Tax Treatment of Income in lieu of Salary

Tax Treatment of Leave Travel Concession or Assistance

Leave travel concession or assistance is the assistance provided by the employer for the employee and his family members for travelling in India

  • during the employment, while employee is on leave or
  • after the retirement from service or termination of service.

Suppose Mr. Aallu is working in Deepgyan. He is going to Goa on holidays with his family for which his employer is providing him cash assistance of Rs. 50,000. This amount is known as Leave travel allowance or concession or assistance.

Such assistance is an extra benefit for the employee; therefore it should be taxable in the hands of employee.

But under Income Tax Laws, out of the total assistance provided by the employer to the employee, the amount spent by employee on travelling (fare of vehicle) is exempted from tax subject to conditions specified under rule 2B of Income Tax Rules, 1962. 

According to Section 10(5), in the case of an individual, the value of any travel concession or assistance received by, or due to, him,—

  • from his employer for himself and his family, in connection with his proceeding on leave to any place in India;
  • from his employer or former employer for himself and his family, in connection with his proceeding to any place in India after retirement from service or after the termination of his service,

shall be exempted from taxation subject to the conditions specified in Rule 2B of Income Tax Rules, 1962.

Maximum amount of exemption
The amount exempt under Section 10(5) shall in no case exceed the amount of expenses actually incurred for the purpose of such travel (fare of vehicle).

It means

  • if employee has taken LTC/LTA without performing journey, whole amount shall be taxable.
  • no exemption shall be allowed in respect of any expenses by employee on hotels, food or any other service/facility except fare of vehicle paid for reaching to destination.

Rule 2B of Income Tax Rules, 1962

Quantum of Exemption
The amount exempted under section 10(5) shall be the amount actually incurred on the performance of such travel subject to the following conditions, namely:—

  1. where the journey is performed by air,
    • an amount not exceeding the air economy fare of the national carrier by the shortest route to the place of destination;
  2. where places of origin of journey and destination are connected by rail and the journey is performed by any mode of transport other than by air,
    • an amount not exceeding the air conditioned first class rail fare by the shortest route to the place of destination; and
  3. where the places of origin of journey and destination or part thereof are not connected by rail, the amount eligible for exemption shall be :—
    • where a recognized public transport system exists, an amount not exceeding the 1st class or deluxe class fare, as the case may be, on such transport by the shortest route to the place of destination; and
    • where no recognized public transport system exists, an amount equivalent to the air-conditioned first class rail fare, for the distance of the journey by the shortest route, as if the journey had been performed by rail.
Leave Travel Concession

Maximum amount of exemption under Rule 2B

Maximum number of times can exemption be claimed
The exemption shall be available to an individual in respect of two journeys performed in a block of four calendar years commencing from the calendar year 1986. (Block of years: 1986-89, 1990-93, 1994-97, 1998-2001, 2002-2005, 2006-2009, 2010-2013, 2014-2017, 2018-2021, 2022-2025)

But where such travel concession or assistance is not availed of by the individual during any such block of four calendar years,

  • an amount in respect of the value of the travel concession or assistance, if any,
    • first availed of by the individual during first calendar year of the immediately succeeding block of four calendar years

shall be eligible for exemption.

In simple words, if an employee has not availed of travel concession or assistance in respect of one or two permitted journeys in a particular block of 4 years, then he is entitled to carry over one journey to the next block. In this situation, exemption will be available for 3 journeys in the next block. However, to avail of this benefit, exemption in respect of journey should be utilised in the first calendar year of the next block.

In other words, in case of carry over, exemption is available in respect of 3 journeys in a block, provided exemption in respect of at least 1 journey is claimed in the first year of the next block.

Suppose, Mr. Kachallu is working in a company. He did not claim any leave travel assistance from his employer in the last block of years 2018-2021. In this case, he could claim exemption in respect of 1 journey in the first calendar year (2022) of the immediately succeeding block of four calendar years (2018-2021). Further, he can claim exemption in respect of two journeys in a block of four calendar years 2022-2025.     

According to Section 10(5), family means-

  • the spouse and children of the individual ; and
  • the parents, brothers and sisters of the individual or any of them, wholly or mainly dependent on the individual;

Exemption is restricted to only 2 surviving children born after October 1, 1998 (multiple births after first single child will be considered as one child only), however, such restriction is not applicable to children born before October 1, 1998.

