The Income Tax Act of 1961 categorises income into five categories to provide for systematic taxation and assessment. The categories assist in identifying how different sources of income are taxed and allow taxpayers to properly calculate their overall income. Income is categorised into five types: salary income, house property income, profit and loss from business or profession, capital gains or losses on the buy or sale of properties, and income from other sources. The Act specifies a distinct set of provisions, deductions, and calculation procedures for every category. This categorization allows the Income Tax Department to distinguish between different kinds of earnings and apply the right tax rules to each.
What is ‘Income From Salary’?
Income from Salary means the salary or wages received by a person from an employer for services rendered in terms of an employment agreement. This is one of the five categories of income recognized by the Income Tax Act 1961. The employer-employee relationship is critical to determining income under this category. Without such a relationship, the income would be classified as “Profits and Gains of Business or Profession” instead.
Compensation includes not just the minimum pay but also other allowances (e.g., house rent allowance and dearness allowance), perks (such as rent-free residence and company cars), bonuses, commissions, pensions, gratuities, and advance payments. Arrears of salary are also chargeable to tax under this head in the year of receipt; however, Section 89(1) provides for some exceptions.
According to Section 15 of the Act, salary is taxable on the date of receipt or the due date, whichever is earlier. Deductions such as the standard deduction under Section 16(ia), professional tax, and entertainment allowance (in case of government servants) can be availed while calculating the taxable income.
In short, “Income from Salary” ensures that all employee benefits are included in the tax net, ensuring tax equality and parity.
What is Salary Under the Income Tax Act 1961?
Based on the Income Tax Act, “salary” refers to both monetary and non-monetary compensation earned by an employee from their employer. Each component is governed by varying rules of taxation, and some portions may be exempted or claimed as a deduction. A complete understanding of these components is crucial in determining the correct tax and complying with the law.
Although the word “salary” is not defined under the Income Tax Act of 1961, Section 17(1) defines it in a general sense. It defines salary to include wages, annuities or pensions, gratuities, fees, commissions, perquisites, profits in lieu of salary, advance salary, leave encashment, and employer contributions to approved provident funds in excess of statutory amounts. It also includes the cash value of any perquisites or facilities given by the employer to employees.
For the tax to apply, there has to be an employer-employee relationship. Without such a relationship, the income will be classified and taxed under other categories.
Elements of salary as stipulated in the Income Tax Act are:
- Base Salary/Wages, the core element of salary and the basis on which many allowances and benefits are computed.
- Allowances are regular, fixed payments made to cover specific expenses.
General instances are:
- House Rent Allowance (HRA), exempt under Section 10(13A) to a specific limit.
- Dearness Allowance (DA), designed to compensate for inflation.
- Transportation/Conveyance Allowance, with partial exemption to disabled persons.
- Children’s Education Allowance, exempted up to ₹100 per month for two children.
What is Taxable Salary?
Taxable salary is the part of income that is subject to income tax after adjustments for exemptions and deductions.
Taxable compensation refers to the portion of an employee’s total compensation that falls under the taxable head of ‘Income from Salaries’ as per the Income Tax Act of 1961. It is calculated after considering all applicable exclusions and deductions under this head. The taxable salary forms part of a person’s total income and is taxed based on the slab rates for the corresponding financial year.
It is different from both CTC and take-home pay. Whereas CTC stands for the employer’s total cost, take-home pay is the amount the employee actually gets after deducting all compulsory deductions and taxes. Understanding the difference is vital for proper financial planning, salary negotiations, and taxation compliance.
CTC is the company’s total outgoings, whereas take-home pay refers to the amount actually taken home by the employee.
Calculation of Income Tax on Salary Under ‘Income From Salary’
As stated under the Income Tax Act of 1961, the procedure and principles for determining salary income are laid out in detail in Sections 15-17. The Act applies an expansive definition to salary, stating that although some elements are specifically listed, others are permissible on the basis of interpretations or rulings.
An employer-employee relationship must exist before income can be taxable under the “Salaries” category. The compensation includes monetary components (like basic pay and allowances) as well as non-monetary components (like perquisites). Not all payments or benefits, however, are chargeable to tax; there might be some exclusions under some articles and others could be taxed under other categories. Proper comprehension and classification of inclusion and exclusions are essential for proper tax compliance and planning.
The following items are included in the computation of salary income:
These items are considered part of salary income and are tax-deductible unless specially exempted.
1. Basic Salary or Wages – The regular remuneration for the work done.
2. Allowances (Section 17.1)
- House Rent Allowance (HRA) is taxable, subject to exemption under Section 10(13A).
- Dearness Allowance (DA) is completely taxable.
