The Income Tax Act, 1961 governs how individuals and entities are taxed on their earnings. One of the key heads of income under this Act is Income from Salary which forms a significant portion of taxable income for most working professionals. The computation of income from salary involves a process of identifying gross salary components, applying exemptions, valuing perquisites and deducting allowable expenses. This article delves into the intricacies of the computation of income from salary and by understanding these provisions, legal practitioners, tax advisors and salaried individuals can navigate tax liabilities effectively.
Are you interested in pursuing a career in Law? The Legal School in collaboration with IndusLaw has created a unique program for a Certification in Mergers & Acquisitions for fresh law graduates as well as professionals looking to advance in their careers! Enquire now for details!
Defining Salary under the Income Tax Act
In order to begin the computation of income from salary, it is essential to understand what constitutes "salary" as per the Act. Section 17(1) provides an inclusive definition, encompassing wages, annuity or pension, gratuity, fees, commissions, perquisites or profits in lieu of or in addition to salary or wages, advance of salary and any payment received for leave encashment. This definition ensures that various forms of remuneration from an employer-employee relationship are captured.
For example, basic salary is the foundational element which is fully taxable and forming the bulk of one's earnings. Other components include allowances like House Rent Allowance (HRA), Dearness Allowance (DA) and special allowances. Pensions received by retirees or family members also fall under this head. The computation of income from salary does not include voluntary retirement compensation or retrenchment compensation, which may qualify for exemptions under Section 10(10B) or 10(10C).
The gross salary figure on a payslip serves as the starting point for computation. However, not all components are taxable at face value. The Act distinguishes between fully taxable, partially exempt, and fully exempt items, which we will explore further. This nuanced approach in the computation of income from salary prevents over-taxation and aligns with the principle of equity in taxation.
Learn about TDS on Salary Income under Section 192 of Income Tax Act, 1961.
Components of Salary: Allowances and Their Treatment
Allowances are a critical part of salary structure are often designed to cover specific expenses and in the computation of income from salary, allowances are categorized based on their taxability under Section 10 and related rules.
Fully taxable allowances include city compensatory allowance, entertainment allowance (except for government employees who can claim a deduction under Section 16(ii)), and overtime allowance. These are added directly to the gross salary without any relief.
Partially exempt allowances add complexity to the computation of income from salary. The most common is HRA under Section 10(13A), exempt to the extent of the least of: (a) actual HRA received, (b) 50% of salary for metro cities (40% for non-metro), or (c) rent paid minus 10% of salary. For example, if an individual in earns a basic salary of Rs 12,00,000, receives HRA of Rs 6,00,000, and pays Rs 40,000 monthly rent, the exempt HRA would be Rs 3,60,000 (calculated as the minimum of Rs 6,00,000, Rs 6,00,000 (50% of salary), and Rs 3,60,000 (rent paid minus 10% of salary)). The remaining Rs 2,40,000 becomes taxable.
Another partially exempt allowance is Leave Travel Allowance (LTA) under Section 10(5), covering travel expenses for the employee and family, exempt up to the actual amount spent or the allowance received, subject to conditions like claiming it once in a block of four years. In the computation of income from salary, unsubstantiated LTA becomes fully taxable. For instance, if LTA of Rs 20,000 is received but only Rs 12,000 is spent and billed, Rs 12,000 is exempt, and Rs 8,000 is added to taxable income.
Fully exempt allowances, such as transport allowance for handicapped employees (up to Rs 3,200 per month) or allowances for United Nations employees, are subtracted entirely from gross salary during computation.
Special allowances under Section 10(14) of the Act can be exempt if they cover expenses like children's education (Rs 100 per child per month) or hostel allowance (Rs 300 per child per month). However, generic special allowances are taxable which ensures that the computation of income from salary reflects actual disposable income after necessary expenditures.
Perquisites: Valuation and Inclusion
Perquisites, or "perks," are benefits provided by the employer in addition to salary, valued under Rule 3 of the Income Tax Act Rules, 1962. In the computation of income from salary, perquisites like rent-free accommodation, company car, or interest-free loans are included at their taxable value.
For accommodation, the taxable value is 15% of salary for unfurnished (10% for furnished) in cities with population over 25 lakhs, reduced by rent paid by the employee. Employer-provided cars are valued at Rs 1,800–2,400 per month depending on engine capacity, plus driver costs if applicable.