 

Retrenchment Compensation [Section 10(10B)]

Retrenchment Compensation means any compensation received by a workman

  • under the Industrial Disputes Act, 1947, or
  • under any other Act or Rules, orders or notifications issued thereunder or
  • under any standing orders or
  • under any award, contract of service or otherwise,

at the time of his retrenchment.

Quantum of exemption
Least of the following

  • Actual Amount Received
  • 15 days’ average pay for every completed year of continuous service or any part thereof in excess of 6 months (as per section 25F of the Industrial Disputes Act, 1947); or
  • Amount notified by the Central Government (Rs. 5,00,000)

Note:

  • Any compensation received by a workman in accordance with any scheme which the Central Government may, having regard to
    • the need for extending special protection to the workmen in the undertaking to which such scheme applies and
    • other relevant circumstances,
      approve in this behalf, shall be 100% exempted.

Compensation received on voluntary retirement under Golden Handshake Scheme [Section 10(10C)]

Any amount received or receivable by an employee of—

  • a public sector company; or
  • any other company; or
  • an authority established under a Central, State or Provincial Act; or
  • a local authority; or
  • a co-operative society; or
  • a University established or incorporated by or under a Central, State or Provincial Act and an institution declared to be a University under section 3 of the University Grants Commission Act, 1956; or
  • an Indian Institute of Technology within the meaning of clause (g) of section 3 of the Institutes of Technology Act, 1961; or
  • any State Government; or
  • the Central Government; or
  • an institution, having importance throughout India or in any State or States, as the Central Government may, by notification in the Official Gazette, specify in this behalf; or
  • such institute of management as the Central Government may, by notification in the Official Gazette, specify in this behalf,

on his voluntary retirement or termination of his service, in accordance with

  • any scheme or schemes of voluntary retirement or
  • in the case of a public sector company, a scheme of voluntary separation.

Quantum of exemption
Minimum of the following shall be exempted:

  • actual amount received or
  • 5,00,000

Note:

This exemption is available only in one assessment year.

Leave Salary or Leave Encashment (Earned Leave)

What is leave salary?

Employees are entitled to various types of free leave while they are in service. Free leaves means where employers do not cut the salary of employees. These leaves

  • may be availed by the employees any time they want or
  • in case leaves are not availed of, depending upon the rules of organisation,
    • they may lapse every year, or
    • they are allowed to be encashed at the end of every year or
    • they are allowed to be accumulated at the end of every year, and employee can encash them anytime either during the employment or after retirement.

The amount which an employee receives in lieu of unavailed leaves is known as leave encashment or leave salary.

Taxability of leave salary

Leave salary or leave encashment is taxable under the head salaries if received by employee whether during the service or after the retirement. But if such amount is received by family members of employee, due to his/her death, in that case it shall be taxable under the head income from other source as there exists no employer-employee relation between employer and family members of employee.

Exemption from taxation

If received during the continuation of service
If employee encash these leaves during the continuation of service, it shall always be taxable under the head salaries. Such amount is always 100% taxable in every case (whether government employees or non-government employees).

If received after retirement:
Encashment of leave at the time of retirement can further be classified as:

  • leave encashment at the time of retirement by Government employee, and
  • leave encashment at the time of retirement by non-Government employee.

In case of a Central Government or State Government employee, any amount received for encashment of accumulated leave at the time of retirement/ superannuation is exempt from tax under section 10(10AA)(i).

In case of non-Government employees (i.e., other than the Central or the State Government employees), leave salary exempt from tax under section 10(10AA)(ii) will be least of the following:

  1. Unavailed leaves in months × Average monthly salary
  2. Average monthly salary × 10 (i.e., 10 months’ average salary)
  3. Maximum amount as specified by the Central Government i.e., Rs. 3,00,000
  4. Leave encashment actually received at the time of retirement

Points to Note:
How to calculate unavailed leave in months
For calculating unavailed leaves, we have to consider least of the following

  • actual leaves available during the service or
  • 30 leaves for every year of actual service (part of the year is to be ignored)

From the above result, we have to deduct the leaves availed by the employee and leaves enchased by the employee. We will get unavailed leaves. Divide unavailed leaves by 30, we will get unavailed leave in months.                                                

How to calculate ‘average monthly salary’?
Average monthly salary means average salary drawn in past ten months immediately preceding the retirement. If retirement date is 15th Jan 2022, than we have to calculate past 10 months starting from 15th Jan, 2022 (16th April, 2021 – 15th Jan, 2022).

