RETIREMENT BENEFITS UNDER HEAD SALARIES

Here are the retirements benefits for the employees stated as under:

These benefits are provided by the employer to the employee for his future, either
while in service or on his retirement. These have different tax treatment. They
include:
a) Pension
Pension is a payment made by the employer after the retirement or death of
employee as a reward for past service. It is normally paid as a periodical payment
on monthly basis but certain employers may allow an employee to forgo a portion
of pension in lieu of lumpsum amount. This is known as commutation of pension.

The treatment of these two kinds of pension is as under:
(i) Periodical pension (or uncommuted pension).

It is fully taxable in the hands of all employee, whereas government or nongovernment.
(ii) Commuted pension

For employees of government organisations, local authorities and statutory
corporations, it is fully exempted from tax, hence not included in gross salary.
For other employees, commuted value of half of the total value of pension is
exempted from tax. Any amount received over and above this amount is taxable,
so included in gross salary.
If, however, the employee is also receiving gratuity (another retirement benefit)
along with pension, then one third of the total value of pension is exempted from
tax. Amount received in excess of this is taxable, so included in gross salary.
Pension received by employee is taxable under the head “Salaries”. However,
family pension received by legal heirs after death of employee is taxable under
‘Income from other sources’.

b) Gratuity

Gratuity is the payment made by the employer to an employee in appreciation of
past services rendered by the employee. It is received by the employee on his
retirement. Gratuity is exempted upto certain limit depending upon the category
of employee. For the purpose of exemption, employees are divided into 3
categories:
(i) Government employees and employees of local authority:
In case of such employees, the entire amount of gratuity received by then is
exempted from tax. Nothing will be added to gross salary.
(ii) Employees covered under Payment of Gratuity Act, 1972.
55
In case of employees who are covered under Payment of Gratuity Act, the
minimum of the following amounts are exempted from tax:
• Amount of gratuity actually received
• 15 days of salary for every completed years of service or part thereof in
excess of six months.
(15 / 26 x [basic salary + Dearness Allowance] x No. of years of service+1
[if fraction > 6 months]).
• Rs.3, 50,000 (amount specified by government).
(iii) Other employees.
In case of employees not falling in the above two categories, gratuity received
from the employers is exempt to the extent of minimum of following amounts:
• Actual amount of gratuity received.
• Half month average salary for every completed year of service
(1/2 x average salary of last 10 months x completed years of service).
• Rs.3, 50,000 (amount specified by government).
c) Leave Salary
Employees are entitled to various types of leave. The leave generally can be taken
(casual leave/medical leave) or it lapses. Earned leave is a kind of leave which an
employee is said to have earned every year after working for some time. This
leave can either be availed every year, or get encashment for it. If leave is not
availed or encashed, it is allowed to be carried forward. This leave keeps getting
accumulated and is encashed by employee on his retirement. The tax treatment of
leave encashment is as under:
(i) Encashment of leave while in service. This is fully taxable and so is added
to gross salary.
(ii) Encashment of leave on retirement. For the purpose of exemption of
accumulated leave encashment, the employees are divided into two
categories:
• State or Central Government employees.
Leave encashment received by government employees is fully exempted
from tax. Nothing is to be included in gross salary.
• Other employees
Leave encashment of accumulated leave at the time of retirement received
by other employees is exempted to the extent of minimum of four
amounts.
- Amount specified by Central Government (3, 00,000).
- Leave encashment actually received.
- 10 months average salary (10 x average salary of 10 months preceeding
retirement).
Cash equivalent of unavailed leave.

(Leave entitlement is calculated on the basis of maximum 30 days leave
every year, cash equivalent is based on average salary of last 10 months).