Other perquisites include free education for children (exempt up to Rs 1,000 per child per month) or club memberships. Exempt perquisites, like medical facilities up to Rs 15,000 annually, are not added. The inclusion of perquisites in the computation of income from salary ensures comprehensive taxation of non-cash benefits, preventing under-reporting.
Deductions from Salary Income
Once gross salary (including allowances and perquisites) is determined, deductions under Section 16 are applied in the computation of income from salary. The standard deduction, introduced in 2018, is Rs 50,000 under the old regime (increased to Rs 75,000 in the new regime for FY 2025-26), replacing transport and medical allowances. This flat deduction simplifies calculations without requiring proofs.
Professional tax paid to state governments is fully deductible under Section 16(iii). Entertainment allowance deduction is limited to government employees, up to the least of Rs 5,000, 20% of basic salary, or actual allowance received.
These deductions reduce the taxable salary figure. For example, with gross salary of Rs 20,00,000 (after exemptions), subtracting Rs 50,000 standard deduction yields Rs 19,50,000 as net salary income under the old regime.
Read about Virtual Digital Assets under Section 194S of Income Tax Act, 1961.
Step-by-Step Computation of Income from Salary
Consider Neha's example: Basic Rs 12,00,000, HRA Rs 6,00,000 (exempt Rs 3,60,000), Special Allowance Rs 2,52,000 (taxable), LTA Rs 20,000 (exempt Rs 12,000), Transport Allowance (taxable). Gross before exemptions: Rs 20,72,000. After exemptions: Rs 16,92,000 (old regime). Deduct standard Rs 50,000: Rs 16,42,000. Add other income Rs 20,000: Rs 16,62,000. Deduct 80C/80D Rs 1,70,000: Rs 14,92,000 taxable. Tax calculated per slabs. In the new regime, fewer deductions but lower slabs apply, with standard deduction at Rs 75,000. The computation of income from salary follows a logical sequence:
Aggregate Gross Salary: Sum basic salary, allowances, perquisites, and other components (e.g., bonuses, commissions).
Apply Exemptions: Subtract exempt portions of allowances (HRA, LTA) and perquisites.
Value Perquisites: Add taxable value of perks.
Deduct Allowable Expenses: Apply standard deduction, professional tax, etc., to arrive at net income from salary.
Integrate with Other Income: Add to income from other heads for gross total income.
Claim Chapter VI-A Deductions (Old Regime): Deduct investments under Section 80C (up to Rs 1,50,000), Section 80D (health insurance), etc.
Compute Tax Liability: Apply slab rates, adding health and education cess at 4%.
Summary
The computation of income from salary under the Income Tax Act, 1961, is a blend of statutory definitions, exemptions, and deductions aimed at fair taxation. By methodically aggregating components, applying reliefs, and selecting the appropriate regime, taxpayers can optimize liabilities. Legal professionals advising on tax matters must emphasize accurate record-keeping and timely filings to avoid penalties under Section 271. As tax laws evolve, staying updated ensures compliance. Ultimately, mastering the computation of income from salary empowers individuals to contribute to nation-building through transparent taxation.
Related posts
Computation of Income from Salary: FAQs
Q1. How to calculate computation of total income?
Add up all income from salary, house property, business, capital gains, and other sources, subtract allowable deductions and exemptions, and apply the tax slab rates.
Q2. How to make salary computation?
Calculate gross salary (basic pay, allowances, bonuses), subtract exempt allowances (like HRA, LTA), and deduct professional tax and other deductions to find taxable salary.
Q3. How to calculate annual income by salary?
Multiply monthly gross salary by 12, then subtract exempt allowances and deductions (like PF, professional tax) to get taxable annual income.
Q4. What is CTC for 18,000 salary?
For a ₹18,000 monthly salary, CTC (Cost to Company) may include basic pay, allowances, and employer contributions (like PF), typically ranging from ₹18,000 to ₹25,000 monthly, depending on company policy.
Q5. How to calculate CTC formula?
CTC = Basic Salary + Allowances (HRA, DA, etc.) + Employer’s PF/Gratuity contributions + Bonuses + Other benefits (like insurance or travel allowances).