Meaning of Salary for the purpose of leave encashment
Salary for this purpose will include following only:

  • Basic salary,
  • Dearness allowance considered while computing retirement benefits (i.e. DA in terms),
  • Commission based on fixed percentage of turnover achieved by the employee.

Gratuity [Section 10(10)]

Gratuity is paid by the employer to his employee(s) at the time of retirement in appreciation of loyal and successful services rendered by him. Gratuity can either be received by:

  • the employee himself at the time of his retirement, or
  • the legal heir on the event of the death of the employee.

If it is received by the employee on his retirement, it is taxable under the head “salaries”, where however, it is received by the legal heir of the deceased employee, it will taxable under the head “income from other sources”.

In both the cases gratuity is exempt up to a certain limits as specified under Section 10(10) of Income Tax Act, 1961.

For the purpose of exemption of gratuity, we can divide all the employees in 3 categories:

  • Government Employees or employees of local authority
  • Employees covered under Payment of Gratuity Act, 1972
  • Employees not covered under Payment of Gratuity Act, 1972

Tax treatment of Gratuity in case of Government Employees or employees of local authority [10(10)(i)]

Any death cum retirement gratuity is fully exempt from tax under such category of employees.

Tax treatment of Gratuity in case of Employees covered under Payment of Gratuity Act, 1972 [10(10)(ii)]

In this case exemption shall be the least of the following amount:

  • Actual amount of gratuity received
  • Maximum Rs. 20,00,000 (by payment of Gratuity (Amendment) Act, 2018)
  • 15 days’ salary for each complete year of service. Salary is based on the last drawn salary of the employee.

For calculating taxable gratuity as per conditions specified under Section 10(10), we shall consider the period of service of employee under previous employer/s if employee had not received gratuity from the previous employer/s. 

 Points to Notes

  1. As per section 4 of the Payment of Gratuity Act, 1972 gratuity shall payable to an employee only after he has rendered continuous service for not less than 5 years (except in case of death or permanent disability). It means if an employee is getting gratuity before rendering the continuous service of 5 years, such gratuity shall be 100% taxable.
  2. Salary’ for this purpose
    • include dearness allowance (DA) whether forming part of retirement benefits or not.
    • but does not include any bonus, commission, house rent allowance, any overtime wages and any other allowance.
  3. How to compute 15 days’ salary: In calculating 15 days salary, the number of days in a month will be taken as 26 working days. Therefore, the monthly salary will be divided by 26 and multiplied by 15.
  4. Complete year of service: For calculating complete year of service any period of more than 6 months shall be taken to be full year and any period equal to or less than 6 months shall be ignored.
  5. While considering the maximum amount of exemption (i.e. 20 Lakhs), we have to deduct exemption already claimed by employee in respect of earlier gratuity received by him (if any)

Tax treatment of Gratuity in case of Employees not covered under Payment of Gratuity Act, 1972 [10(10)(iii)]

Any gratuity received by an employee not covered under Payment of Gratuity Act, 1972, shall be exempt up to the least of the following amounts:

  • Actual amount of gratuity received
  • 20,00,000 (by payment of Gratuity (Amendment) Act, 2018)
  • Half month’s average salary for each complete year of service.

Notes

  1. Any amount in excess of aforesaid limit will be taxable under the head ‘salaries’ if it is received by the employee, or under ‘income from other sources’ if such amount is received by the legal heirs of the assessee.
  2. ‘Salary’ for this purpose includes DA (if terms of employment so provided) and commission (on fixed percentage of turnovers).
  3. How to compute ‘Average salary’
    ‘Average salary’ is calculated on the basis of average salary of 10 months immediately preceding the month in which such employee retires.
  4. Complete year of service
    For calculating complete year of service any fraction of year will be ignored, therefore, only complete only complete year of service is to be taken into account.
  5. Where gratuity is received from more than one employer
    Where any gratuity is received by an employee from more than one employer, the aggregate amount exempted shall not exceed Rs. 20,00,000.
    Thus, where any such gratuity was received in any one or more earlier previous year also, the limit so specified i.e. Rs. 20,00,000 shall be reduced by exemption so claimed in any such previous year or year.

