Section 17 (1) of Income Tax Act

Section 17 (1) of the Income Tax Act defines the term salary for taxes. It also provides guidelines to determine the tax liability of the salary earned by an individual. As per Section 17 (1), salary is a payment in cash, kind, or facility received by an employee from his employer.

The meaning of salary in the Income Tax Act is broader than what is perceived generally. In the context of taxes, salary includes the basic pay, allowances, bonuses, commissions, perquisites and profits received by an employee in lieu of salary. Thus, salary is a comprehensive term which includes a wide range of components that an employee earns from his employer.

As mentioned earlier, the definition and components of income from salary under Income Tax Act are specific and extensive. Income chargeable under salaries includes several payments that an employee may receive for rendering his services to the employer.

The following terms are included in the definition of salary for the purpose of Income Tax.

Profit in Lieu of Salary 

These are benefits that an employee may receive in connection with the employment. Here are some examples of such payments.

• It is a monetary compensation given to an employee for modification of employment terms or employment termination.
• A person receives payment before joining as an employee or after termination of employment.
• An amount due or received from an unrecognised PF or superannuation fund. The amount is limited to the employer’s contribution and the interest on such contribution.
• Any payment or bonus received from a Keyman insurance policy.

Wages 

All the payments made by an employer to the employee in return of the services under the contract are termed as wages under the Income Tax Act. Wages may be called by different titles such as salary, remuneration, basic pay, etc. Wages include payment made for actual work days, paid leaves, or an amount received or due during the previous year.

Gratuity Payment 

Gratuity is a one-time payment that an employee receives from the employer in acknowledgement of his services. It is a token of appreciation in monetary form paid to the employer. Gratuity is governed under The Payment of Gratuity Act, 1972, which is considered as income chargeable under salaries.

Fees 

Fees are also a part of the salary that an employee may receive from the employer for providing his valuable services.

Commission 

Any commission received by the employee from the employer is also included in the salary component. A commission may be fixed or maybe a percentage of the sales or profit.

Annuity or Pension 

An annuity or pension is a fund arranged by the employer, which pays the employees over a long period of time after their retirement. The employees receive this benefit/payment for their services to the organisation.

Advance Salary 

An advance salary is a payment that an employer makes to the employee before it is due. It forms a part of the salary of the financial year in which it is taken. An advance salary is different from a loan that an employee may take from the company.

Bonus 

A bonus is an additional payment made to the employee as a reward for his achievements or extraordinary performance.

Special Allowance 

Special allowances may be granted to employees to support their additional requirements, such as travel, education and others. It includes house rent allowance, transport allowance, leave travel allowance, uniform allowance and so on. All these allowances will form a part of the employee’s salary as per section 17 (1) of Income Tax Act.

EPF 

Employee provident fund will be included in an individual's salary when the employer contributions exceed 12% of the salary or the annual interest rate in excess of the rate specified by the Central Government.

Leave Encashment 

Leave encashment is an amount that an employee receives in lieu of unutilised leaves in a financial year. Leave encashment is paid by many private and government companies to their employees during their service or after retirement/resignation. Any amount paid as leave encashment will be considered a part of the salary.

National Pension Scheme 

Any contribution made by the employer to the employee’s account during a financial year under the National Pension Scheme will be treated as salary for taxes.

Perquisites 

Any form of additional benefits that an employee receives from his employer is termed as perquisites. Perquisites may be in the form of cash or kind, such as interest-free loans, club benefits or membership,  educational expenses, rent-free housing facilities, insurance premiums for employees, etc. 

Dearness Allowance 

Dearness allowance is a payment made to employees to help them deal with the inflation effect. Such a payment will be counted as a part of the salary.

PF Balance Transfer 

If a taxable portion of the unrecognised provident fund is transferred to a recognised provident fund, it will be considered part of the salary.

Salary is deemed to accrue at a place where an employee renders his services. The place of accrual of salary is one of the most crucial factors in determining the salary taxability under section 17 (1) of the Income Tax Act.

Salary is considered to accrue in India under the following circumstances-

Services Provided in India:  If an employee receives a salary for the services provided in India, the income is deemed to accrue in India. The income will be considered to accrue in India, irrespective of the location of the employer or the residential status of the employee. If any services are provided within the territory of India, the salary income will be taxable in India. 

Services Provided in India & Salary Paid Outside India: Under this scenario, a non-resident may receive salary payment for the services he provides in India. Such a salary payment will be taxable in India because the services were provided within the boundaries of India.

Employees' Residential Status: If an individual is a resident as per the Income Tax rules, his salary will be taxable in India whether it is earned in India or abroad. However, the salary earned by non-resident employees is subject to income tax only if it accrues in India.

Exceptional Cases: In some cases, individuals may be working in India, but their salary is received from employers outside India. In such cases, the provisions of double tax avoidance agreements will be applicable.

Employees on a Ship/Aircraft: If a person is employed on a ship or aircraft, his income accrual will be determined by the location of his duty. If he offers services while the aircraft or ship is in India, the salary earned will be taxed under the Income Tax Act.

Another important aspect of determining salary for the purpose of income tax is the basis of charge. Section 15 of the Income Tax Act states that salary will be taxable either on a due basis or a receipt basis, whichever is earlier. For the purpose of income tax, the following shall be considered as salary income for the year.

• Any salary due to the employee, whether it is paid or not.
• Any advance amount paid to the employee as his salary, whether it becomes due or not.
• Salary arrears paid to the employee which were not included in tax for the previous years. Such an amount must be paid in the current year.

Let us understand the provisions of section 15 with a few examples.

Example 1: If  Mr A  receives a salary for the month of April 2024 in the month of March 2024, then this salary will be added to the income of the AY 2023-24. Hence, it will be charged to income tax in the year in which it is received. Thus, it will not form a part of the salary for the month of April 2024 and subsequently, it will not be included in the taxable income for AY 2024-25.

Example 2: Mr B receives the salary due in March 2024 in April 2024. In this circumstance, the salary will be charged to tax for the AY 2023-24 as it is due earlier. However, when Mr B actually receives the salary in April 2024, it will not be included in the income for the AY 2024-25.

Example 3:  Mr C receives a salary of ₹50,000 per month. The company revised his salary to ₹70,000 from February 2024. However, the increased salary was paid to him in May 2024. Under such a situation, the arrears of salary (₹20,000) for February 2024 and March 2024 will be treated as arrears of salary and it will be subject to tax in AY 2024-25.

Now that we have defined the components forming part of the salary let us understand how to calculate income tax on salary. To calculate the taxes, one must be aware of the tax slabs/rate at which income is taxable.

Here is a table depicting the tax slabs under the new tax regime for the AY 2024-25:

• Example of Income Tax on Salary

Following are the steps to calculate tax on income from salary:

1. Calculate gross income
2. Reducing the deductions
3. Arrive at the net taxable income
4. Calculate the taxes

Let us consider an example of calculating the income tax liability (new Regime) of a person with a monthly salary and other allowances. 

Section 17 (1) of the Income Tax Act provides a clear and comprehensive definition of the salary for the purpose of Income tax. It helps employees and employers to understand the various components of salary and arrive at the taxes.

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