to his account under New Pension Scheme as referred u/s 80CC
      4. Employee retires or terminates job before 5 years of continuous service:
        • by reason of ill health; or
        • by reason of contraction or discontinuance of employer’s business; or
        • any other reason beyond the control of employee.
    2. In any other case, amount withdrawn shall be taxable as in the case of URPF. [Refer Note 1].
Transferred Balance (Conversion of URPF to RPF) [Rule 11(4) of Part A of the Fourth schedule

An organisation maintaining URPF, may later get recognition from Commissioner of Income tax. In such case, the accumulated balance under URPF shall be converted to RPF. Tax treatment of such transferred balance will be as under:

Calculation is made of all sums comprised in the transferred balance that would have been liable to income tax if the recognition of the fund had been in force from the date of institution of the fund. However, in case of serious accounting difficulty, the Commissioner may make a summary calculation of such aggregate.

Such aggregate sum is deemed to be the income received by the employee in the previous year in which the recognition of the fund takes effect.

On taxability of such conversion, assessee cannot claim relief u/s 89(1).

Annuity [Sec. 17(1)(ii)]

Annuity means a yearly allowance, income or the grant of an annual sum for life or in perpetuity. While annuity payable by a present employer is taxable as salary even if, it is received voluntarily without any contractual obligation of the employer, whereas an annuity received from an ex-employer is taxed as profit in lieu of salary’ u/s 17(3)(ii). Annuity received from a person other than employer e.g. from insurer, etc. is taxable u/s 56 as Income from other sources’.

Treatment: Fully taxable.

Salary received in lieu of notice period

When an employer retrenches an employee then he will have to give a proper notice. If an employer fails to do so then he will have to pay salary equivalent to notice period, apart from retrenchment compensation. Such amount is known as salary received in lieu of notice period.

Treatment: Fully taxable in the year of receipt.

Profits in lieu of salary [Sec.17(3)]

Following receipts are taxable as profits in lieu of salary:

  • The amount of any compensation due to or received by an assessee from his employer or former employer or in connection with the (a) termination of his employment, (b) modification of the terms and conditions of employment.
  • Any payment due to or received by an assessee from his employer or former employer except the following:
    1. Gratuity exempted u/s 10(10);
    2. House rent allowance exempted u/s 10(13A);
    3. Commuted pension exempted u/s 10(10A);
    4. Retrenchment compensation exempted u/s 10(10B);
    5. Payment from an approved Superannuation Fund u/s 10(13);
    6. Payment from statutory provident fund or public provident fund;
    7. Payment from recognised provident fund to the extent it is exempt u/s 10(12).
  • Any payment from unrecognised provident fund or such other fund to the extent to which it does not consist of contributions by the assessee or interest on such contributions.
  • Any sum received by the employee under the Keyman Insurance Policy including the sum allocated by way of bonus on such policy.
  • Any amount received (in lump sum or otherwise) prior to employment or after cessation of employment.
Also Read  Computation of income under the head Salary - Part 2

Deduction from Gross Salary [Sec. 16]

Entertainment Allowance [Sec. 16 (ii)]

Entertainment allowance is initially included in taxable allowances as fully taxable. Thereafter, a deduction is allowed under this section from gross taxable salary. However, deduction u/s 16(ii) shall be available to the Government employee only.

Deduction for Entertainment allowance being minimum of the following:

  1. Actual Entertainment Allowance
  2. ₹ 5,000/-
  3. 20% of Basic
  • Deduction allowed shall be irrespective of actual expenditure incurred, whether for office or personal purpose.
  • No deduction is available under this section to a Non-government employee.
Tax on employment or professional tax [Sec. 16(iii)]

Tax on employment, profession, trade, etc. levied by a State under Article 276 of the Constitution will be allowed as deduction on cash basis, whether paid by employee or by employer (on behalf of employee) from gross taxable salary.

Note: If employer (on behalf of employee) pays Professional tax then:

  1. Firstly, it is to be included as taxable perquisite; and
  2. Further, it is allowed as deduction u/s 16(iii).

Meaning of Salary for different purposes

For Retirement benefit
Gratuity (covered by the Payment of Gratuity Act)(Basic  + DA) last drawn
Gratuity (not covered by the Payment of Gratuity Act)(Basic +DA1 + Commission2)  being average of last 10 months preceding the month of retirement.
Leave encashment(Basic +DA1 + Commission2)  being average of last 10 months immediately from the retirement.
Voluntarily retirement(Basic +DA1 + Commission2) last drawn
For regular benefit
Rent Free Accommodation(Basic + DA1 + Commission2 + Bonus + Fees + Any other taxable allowance + Any other monetary benefits excluding perquisite)
Specified employee(Basic + DA + Commission2 + Bonus + Fees + Any other taxable allowance + Any other monetary benefits – Deduction u/s 16)
Entertainment AllowanceBasic only
Any other case(Basic + DA1 + Commission2)

1. DA only if it forms a part of retirement benefit.
2. Commission as a fixed percentage on turnover.
Hopefully, you have enjoyed this knowledge series. Learn and enjoy!

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