CLASS XI - SEMESTER II
COSTING AND TAXATION (CSTX)
Unit 3: Income Under the Head "Salaries"
This resource is for educational purposes only and does not constitute legal advice.
A. Basis of Charge - Section 15
What Constitutes Salary Income?
Section 15 of the Income Tax Act defines the basis of charge for salary income. Salary is chargeable to tax on DUE BASIS or RECEIPT BASIS, whichever is earlier.
Flowchart: Salary Taxability
Essential Norms of Salary Income
| Norm | Description | Example |
|---|---|---|
| Employer-Employee Relationship | There must be a master-servant relationship | Company employee, Government servant |
| Due or Receipt Basis | Tax liability arises when salary becomes due or is received, whichever is earlier | Salary due in March 2025 but received in April 2025 - taxable in FY 2024-25 |
| Includes Allowances & Perquisites | All monetary and non-monetary benefits | HRA, Free accommodation, Medical facilities |
| Advance Salary | Taxed in the year of receipt | Advance for FY 2025-26 received in FY 2024-25 is taxed in FY 2024-25 |
B. Various Types of Allowances
1. Basic Salary
Basic Salary is the fundamental component of salary and is fully taxable. It forms the base for calculating other allowances like DA, HRA, etc.
2. Dearness Allowance (DA)
DA is provided to offset the impact of inflation. It can be of two types:
- DA forming part of salary: Fully taxable and considered for retirement benefits
- DA not forming part of salary: Fully taxable but not considered for retirement benefits
3. City Compensatory Allowance (CCA)
CCA is granted to compensate for higher cost of living in metro cities. It is fully taxable with no exemptions.
4. House Rent Allowance - Section 10(13A)
HRA is partially exempt from tax. The exempt amount is calculated as the LEAST of the following three:
| Condition | Calculation |
|---|---|
| Condition 1 | Actual HRA Received |
| Condition 2 | Rent Paid - 10% of Salary (Basic + DA forming part of salary) |
| Condition 3 | 50% of Salary (for Metro cities: Mumbai, Delhi, Kolkata, Chennai) 40% of Salary (for Non-Metro cities) |
Example: HRA Calculation
Mr. Sharma's Details:
- Basic Salary: ₹50,000 per month
- DA (forming part of salary): ₹20,000 per month
- HRA Received: ₹25,000 per month
- Rent Paid: ₹30,000 per month
- City: Mumbai (Metro)
Calculation:
| Actual HRA Received | ₹25,000 × 12 = ₹3,00,000 |
| Rent Paid - 10% of Salary | ₹30,000 × 12 - 10% of (₹70,000 × 12) = ₹3,60,000 - ₹84,000 = ₹2,76,000 |
| 50% of Salary (Metro) | 50% of (₹70,000 × 12) = ₹4,20,000 |
Exempt HRA = LEAST of above three = ₹2,76,000
Taxable HRA = ₹3,00,000 - ₹2,76,000 = ₹24,000
5. Medical Allowance
Medical allowance paid by employer is fully taxable. However, actual medical reimbursement against bills is exempt.
6. Bonus
Bonus received from employer is fully taxable as salary income in the year of receipt.
7. Children Education Allowance
Exempt up to ₹100 per month per child (maximum 2 children). Total exemption = ₹2,400 per year (₹1,200 per child × 2).
Hostel Expenditure Allowance: Exempt up to ₹300 per month per child (maximum 2 children).
8. Transport Allowance
Transport allowance for commuting between home and office is fully taxable. However, allowance for physically challenged employees is exempt up to ₹3,200 per month.
| Allowance Type | Taxability | Exemption (if any) |
|---|---|---|
| Basic Salary | Fully Taxable | Nil |
| Dearness Allowance | Fully Taxable | Nil |
| City Compensatory Allowance | Fully Taxable | Nil |
| House Rent Allowance | Partially Taxable | As per Section 10(13A) |
| Medical Allowance | Fully Taxable | Nil |
| Bonus | Fully Taxable | Nil |
| Children Education Allowance | Partially Taxable | ₹100 pm per child (max 2) |
| Transport Allowance | Fully Taxable | ₹3,200 pm for disabled employees |
C. Perquisites - Section 17(2)
Perquisites are benefits or facilities provided by employer in addition to salary. They may be taxable or tax-free depending on their nature.