- Transport, medical, education, and other allowances are taxable, subject to exemption.
3. Bonus/Commission – Contractual and performance-based bonuses and commissions are taxed fully.
4. Perquisites (Section 17.2)
- Non-monetary benefits are offered by employers, including rent-free accommodation.
- Personal car
- Free meals or membership in clubs
- Stock options (ESOPs)
- Assessed in accordance with Rule 3 of the Income Tax Rules.
5. Retirement Benefits
- Uncommuted pensions are taxable, while commuted pensions are partly exempt according to Section 10(10A).
- Gratuity is exempt as per the limits prescribed under Section 10(10).
- Leave Encashment is partly exempt under Section 10(10AA).
6. Advance Salary and Arrears:
- They are taxable in the year received.
- Section 89(1) relief is available.
7. Employer contributions that are in excess of the prescribed limits
- Provident Fund contributions exceeding 12% of wages.
- Contributions in excess of ₹7.5 lakh to NPS or Superannuation Funds (combined maximum under the Finance Act 2020).
8. Profits in lieu of salary [Section 17(3)]
Payments in respect of services, such as:
- Termination compensation.
- Amounts received under Keyman insurance policies (if not already taxed).
- Amounts received from non-recognised provident funds.
What is not included while calculating salary income?
The following are not taxable as ‘salary income’ on account of being exempt, falling under a different category of tax, or non-taxable:
1. Reimbursement of Actual Expenses – Expenses related solely to official work, including travel, transport, or uniform allowances, are not categorized as remuneration.
2. Employer Contributions within Limit
- Employer contributions under the Provident Fund are permissible up to 12% of salary.
- Contributions to the NPS/Superannuation Fund should stay within the permitted limits (total exemption up to ₹7.5 lakh a year).
3. Totally Exempt Allowances
- Allowances received by government personnel posted overseas.
- Foreign allowances to officers of the UN or diplomatic cadre.
- Special compensatory allowances for employees in hilly or remote posts (as defined).
4. Exempt perquisites are medical reimbursement up to the legal limits (albeit largely phased out save for exclusions relating to COVID), laptops or computers used for work, and mobile phones supplied by the employer.
5. Capital Receipts
- VRS refund on voluntary retirement [exempted up to ₹5 lakh under Section 10(10C)].
- Gratuity, leave encashment (up to the extent that it is exempted), and commuted pensions.
6. Freelancing, Consultancy, or Business income
- This is not taxed as ‘Salaries’ since it is not included under that category.
- It is Taxed under ‘Profits and Gains of Business or Profession’.
Tax Rates And TDS on Salary
Salaries come under slab rate taxation both in the old and new tax regimes. To efficiently maintain TDS and tax liability, employees have to furnish evidence of investments and disclose their choice of tax regime. TDS as prescribed under Section 192 makes sure of the collection of taxes punctually and regularly throughout the financial year.
A. New Tax Regime (Applicable from FY 2023-24)
According to Section 115BAC(1A):
| Annual Income (₹). | Tax Rate |
| Up to ₹3,00,000. | Nil |
| ₹3,00,001 – ₹6,00,000. | 5% |
| ₹6,00,001 – ₹9,00,000. | 10% |
| ₹9,00,001 – ₹12,00,000. | 15% |
| ₹12,00,001 – ₹15,00,000. | 20% |
| Over ₹15,00,000. | 30% |
- From FY 2023-24, a basic deduction of ₹50,000 can be allowed.
- Allowances and deductions are barred (e.g., HRA, LTA, 80C, or 80D do not apply).
- Some exemptions, such as EPF contribution, NPS under Section 80CCD(2), and deduction of family pension, are still applicable.
B. Old Tax Regime (optional)
| Annual income (₹). | Tax Rate |
| Up to ₹2,50,000. | Nil |
| ₹2,50,001 – ₹5,00,000. | 5% |
| ₹5,00,001 – ₹10,00,000. | 20% |
| Above ₹10,00,000. | 30% |
- A rebate of up to ₹12,500 is permissible under Section 87A for total income ≤ ₹5,00,000.
- The regime permits standard deductions and exemptions, which are:
- ₹50,000 standard deduction under Section 16.
- HRA, LTA, and Children’s Education Allowance.
- Deductions under Chapter VI-A, like 80C, 80D, 80E, and 80G.
C. Surcharge (Applicable to Both Regimes)
This surcharge is imposed on total income (before cess):
| Total Income (₹). | Surcharge Rate |
| ₹50 lakh – ₹1 crore. | 10% |
| ₹1 crore – ₹2 crore. | 15% |
| ₹2 crore – ₹5 crore. | 25% (Old Regime), capped at 25% (New Regime) |
| Above ₹5 crore. | 37% (Old Regime), capped at 25% (New Regime) |
D. Health & Education CESS
A further 4% is imposed on the total tax (including surcharge).
