How to calculate income tax on salary?

Majority population of our country is the hardworking class of people who are under employment of some or the other organisation. They render their services to their employers in return for a consideration in the form of salary. There exists a formal employer employee agreement wherein all the terms of services and breakups of salary structures are mentioned. 

Income tax has also divided the components of salary for the purpose of allowing salaried individuals various tax benefits wherein some of the components of salary are exempt from taxes. We will discuss taxation for the income head of “Income from salaries”.  

Salary: 

Section 17(1) of Income tax act, 1961 has defined salary as, salary includes: i) wages ii)annuity or pension iii) gratuity iv) fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages v) advance of salary va) leave encashment vi) annual accretion to the balance at the credit of an employee participating in a recognised provident fund vii) 80CCD Contribution by central government ix) Contribution made by central government in Agniveer corpus fund for individuals enrolled in Agnipath scheme 

Salary also includes various perquisites and profits in lieu of salary. Perquisites means when the employer provides extra benefits and other advantages along with the basic salary or wage, they are referred to as perquisites in income tax. However, perquisite do not include the reimbursements offered by employer. Profits in lieu of salary also means additional amount paid to the employee on occurrence of certain events apart from his basic salary. 

Taxability of Salary income: 

Section 15 of the Income Tax Act deals with the basis of charge. Salary shall be chargeable to tax either on a ‘due basis’ or ‘receipt basis’, whichever is earlier. 

A person under employment is liable to pay income tax based on his income level. He is entitled to various tax exempt allowances and deductions while computing final tax liability. 

How to calculate income tax on salary income? 

While computing income tax on salaries there are so many factors that are to be taken into account. We will discuss certain general points for computing income tax on salaries: 

• Gross Salary Calculation: This include basic components like basic salary, dearness allowance, bonuses or other taxable components. 
• Exempt allowances: There are certain allowances which are exempt from taxes such as HRA, Leave allowances, standard deductions etc. 
• Deductions: In this section we have to analyse the payments by employee towards certain tax exempt deductions like payment to PPF, LIC Premium, Mediclaim amount, NPS contribution, PF contribution, tax exempt investments, interests paid on home loan etc. 
• Calculate tax: Upon considering all the exemptions and deductions, net taxable income is determined for applying tax calculations. The amount of tax liability would determine the amount of rebate available from tax to the employee. Calculation of surcharge is done depending upon the income limits. 
• Calculation of Cess: After considering the rebates, surcharges and tax liabilities, final education cess is levied on the tax amount and net tax liability is determined. 

Treatment under old tax regime and new tax regime: 

Tax rates on salary income will vary based on the tax regime chosen by the employee. The above-mentioned process for calculating tax is considered as per old tax regime. 

Under new tax regime, many exemptions and deductions are under salary income will not be allowed to employees. Majority deductions such as mentioned in Section 80C to 80U are not available under new tax regime. However, slab rates of incomes are different for calculating the tax amount. 

Let us understand tax on salary by an example: 

Mr. Prakash is an employee in a private sector company. He earns a salary of Rs. 20,000 per month with DA of Rs. 4500 per month, entertainment allowance of Rs. 2250 per month and he pays Rs. 2500 towards professional tax, then his taxable income would be calculated as follows: 

Basic Salary	30,000*12	3,60,000
Dearness Allowance	4,500*12	54,000
Entertainment Allowance	2,250*12	27,000
Gross Salary		4,41,000
Less: Standard Deduction		(50,000)
Less: Professional Tax		(2,500)
Net Taxable Income		3,88,500

Tax on above in come shall be Rs. 6,925 and cess shall be Rs.277 which makes net tax liability at Rs.7,202. Entertainment allowance is taxable in case of a non-government employee. 

Now, as per old tax regime Rebate from tax under section 87A is allowed upto Rs.12,500 for Net taxable income less than Rs.5,00,000.  

Therefore, no tax liability arises to Mr.Prakash. 

Conclusion: 

Salary income includes various exempt as well as taxable allowances making it one of the complex head of income for computing tax. One needs to have good knowledge of the taxability of such allowances and deductions for correctly computing tax calculations. Salary incomes are also subjected to provisions of TDS and therefore such TDS amounts are also required to be taken into consideration. 

About Author: 

CA Chinmay Shirish Agate 

Chinmay Agate is a Practicing Chartered Accountant having 4+ years of experience and expertise in the field of Direct Taxation and Auditing compliances. In the past, he worked in various CA firms and comes with wide industry experience from services, retail to manufacturing to trading where he has handled various complex assignments. He has keen interest in Forex and Derivative knowledge as well as fundamental analysis.