Definition and Types
Section 17(2) defines perquisites as any benefit or amenity granted or provided free of cost or at concessional rate by employer.
Classification of Perquisites
D. Valuation of Rent-Free Accommodation
Rule 3(1): Valuation of Unfurnished Accommodation
For Central and State Government Employees
License Fee as per Government Rules is taken as the value of perquisite.
For Private Sector Employees
Value depends on whether accommodation is owned or hired by employer:
| Type of City | Owned by Employer | Hired by Employer |
|---|---|---|
| Metro Cities (Pop. > 25 lakhs) | 15% of Salary | Actual rent paid OR 15% of salary (whichever is lower) |
| Cities (Pop. 10-25 lakhs) | 10% of Salary | Actual rent paid OR 10% of salary (whichever is lower) |
| Other Places | 7.5% of Salary | Actual rent paid OR 7.5% of salary (whichever is lower) |
Note: "Salary" for this purpose = Basic Salary + DA (if forming part of salary for retirement benefits) + Turnover based commission
Valuation of Furnished Accommodation
Value of Furnished Accommodation = Value of Unfurnished Accommodation + Value of Furniture
Value of Furniture:
- If furniture owned by employer: 10% per annum of original cost of furniture
- If furniture hired by employer: Actual hire charges OR 10% of original cost (whichever is lower)
Example: Accommodation Perquisite Valuation
Mr. Verma works in Mumbai (Metro) for a private company:
- Basic Salary: ₹60,000 per month
- DA: ₹25,000 per month (forms part of salary)
- Accommodation: Company-owned flat (unfurnished)
Calculation:
Salary for perquisite = (₹60,000 + ₹25,000) × 12 = ₹10,20,000
Value of Perquisite = 15% of ₹10,20,000 = ₹1,53,000
If furniture worth ₹5,00,000 is also provided:
Furniture perquisite = 10% of ₹5,00,000 = ₹50,000
Total perquisite = ₹1,53,000 + ₹50,000 = ₹2,03,000
E. Valuation of Education Perquisites
(i) Free Education to Employee's Children
If employer provides free education in own educational institution:
- If cost to employer is NIL or INSIGNIFICANT: Not a taxable perquisite
- If there is substantial cost to employer: Cost to employer minus amount recovered from employee is taxable
(ii) Payment of School Fees by Employer
If employer directly pays fees to external educational institution for employee's children, the entire amount is a taxable perquisite.
| Scenario | Valuation | Example |
|---|---|---|
| Own Institute - No Cost | Nil (Tax-Free) | Employee's child studies in company's school where marginal cost is nil |
| Own Institute - With Cost | Cost to employer - Amount recovered | Cost ₹50,000, Recovered ₹10,000 → Perquisite = ₹40,000 |
| External Institute | Fees paid by employer | Employer pays ₹1,00,000 to external school → Perquisite = ₹1,00,000 |
(iii) Education Facility in Employee's Institute
When employee works in an educational institution and their children study there:
- If no extra cost is incurred by employer: Not taxable
- If concession is given from normal fees: Not taxable as it's considered welfare measure
Example: Education Perquisite
Scenario 1: Mr. Singh works in ABC Ltd. The company runs a school. His son studies there. The school would have had 5 vacant seats anyway, so no additional cost is incurred.
Perquisite Value = NIL (Tax-Free)
Scenario 2: Same facts, but company incurs ₹80,000 as cost and recovers ₹20,000 from Mr. Singh.
Perquisite Value = ₹80,000 - ₹20,000 = ₹60,000 (Taxable)
Scenario 3: Mr. Gupta's employer pays ₹1,50,000 directly to XYZ International School for his daughter's education.
