Income from Salary is the first head of income under S.14 of the Income Tax Act. It covers all remuneration received by an employee from an employer under a contract of service. The relationship of employer-employee (master-servant) is essential; payments under a contract for service (independent contractor) do not fall under this head.
Legal Framework
| Provision | Content |
|---|---|
| S.15 | Charging section: salary due, received, or arrears taxable |
| S.16 | Deductions from salary (standard deduction, entertainment allowance, professional tax) |
| S.17(1) | Definition of "salary" (wages, annuity, pension, gratuity, advance, commission, perquisites, profits in lieu of salary) |
| S.17(2) | Definition of "perquisite" (rent-free accommodation, car, club, etc.) |
| S.17(3) | Definition of "profits in lieu of salary" (compensation, payments from unrecognised PF, etc.) |
| S.10(10) | Gratuity exemption |
| S.10(10A) | Commuted pension exemption |
| S.10(10AA) | Leave encashment exemption |
| S.10(14) | Prescribed allowances exemption |
Basis of Charge (S.15)
Salary is taxable on the earliest of:
| Basis | Meaning |
|---|---|
| Due basis | When salary becomes due (whether or not received) |
| Receipt basis | When salary is actually received (even if not due) |
| Arrears | Salary received in arrears (if not charged earlier) |
Why: The dual basis (due OR receipt, whichever is earlier) prevents both acceleration and deferral of tax liability. An employer cannot escape deducting TDS by delaying payment; an employee cannot escape tax by deferring receipt.
Components of Salary (S.17(1))
| Component | Section | Taxability |
|---|---|---|
| Basic salary | S.17(1)(i) | Fully taxable |
| Dearness allowance | S.17(1)(i) | Fully taxable |
| Advance salary | S.17(1)(v) | Taxable in year of receipt |
| Arrears of salary | S.15(b) | Taxable (relief u/s 89 available) |
| Gratuity | S.17(1)(iii) | Exempt up to limits u/s 10(10) |
| Pension | S.17(1)(ii) | Uncommuted: fully taxable; Commuted: exempt u/s 10(10A) |
| Leave encashment | S.17(1)(va) | Exempt on retirement u/s 10(10AA), max Rs.25 lakh |
| Commission | S.17(1)(iv) | Fully taxable |
| Bonus | S.17(1)(iv) | Fully taxable |
Allowances
| Category | Examples | Taxability |
|---|---|---|
| Fully taxable | Dearness allowance, city compensatory allowance, lunch allowance | 100% taxable |
| Partially exempt (S.10(14)) | HRA (S.10(13A)), transport allowance, children education allowance | Exempt up to prescribed limits |
| Fully exempt | Foreign allowance to Govt. employees posted abroad | Fully exempt |
HRA Exemption (S.10(13A), Rule 2A)
Least of:
- Actual HRA received
- 50% of salary (metro) / 40% (non-metro)
- Rent paid minus 10% of salary
Worked Example: HRA Computation
Facts: Mr. Arjun works in Hyderabad. Basic salary Rs.50,000/month. DA (forms part of retirement benefits): Rs.10,000/month. HRA received: Rs.20,000/month. Rent paid: Rs.18,000/month.
Salary for HRA purpose = Basic + DA (if part of retirement) = Rs.60,000/month = Rs.7,20,000/year
Exemption = Least of:
- Actual HRA received = Rs.20,000 × 12 = Rs.2,40,000
- 40% of salary (Hyderabad is non-metro for HRA) = 40% × 7,20,000 = Rs.2,88,000
- Rent paid minus 10% of salary = (18,000 × 12) minus (10% × 7,20,000) = 2,16,000 minus 72,000 = Rs.1,44,000
Exempt HRA = Rs.1,44,000 (least of three) Taxable HRA = Rs.2,40,000 minus Rs.1,44,000 = Rs.96,000
Exam tip: Always identify "salary" for HRA as Basic + DA (if it forms part of retirement benefits). Commission on turnover is also included if specifically provided.
Deductions from Salary (S.16)
| Deduction | Section | Amount |
|---|---|---|
| Standard deduction | S.16(ia) | Rs.75,000 (from AY 2025-26) |
| Entertainment allowance | S.16(ii) | Least of: actual, Rs.5,000, or 20% of salary (Govt. employees only) |
| Professional tax | S.16(iii) | Actual amount paid (max Rs.2,500) |
Recall Check
- What is the basis of charge for salary income under S.15?
- What are the three components of S.17 (salary, perquisite, profits in lieu)?
- How is HRA exemption calculated under S.10(13A)?
Key Cases
Ram Prashad v. CIT (1972) Ram-Prashad-v-CIT-1972 Issue: Whether remuneration paid to a director who also holds a professional position constitutes "salary" or "professional income." Rule: The test is whether an employer-employee (master-servant) relationship exists; if the company controls the manner of work, it is salary. Held: Remuneration received by a director functioning under the control and supervision of the board constitutes salary under S.15. The employer-employee relationship is determined by the degree of control, not the designation.
Gestetner Duplicators v. CIT (1979) Gestetner-Duplicators-v-CIT-1979 Issue: Whether contributions to an unrecognised provident fund constitute "salary" for TDS purposes. Rule: S.17(1) read with S.17(3); employer's contributions to unrecognised PF become taxable as profits in lieu of salary when received by the employee. Held: Employer's contribution to an unrecognised PF is not taxable as salary during the employment period; it becomes taxable as "profits in lieu of salary" u/s 17(3) when the accumulated sum is received by the employee.
Distinctions
| Feature | Salary (S.15) | Professional Income (S.28) |
|---|---|---|
| Relationship | Employer-employee (contract OF service) | Client-professional (contract FOR service) |
| Control test | Employer controls manner of work | Professional has autonomy |
| TDS section | S.192 | S.194J |
| Deductions | Standard deduction (S.16) | All business expenses (S.30-37) |
| Examples | Employee's monthly pay | Advocate's fees, doctor's consultation |
| Return filing | Usually Form 16 based | Books of accounts required |
Flashcards
Q: What is the charging section for income from salary? A: Section 15 of the Income Tax Act, 1961.
Q: On what basis is salary taxable under S.15? A: On due basis or receipt basis, whichever is earlier; also arrears not charged earlier.
Q: What is the standard deduction for salaried employees from AY 2025-26? A: Rs.75,000 under S.16(ia).
Q: What are the three elements included in S.17? A: S.17(1) defines "salary"; S.17(2) defines "perquisite"; S.17(3) defines "profits in lieu of salary."
Q: What is the maximum exemption for leave encashment on retirement? A: Rs.25,00,000 under S.10(10AA).
Q: What test determines whether payment is "salary" or "professional income"? A: The master-servant relationship (control test). If the payer controls the manner of work, it is salary (Ram Prashad v. CIT).
Exam Scenario
Ms. Priya is a chartered accountant employed full-time by ABC Ltd. She also provides consultancy to XYZ Ltd on weekends under a separate agreement. ABC Ltd pays her Rs.12 lakh salary; XYZ Ltd pays Rs.4 lakh fees. The AO proposes to tax the entire Rs.16 lakh under "Salary." Advise.
Approach: Apply the control test (Ram Prashad v. CIT). With ABC Ltd, Priya works under their control and direction (contract OF service) → Rs.12 lakh is salary under S.15. With XYZ Ltd, she provides independent professional services without their control over manner of work (contract FOR service) → Rs.4 lakh is income from business/profession under S.28. The AO is incorrect in clubbing both under salary. Each relationship must be independently assessed.