d) Provident Fund

Provident Fund Scheme is a welfare scheme for the benefit of employees. Under
this scheme, certain amount is deducted by the employer from the employee’s
salary as his contribution to Provident Fund every month. The employer also
contributes certain percentage of the salary of the employee to the Fund. The
contributions are invested outside in securities. The interest earned on it is also
credited to the Provident Fund Account. At the time of retirement, the
accumulated balance is given to the employee.
Tax treatment of provident fund depends upon the type of provident fund being
maintained by the employer. Employee’s provident fund may be of the following
3 types:
(i) Statutory Provident Fund
This is set up under the provisions of Provident Fund Act, 1925 and is maintained
by Government and Semi-Government organisations, local authorities, railways,
universities and recognised educational institutions.
(ii) Recognised Provident Fund
This is set up under the Employee’s Provident Fund and Miscellaneous Provisions
Act, 1952 (PF Act, 1952) and is maintained by private sector employees. The
establishments covered under PF Act, 1952 have two options; either to follow the
same scheme at by the Government under the PF Act or draft their own scheme of
PF but get recognition from Commissioner of Income Tax.
(iii) Unrecognized Provident Fund
If a provident fund is not recognized by the Commissioner of Income Tax, it is
known as unrecognized PF.
Besides these 3 funds, a person can also become a member of Public Provident
Fund.
(iv) Public Provident Fund
The Central Government has established the Public Provident Fund for the
benefits of general public to mobilize personal savings. Any member of general
public (whether salaried or self employed) can participate in this fund by opening
a Provident Fund Account at the State Bank of India or its subsidiaries or other
nationalised banks. A salaried employee can simultaneously become member of
employees provident fund (whether statutory, recognized or unreconised) and
public provident fund. Any amount may be deposited (subject to minimum of
Rs.500 and maximum of Rs.70, 000 per annum) under this account. The
accumulated sum is repayable after 15 years. At present, it carries an interest rate
of 8% per annum which is credited every year but payable only the time of
maturity.


DEDUCTIONS FROM GROSS INCOME
The income chargeable under the head salaries is computed after making the
following deductions under Section 16:
1. Standard deduction [section 16(i)] of the Act: From assessment year 2006-
07, standard deduction has been withdrawn.
2. Entertainment Allowance [section 16(ii)] of the Act as given earlier,
entertainment allowance received from employer is first included in gross
salary and thereafter, a deduction is allowed to government employees
(State or Central Government) to the extent of least of following 3
amounts:
(i) Rs.5000
59
(ii) 20% of basic salary
(iii) Amount of Entertainment Allowance actually received during the
year.
3. Professional Tax [Section 16(iii)] of the Act.
Professional tax or tax on employment levied by a State under Article 276
of the Constitution is allowed as a deduction only in the year when it is
actually paid. If the professional tax is paid by the employer on behalf of
the employee, it is first included in gross salary as a perquisite (since it is
an obligation of employee fulfilled by employer) and then the same
amount is allowed as deduction on account of professional tax from gross
salary.


Illustration for ur reference:

Mr. X is working in a factory in Delhi since August 1970. He gets Rs.4000 per
month as basic salary, Rs.400 per month as dearness allowance and Rs.500 per
month as house rent allowance. He resides in his own house.
On 1st January, 2005 he retires and gets Rs.40, 000 as gratuity and Rs.50, 000 as
accumulated balance from unrecognized provident fund. His own contribution
and that of factory to the fund was equal. From January 2005 onwards, he starts
getting pension of Rs.1000 per month.
Compute Net Income of Mr X for the Assessment Year 2006-07.

Solution.
Computation of Net Salary of Mr. X
for the Assessment Year 2006-07
Rupees
Basic Salary (Rs.4000 x 9) 36,000
Dearness Allowance (Rs.400 x 9) 3,600
House Rent Allowance (Rs.500 x 9)
(No exemption since X resides in own house)
4,500
½ Lumsum received from unrecognized provident fund 25,000
Pension Rs.1000 x 3 3,000
Gratuity (Rs.40,000 – amount exempt Rs.68,000 NIL
Gross Salary 72,100
60
Less deductions -
Net Salary 72,100
Amount of gratuity exempt is least of following 3 amounts for other employees:
1. ½ months salary for completed years of service
(½ x 4000 x 34) = Rs.68, 000
2. Actual gratuity received (Rs.40, 000)
3. Limit by Central Government – Rs.3, 50,000
Amount exempt is Rs.68, 000; amount received is Rs.40, 000.
So, entire amount of gratuity is exempt


Example 2.
COMPUTATION OF INCOME FROM SALARIES

Computation of Net Salary of Mr. X
for the Assessment Year 2006 -2007
Rupees
Particulars Amount
Basic Salary
Fees, Commission and Bonus
Taxable value of cash allowances
Taxable value of perquisites
Retirement Benefits
GROSS SALARY
Less: Deductions from Gross Salary
1. Standard Deduction
2. Entertainment allowance deduction
3. Professional tax deduction