Perquisite Value = ₹1,50,000 (Fully Taxable)
F. Common Tax-Free Perquisites
Following are some very common examples of perquisites which are NOT taxable:
| S.No. | Perquisite | Conditions |
|---|---|---|
| 1 | Medical Facilities | Treatment in hospital maintained by employer OR approved hospital/clinic (including family members) |
| 2 | Refreshments | Tea, coffee, snacks during working hours in office premises |
| 3 | Leave Travel Concession (LTC) | Travel within India for self and family (twice in block of 4 years) |
| 4 | Telephone/Mobile | For official purposes (including installation and call charges) |
| 5 | Computer/Laptop | For official purposes |
| 6 | Interest-Free Loan | Medical treatment of specified diseases, natural calamity |
| 7 | Free Meals | Provided in remote area OR during working hours (up to ₹50 per meal) |
| 8 | Conveyance | For official duties (not home to office) |
| 9 | Gifts | Up to ₹5,000 per year from employer |
| 10 | Recreation Facilities | Gym, sports, club membership for official purposes |
| 11 | Education to Children | In employer's own institution without cost |
| 12 | Insurance Premium | Health insurance for employee and family (any amount) |
Quick Check: Is Perquisite Taxable?
G. Deduction for Professional Tax - Section 16(iii)
Section 16(iii) allows deduction of Professional Tax or Tax on Employment paid by the employee to the State Government.
Key Points
- Professional Tax is levied by State Governments (not Central Government)
- Maximum limit of Professional Tax is ₹2,500 per year as per Article 276 of the Constitution
- Deductible on payment basis (not on accrual basis)
- Must be actually paid by the employee (even if deducted by employer from salary)
- Allowed as deduction from Gross Salary
| Aspect | Details |
|---|---|
| Who levies it? | State Governments (Maharashtra, Karnataka, West Bengal, etc.) |
| Maximum Amount | ₹2,500 per annum |
| When deductible? | In the year of actual payment |
| Section | Section 16(iii) |
| From which head? | Income from Salaries |
Example: Salary Computation with Professional Tax
Mr. Joshi's Salary Details for FY 2024-25:
- Basic Salary: ₹50,000 pm
- DA: ₹20,000 pm (forms part of salary)
- HRA: ₹18,000 pm (Rent paid: ₹22,000 pm, Mumbai)
- Transport Allowance: ₹3,000 pm
- Professional Tax paid: ₹2,400
Computation of Taxable Salary:
| Basic Salary | ₹50,000 × 12 = ₹6,00,000 |
| Dearness Allowance | ₹20,000 × 12 = ₹2,40,000 |
| House Rent Allowance | ₹18,000 × 12 = ₹2,16,000 |
| Transport Allowance | ₹3,000 × 12 = ₹36,000 |
| Gross Salary | ₹10,92,000 |
Less: Exempt HRA
| Actual HRA | ₹2,16,000 |
| Rent - 10% Salary | ₹2,64,000 - ₹84,000 = ₹1,80,000 |
| 50% of Salary (Metro) | ₹4,20,000 |
| Exempt (Least) | (₹1,80,000) |
Less: Deduction u/s 16(iii) - Professional Tax: (₹2,400)
Net Taxable Salary = ₹10,92,000 - ₹1,80,000 - ₹2,400 = ₹9,09,600
H. Comprehensive Practical Examples
Example 1: Comprehensive Salary Calculation
Mr. Agarwal's Complete Salary Structure for FY 2024-25:
Salary Components:
- Basic Salary: ₹60,000 pm
- DA (forms part of salary): ₹25,000 pm
- HRA: ₹30,000 pm
- CCA: ₹3,000 pm
- Medical Allowance: ₹2,500 pm
- Children Education Allowance: ₹150 pm per child (3 children)
- Transport Allowance: ₹3,500 pm
- Bonus: ₹1,00,000 (annual)
Other Details:
- Working in Delhi (Metro)
- Rent Paid: ₹35,000 pm
- Professional Tax: ₹2,500
- Provided furnished accommodation in company-owned flat
- Furniture cost: ₹6,00,000
- Company pays school fees of ₹1,20,000 to external school
Step-by-Step Calculation:
| GROSS SALARY RECEIVED | |
| Basic Salary | ₹7,20,000 |
| DA | ₹3,00,000 |
| HRA | ₹3,60,000 |
| CCA | ₹36,000 |
| Medical Allowance | ₹30,000 |
| Children Education Allowance | ₹5,400 |
| Transport Allowance | ₹42,000 |
| Bonus | ₹1,00,000 |
| Sub-Total (A) | ₹15,93,400 |
| ADD: PERQUISITES | |
| Accommodation (15% of ₹10,20,000) | ₹1,53,000 |
| Furniture (10% of ₹6,00,000) | ₹60,000 |
| School Fees Paid by Employer | ₹1,20,000 |
| Total Perquisites (B) | ₹3,33,000 |
| GROSS SALARY (A+B) | ₹19,26,400 |
| LESS: EXEMPTIONS | |
| HRA Exempt (Least of ₹3,60,000/₹3,18,000/₹5,10,000) | (₹3,18,000) |
| Children Education (₹100 × 2 × 12) | (₹2,400) |
| Professional Tax u/s 16(iii) | (₹2,500) |
| Total Deductions (C) | (₹3,22,900) |
| NET TAXABLE SALARY | ₹16,03,500 |
Note: HRA received was ₹3,60,000, but only ₹3,18,000 is exempt. Balance ₹42,000 is already included in gross salary.