 Other Notes

  1. Gratuity received while in service: Any gratuity paid to an employee while he continues to remain in service is not exempt from tax. However, relief under section 89 can be claimed for such amount.
  2. Differences in gratuity calculation if employee is covered and not covered

Basis of difference

Employees covered

Employees not covered

No. of days in a month

26 days

30 days

Complete year of service

Period of more than 6 month shall be considered as full year.

Any part of the year shall be ignored.

Meaning of salary

Basic + DA(full)

Basic + DA(RB) + Commission

Basis of salary

Last drawn salary

Average salary of last 10 months preceding the month of retirement.

 

Tax Treatment of Pension

Pension is a payment made by the employer to the employee after his/her retirement/death as a reward of past services provided by such employee. Pension is normally paid as a periodical payment on monthly basis but in certain cases, depending upon the rules of organisation, employees are allowed to receive certain amount of pension in lump sum and rest in monthly payments.

For example, suppose my pension is Rs. 10,000 pm. According to the rules of my organisation, I can take 25% pension in lump sum and rest in monthly payments. Suppose, my total pension is Rs. 5,00,000. So I can take Rs. 1,25,000 as lump sum. If I take this amount, my monthly pension shall be reduced by 25% and I will get Rs. 7,500 pm instead of Rs. 10,000 pm.

The lump sum pension is known as commuted pension whereas monthly pension is known as uncommuted pension.

  • Uncommuted pension (monthly payment) is always 100% taxable in every case.
  • Commuted pension (Lump sum payment) is exempted upto certain extent as specified under Section 10(10A).

Taxability of Commuted pension

From commuted pension (Lump sum payment) point of view, we can divide all the employees in 2 broad categories:

  1. Employees of government, local authorities and statutory corporations who receive commuted pension under Civil Pensions (Commutation) Rules of Central Government or any other similar scheme
  2. Other employees (not covered in point 1)

Commuted pension (Lump sum payment) received to employees covered in point 1 is fully exempted.
Taxability of Commuted pension (Lump sum payment) received to other employees depends upon whether the employee receives gratuity or not.

  • Where gratuity is received – Value upto 1/3rd of the total Commutable pension is exempted from tax.
  • Where gratuity is not received – Value upto half (1/2) of the total Commutable pension is exempted from tax.

Steps for calculating commuted pension exemption
Step 1 – Ascertain the category of employee
Step 2 – In case of other employees, first of all calculate total commutable pension, if not given in the question.
Step 3 – Ascertain whether employee received gratuity or not
Step 4 – Calculate the exempted pension as discussed above.

Provident Fund

Provident means “making of timely preparations for future”. So, provident fund means fund created for future benefits of employees.

In this fund, generally, some amount is credited from the salary of the employee and some amount is contributed by the employer on behalf of employee every month. The amount so collected in the fund is further invested to earn interest income. This interest income is also credited to the PF a/c of employee. The balance keeps on accumulating year after year.

For Example:
My salary is Rs. 10,000 per month. Every month Rs. 1,000 is deducted from my salary and credited to my P.F a/c. Further, my employer also contributes Rs. 1,000 in my P.F a/c. In this way Rs. 2000 is credited to my PF a/c. This amount is further invested in the approved securities to earn interest income. Such interest income is also credited to my PF a/c.

