What is Salary?
Salary is something paid by the employer to an employee in lieu of services provided to the organisation as per the terms of the employment agreement. Individuals receiving salary/wages are required to pay tax on any income above the exempted threshold. The salary received by an employee is also impacted by various deductions, such as statutory contributions and tax deducted at source (TDS). However, an employee may be able to increase his/her take-home salary by means of an intelligent salary structure and efficient tax planning.
Section 17 of Income Tax Act defines salary to include: - Wages - Pensions or Annuities - Gratuities - Advance of Salary - Any cess, commission, perquisites or profits in lieu of or in addition to salary or wages. - Any encashment of leave salary. - Any amount of credit to provident fund of employee to the extent it is taxable.
Therefore "salary" includes basic salary, encashment of leave salary, advance of salary, arrears of salary, various allowances such as dearness allowance, entertainment allowance, house rent allowance, conveyance allowance and also includes perquisites by way of free housing, free car, free schooling for children of employees, etc.
Section 15 of the Income Tax Act states that salary can be taxed on due or receipt basis, whichever is earlier.
Components & Deductions:
Salary comprises various components aimed at meeting the defined requirements of employees. Deductions from the salary would include contributions to the superannuation fund, which is essential to meet post-retirement financial needs. Tax deductions are also available on contributions to statutory funds as well as some of the other components.
Main Components of salary and tax implications:
Basic: It is the base or the primary component of the salary. The contribution to statutory funds is included in this. The basic component is a fixed part of the salary or compensation structure. This is fully taxable after deducting the EPF contribution.
Dearness Allowance: As the name suggests, it’s an allowance paid to combat the rising cost of living. However, it is not mandatory for an organisation to pay DA. DA is also taken into consideration while calculating the contribution to statutory funds. It features as a prominent component of the salary for government and Public Sector Undertaking (PSU) employees. This is fully taxable after deduction of EPF contribution.
Taxable Allowances: Allowances are generally provided in lieu of DA in the private sector; this does not attract contribution to statutory funds, thereby allowing individuals a high take-home salary. These allowances are fully taxable.
Non-Taxable Allowances: Common types of non-taxable allowances include Conveyance/Transport allowance, House Rent allowance, Leave Travel allowance, Medical allowance, Special allowance etc.
Employees Provident Fund (EPF): Employees have to contribute 12% of (Basic salary + DA) to the EPF on a monthly basis. Individuals with a salary above Rs. 15,000 per month have the option to opt out, or one may cap their contribution to a maximum of Rs. 15,000 of the salary (Rs. 1800 contribution to EPF). Employers are required to contribute an equal amount to the fund. However, out of the employer’s 12% contribution, 8.67% is deposited to the EPS, while the remaining goes to the EPF Fund.
Employees State Insurance (ESI): ESI is the medical insurance benefit available to employees with salary/wages up to Rs. 21,000. ESI entitles employees and their dependents to free medical treatment in ESI hospitals across the country. The employer contributes 4.75% while employees have to contribute 1.75% towards the ESI Fund.
Professional Tax: This is levied by the state where the business is situated and the employee is employed. The maximum tax payable is Rs. 2,500 based on the income slab of an individual. However, not all states levy professional tax. This amount is exempted from taxable income.
Tax Deducted at Source (TDS): TDS is deducted on the income as prescribed under the Income Tax Act.
Standard Deduction of Rs. 40,000 was introduced in Budget 2018, giving the salaried class something to rejoice about. It replaced the transport allowance Rs. 19,200 and medical reimbursement of Rs. 15,000 per annum. As a result, the effective additional benefit on account of the standard deduction would be an additional income exemption of Rs. 5,800. Further, Standard Deduction was increased in Budget 2019 from Rs. 40,000 to 50,000. This has increased the additional income exemption to salaries persons to the extent of Rs. 10,000 which help taxpayers immensely to reduce their tax outgo.
Objectives of the perfect salary structure:
While creating the ideal salary structures, there are 3 things you should keep in mind:
Tax Efficient: This means that it should give employees the opportunity to save as much tax as possible. Salary amounts should be divided into components giving the employee the opportunity to avail as much tax deduction as possible.
Reduce the employer’s liability: The salary structure should reduce the liability of the employer. The employer’s contribution to PF, Gratuity etc. should be kept as low as possible.
Compliant with prevailing laws: Compliance norms like minimum wages and PF laws should be kept in mind while drafting the salary structure.
Ideal Salary Structure:
An ideal salary structure should contain various components which are shown in below table with recommendations:
Old v/s New Tax Regime:
Being a salaried person, first compare old and new tax regime and find out which tax option suits you. There are some terms and condition to opt the New tax regime that you need to be aware:
- The new tax Regime is optional that means, the assessee have the option to choose between New Tax Regime or Old Tax Regime.
- The New Tax Regime is only applicable if you are willing to give up exemption (such as Leave Travel Allowance (LTA), House Rent Allowance (HRA), etc) and deduction (available under chapter VI A of the Act U/S 80 such as 80C, 80CCC, 80CCD, 80D, 80DD, 80E, 80EE, 80G, 80GG, 80GGA, 80GGC, etc) available under various section of Income Tax Act, 1961.
- Only the deduction under Section 80CCD (2) [i.e., employer’s contribution on account of an employee in a notified pension scheme] and Section 80JJAA [i.e. for new employment] can be claimed.
- Standard Deduction under Section 16 [which is currently Rs 50,000] available to salaried individuals will be disallowed.
- Also, the deduction on home loan interest, under Section 24(b) will be disallowed.
Paying taxes is inevitable, whether you stand up for the Act or fight against it. So, as an Indian citizen, you are eligible to pay taxes if your income exceeds Rs. 2.5 lakh, annually. You can, thus, structure your salary keeping these broad parameters in mind i.e. Components, Deductions and Tax regimes. The combination of a sound investment plan together with a favorable salary structure will go a long way in helping employees take home more and thereby add more smiles along the way. You can also take the help of your employer or organisation in doing so.
The contents of this article are for information purposes only and do not constitute advice or legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point in time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of the statute, latest judicial pronouncements, circulars, clarifications and other factors before acting on the basis of the above write up. The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author / Simplify Business and Tax Consultants are not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.
Name: CA Natesh Rao B.
Qualification: Chartered Accountant in Practice
Firm: Rao N & Associates | Chartered Accountants
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