E. TDS on Salary (Section 192)
TDS on salaries is governed by Section 192 of the Income Tax Act, 1961.
Important points:
- Who deducts TDS? It is deducted by the employer from salary payments.
- TDS is deducted at the time of payment, not when it is received.
- There is no set rate; it is dependent on the slab rates applicable (which are dependent on the tax regime).
- In order to choose a tax regime, employees will need to notify the employer at the start of the fiscal year. Failing this, the new regime will be applied automatically.
- In the absence of a PAN, TDS will be deducted at the maximum rate applicable or at 20%.
- TDS Certificate in Form 16 is issued every year by the employer and records salary payment and TDS deduction. It is mandatory to submit the income tax return (ITR).
Illustration
Given:
Mr. Raj, aged 30 years.
Annual Salary Structure:
Component amount (₹) Basic Salary: 6,000.00
House Rental Allowance (HRA) 2,40,000
Special Allowance 1,20,000
Bonus: 60,000
Gross Salary: 10,20,000
He incurs a monthly rent of ₹20,000 in a metropolitan area. Investment under Section 80C: ₹1,50,000 (PPF + ELSS). The medical insurance premium under Section 80D amounts to ₹25,000. Standard deduction of ₹50,000 (available under both tax regimes).
Step-by-step Calculations of Income tax on salary
A. Under the old tax regime
1. Gross salary – ₹10,20,000.
2. Less: exemptions
The HRA exemption under Section 10(13A) is determined by the least of the following:
HRA received: ₹2,40,000.
50% of Basic (for metropolitan cities): ₹3,00,000.
Rent paid minus 10% of basic = (₹2,40,000 – ₹60,000) = ₹1,80,000.
→ HRA Exemption = ₹1,80,000
3. Net salary is ₹8,40,000, calculated by deducting ₹1,80,000.
4. Less: deductions.
Standard deduction: ₹50,000
Section 80C: ₹1,50,000
Section 80D: ₹25,000.
→ Total deductions: ₹2,25,000.
5. Taxable income = ₹8,40,000 – ₹2,25,000 = ₹6,15,000.
6. Tax Calculation (Old Regime Slabs)
Tax slab (₹) Up to ₹2,50,000 – Nil
₹2,50,001 – ₹5,00,000 – 5% of ₹2,50,000 = ₹12,500
₹5,00,001 – ₹6,15,000 20% of ₹1,15,000 = ₹23,000
→ Total Tax = ₹35,500
Less: Rebate under Section 87A? Not applicable (income exceeds ₹5L)
Add: Health & Education Cess @ 4% ₹35,500 × 4% = ₹1,420
→ Total Tax Payable = ₹36,920
B. Under the New Tax Regime
HRA exemption or deductions under sections 80C/80D are not allowed.
Only a standard deduction of ₹50,000 can be allowed.
1. Gross Salary = ₹10,20,000
2. Deduction: Standard Deduction = ₹50,000
→ Taxable Income = ₹9,70,000
3. Calculation of Tax (New Regime Slabs)
| Slab. | Tax (₹) |
| up to ₹3,00,000. | Nil |
| ₹3,00,001 – ₹6,00,000. | 5% of ₹3,00,000 = ₹15,000 |
| ₹6,00,001 – ₹9,00,000. | 10% of ₹3,00,000 = ₹30,000 |
| ₹9,00,001 – ₹9,70,000. | 15% of ₹70,000 = ₹10,500 |
→ Total Tax = ₹55,500
Add: Cess @ 4% = ₹2,220
→ Total Tax Payable = ₹57,720
FINAL COMPARISON
| Regime. | Taxable Income (₹). | Total Tax (₹) |
| Old Regime. | ₹6,15,000. | ₹36,920 |
| New Regime. | ₹9,70,000. | ₹57,720 |
Here, the Old Regime is more beneficial, and there is a tax saving of ₹20,800, due to the inclusion of HRA and deductions under Sections 80C and 80D.
Employees are motivated to review their personal salary structures and the deductions applicable before selecting a tax regime.
Conclusion
Calculation of the tax on salary as per the Income Tax Act of 1961 requires an understanding of the components of income, applicable exemptions, and the option for the right tax regime.
Sound tax planning ensures compliance with legal issues while maximising savings.
An informed decision between the new and old tax regimes helps salaried individuals maximise their net income and reduce their overall tax burden.
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