I. Important Case Law
Leading Case: Commissioner of Income Tax vs. L.W. Russell (1964) 53 ITR 91 (SC)
Facts of the Case
L.W. Russell was employed by a company. The question arose whether certain payments received by him constituted "salary" under the Income Tax Act.
The key issue was to determine the true nature and character of the payments - whether they were in the nature of salary income or business income.
Issue Before the Court
Whether the relationship between the payer and payee was that of employer-employee, which would make the payments taxable as "Salary" income?
Judgment and Ruling
The Supreme Court held that:
- Master-Servant Relationship: For income to be taxable as "salary", there must be a relationship of employer and employee (master and servant relationship)
- Control and Supervision: The employer must have control over the employee regarding how the work is to be done, not just what work is to be done
- Terms of Employment: The existence of terms of employment such as fixed hours, leave, subordination, etc., indicate salary relationship
- Not Merely Payment for Services: Mere payment for services rendered does not automatically constitute salary - there must be employer-employee nexus
Key Principles Established
| Principle | Explanation |
|---|---|
| Employer-Employee Nexus | Essential requirement for salary income - without this relationship, income cannot be taxed as salary |
| Nature of Control | Employer must have control over HOW work is done, not just WHAT work is done |
| Substance over Form | The real nature of relationship matters, not just the label or designation given |
| Regular Employment Features | Presence of fixed salary, defined hours, leave provisions indicate employer-employee relationship |
Relevance and Application
This landmark judgment is crucial because it:
- Defines the scope of "salary" income under the Income Tax Act
- Distinguishes between salary and professional income - important for consultants, freelancers, and professionals
- Establishes tests to determine employment relationship - used even today in tax assessments
- Protects independent contractors from being wrongly assessed as employees
- Clarifies that all monetary benefits received during employment are not automatically "salary"
Practical Application Example
Scenario: Dr. Sharma provides medical consultation to ABC Company for their employees. He visits the company once a week, uses his own equipment, sets his own hours, and is paid ₹50,000 per month.
Question: Is this payment taxable as "Salary" or "Professional Income"?
Analysis based on L.W. Russell case:
- ✗ No fixed working hours
- ✗ No control by ABC Company on how Dr. Sharma conducts consultations
- ✗ Uses own equipment and resources
- ✗ No leave, PF, or other employment benefits
- ✓ Provides professional services independently
Conclusion: Based on the principles in L.W. Russell case, this payment would be taxable as "Professional Income" (under head "Profits and Gains of Business or Profession") and NOT as "Salary", because there is no employer-employee relationship.
Quick Summary - Key Takeaways
| Topic | Key Points |
|---|---|
| Basis of Charge | Salary taxable on due or receipt basis (whichever is earlier); Must have employer-employee relationship |
| HRA Exemption | Least of: Actual HRA, Rent-10% Salary, 50%/40% of Salary |
| Accommodation (Metro) | 15% of salary (owned) OR Lower of rent paid/15% of salary (hired) |
| Children Education | ₹100 pm per child (max 2 children) exempt as allowance |
| Professional Tax | Deductible u/s 16(iii); Maximum ₹2,500 per year |
| Tax-Free Perquisites | Medical facilities, Refreshments, LTC, Official telephone, Gifts up to ₹5,000 |
| L.W. Russell Case | Employer-employee relationship essential for salary income; Control over HOW work is done |