Points to note:
There may be 3 main components of provident fund:

  1. Taxable part of employee’s salary is credited to the PF a/c
    In the above example, I am contributing that amount to my PF a/c which is the part of my total income and is liable to tax. Although I receive only Rs. 9,000 p.m. but entire Rs. 10,000 shall become part of my total taxable income. Rs. 1000, which is my contribution to my PF a/c, shall be considered as ‘income deemed to be received’ in my hands and is taxable every year.
    Thus I am paying taxes on my contributed amount. Therefore, this amount shall never be taxed again in future.
    Under Income Tax Act, I can claim deduction of my contributed amount from gross total income under Section 80C. But the aggregate amount of deduction under Section 80C, 80CCC and 80CCD is limited to Rs. 1,50,000.
  2. Employers contribution to PF a/c is a future benefit to employee
    Contribution of employer is an extra benefit for employee. But employee doesn’t get this benefit immediately. Employee gets this benefit only when he/she receives amount of provident fund. Therefore, such contribution is not taxable in the hands of employee in the P.Y. in which such contribution is credited. But employer’s contribution above certain level is taxable.

  3. Interest credited to the PF a/c is also a future benefit to employee
    Interest credited to the provident fund account of the employee is also an income of the employee over and above the salary income. Like employer’s contribution, employee doesn’t get this benefit immediately. Employee gets this benefit only when he/she receives amount of provident fund. Therefore, such contribution is not taxable in the hands of employee in the P.Y. in which such interest is credited. But interest credited above certain level is taxable.

 

Types of Provident Funds

Statutory Provident Fund (SPF)
Created under Provident Fund Act, 1925 – Recognized by Income Tax Commissioner
Created mainly for Government and Semi-Government Employees, Employees approved of Educational Universities

Recognized Provident Fund (RPF)
Created under Employee’s Provident Funds and Miscellaneous Provisions Act, 1952 – Beside taking approval of Provident Fund Commissioner, employer shall take approval of Income Tax Commissioner also. Without approval of Income Tax Commissioner, provident fund created under this act cannot be considered as Recognized Provident Fund.

Unrecognized Provident Fund (URPF) 
A provident fund which is not approved by Income Tax Commissioner (whether approved by Provident Fund Commissioner or not)

Public Provident Fund (PPF)
Created under Public Provident Fund Act, 1968
This scheme is created for general public. In this scheme anyone from the public may contribute, whether such person is employee or not. It means even a self-employed person can contribute in this scheme and create his PF a/c for future. There is no concept of employer’s contribution in this scheme. Every individual has to contribute from his own pocket.
Maximum amount of contribution per year is Rs. 1,50,000
Minimum amount of contribution per year is Rs. 500

Tax Treatment of Provident Funds

ParticularsSPFRPFURPFPPF
Employee’s contribution  Deduction u/s 80C is available for it.Deduction u/s 80C is available for it.No deduction under section 80C is availableDeduction u/s 80C is available for it.
Employer contributionExempted from tax
  • Exempt up to 12% of salary;
  • Any excess over 12% of salary is taxable.
Not treated as income of the year in which contribution is made.Not applicable as there is only employee’s contribution.
Interest on provident fundExempted from tax
  • Exempt up to 9.5%.
  • Any excess over 9.5% is taxable.
Not treated as income of the year in which interest is created.Exempt from tax
Lump-sum payment at the time of retirement/ resignation/ termination etc. Exempted from taxExempted from tax, subject to fulfillment of certain conditions (See note given below).
But if not exempt due to non-fulfillment of these conditions, it will be treated as unrecognised from the beginning.

Receipts of:

  • Employee’s own contribution, is exempt.
  • Interest on employee’s contribution, is taxable under “other sources”.
  • Any other receipts like amount in respect of employer’s contribution shall be taxable under the head “salaries”.
Exempt from tax

Notes-

  1. “Salary” for this purpose means basic salary, it includes dearness allowance if terms of employment so provide, and exclude all other allowances and perquisites. It also includes the amount of commission based on fixed percentage of turnover.
  2. The accumulated balance due and becoming payable to an employee participating in a recognized provident fund shall be exempted in the following situations:
    • If employee has rendered continuous service with his employer for a period of 5 years or more.
    • If he has not rendered such continuous service, the service has been terminated by reason of the employee’s ill-health or discontinuance of employer’s business or other reason beyond the control of the employee.
    • In case of change of job, if the accumulated balance is transferred to his account in any RPF maintained by such other employer.
  1. Where accumulated balance become taxable due to non-fulfillment of conditions mentioned above, the total income of the employee will be recomputed by the Assessing Officer, as if the fund was not recognized from the beginning.

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