Illustration

Mr. X is a lecturer in a private college in Chennai. During the previous year
2005-06, he gets the following emoluments: Basic salary Rs.10, 000 per month,
dearness allowance: 10% of basic salary, city compensatory allowance: Rs.300
per month, children education allowance: Rs.500 per month (for 3 children),
house rent allowance: 20% of salary (rent paid Rs.2000 per month). He gets
Rs.18, 000.
a) Reimbursement from his employer in respect of medical expenditure incurred
on treatment of his wife in a private clinic. Besides, he gets Rs.11, 400 as
reimbursement from the employer in respect of books and journals purchased
by him in discharging his official work.
He contributes 11% of his salary to statutory provident fund to which a
matching contribution is made by the employer. During the year, he spends
Rs.15, 000 for maintaining a car for going to the college. Determine his net
income under the head salaries.

Solution:

Computation of Net Salary of Mr. X
for the Assessment Year 2006 -2007
Rupees
Particulars Amount
Basic Salary (Rs.10, 000 x 12) 1, 20,000
Dearness allowance (10% of 1, 20,000) 12,000
City compensatory allowance (Rs.300 x 12) 3,600
Children education allowance (Rs.500 x 12 less
amount exempt Rs.100 x 12 x 2)
3,600
House Rent Allowance (20% of 1, 20,000 less amount
exempt Rs.12, 000)
12,000
Reimbursement of medical expenses (Rs.18, 000 -
Rs.15, 000)
3,000
Reimbursement of expenses on books (not chargeable
to tax)
-
GROSS SALARY 1, 54,200
Less Standard deduction NIL
NET SALARY 1, 54,200
Working Notes:
1. Amount of HRA exempt is least of 3 figures:
a) 50% of Salary (1, 20,000) 60,000
b) Actual HRA received (20% of 1, 20,000) 24,000
c) Rent paid in excess of 10% of Salary
2000 x 12 - 10 / 100 x 1, 20,000 12,000
Amount of HRA exempt is 12,000
2. Expenditure on maintenance of car is an application of income, not
deductible.
3. Contribution of employer towards employee’s statutory provident fund is
exempt upto 12%.
4. Reimbursement of medical expenditure by employer in private clinic is
exempt upto Rs.15, 000.
5. Children education allowance is exempt to the extent of Rs.100 per month
per child for maximum 2 children


Summary:

1. Heads of Income: There are 5 heads of income into which income of
persons can be divided namely Income from salary, house property,
business or profession, capital gains and other sources.
2. Meaning of Salary: Any remuneration paid by an employer to an
employee in consideration of his services is called salaries. It includes
monetary value of those benefits and facilities which are provided by the
employer and are taxable.
3. Income forming part of salary: They include basic salary, advance salary,
fees, commission, and bonus, taxable value of cash allowances, perquisites
and retirement benefits.
4. Allowances: These are of three types
(a) Taxable Allowances: Dearness allowance, Medical allowance, Servant
allowance, Warden Allowance, Family allowance, City Compensatory
allowance etc.
(b) Allowances exempt upto specified limit: House rent allowances,
Entertainment allowance, Certain Special allowances, etc.
(c) Fully exempted allowances: Foreign allowance, sumptuary allowance to
High Court / Supreme Court Judges, Allowances from U.NO.
5. Perquisites: These are of three types:
(a) Taxable perquisites for all employees: Facility of rent-free house or house
at concessional rent, payment of employee’s obligations, payment of life
insurance premium of the employee, etc.
(b) Perquisites taxable in specified cases only: Facility of servant, gardener,
gas, electricity, water, education, etc.
(c) Tax-free perquisites: Free Medical facility or reimbursement of medical
expenses, free facility of refreshments, entertainment, telephone, family
planning, scholarship, leave travel concession, free motor car, club
facility, gifts etc.
6. Valuation of perquisites: See Rule 3 of Income Tax Rules.
7. Deductions: Following three deductions are admissible:
(a) Standard Deduction: This has been withdrawn from Assessment Year
2006-07.
65
(b) Entertainment Allowance:
(i) Government employees – 1/5th of salary or Rs.5, 000, whichever is
less.
(ii) Others - Nil
(c) Employment Tax – Full Amount
8. Provident Funds: These are of four types:
(a) Statutory provident fund
(b) Recognized provident fund
(c) Unrecognized provident fund and
(d) Public provident fund