Ultimate guide on how to calculate Income Tax on Salary with Example
This post is the most detailed guide on understanding Income Tax on Salary in India.
At the end, you will be able to learn how to calculate income tax on salary and how to save tax on Salary Income in India
Who will benefit from this guide? This guide will be extremely helpful if you are :
- salaried person in India,
- Professional (Chartered Accountant/Tax Consultant/Accountant)
- Student of Accounts and Taxation
.You can find below the list of contents, if you want to skim through this guide.
How to read this article?
This is a very long post on understanding income tax on salary. Probably, the most exhaustive guide. It may not possible to read and understand in one go. Here's what you can do to make the best out of this guide.
- If you are in hurry and just need quick tax planning and tax saving tips, please go through the 'How to save tax on Salary Income' section of this guide at the end. But do read the full guide when you have time because devil is in the detail.
- If you want to understand, any allowances you are getting from your employer is taxable or exempt, go through 'Allowances (Taxable and Exempt)' section.
- If you are getting free benefits from your employer, you might want to check their taxability as well. Go through, 'Valuation of Perquisites' section. This is very long section, so you can also skim through table of contents to go to the specific perquisite you are getting.
- To understand about TDS on Salary, go through the 'TDS on Salary' section. You will get a quick idea of how Tax Deducted at Source from Salary is calculated.
- I have added boxes at various places in between the article. These boxes contains important points related to the discussed topic. It is useful for professional and students so that they don't miss out on something important.
- What is Salary and what does it include?
- Allowances (Exempt and Taxable)
- Valuation of Perquisites
- #1. Valuation of Rent Free Unfurnished Accommodation
- #2. Valuation of Rent Free Furnished Accommodation
- #3. Perquisite in respect of free domestic help
- #4. Perquisite in respect of free gas, electricity or water supply
- #5. Free Education Facilities
- #6. Leave Travel Concession (LTC) in India
- #7. Employee’s obligation met by employer
- #8. Amount paid for Life Insurance of Employee
- #9. Interest Free loan or Loan at concessional rate of interest
- #10. Perquisite in respect of use of movable assets :
- #11. Transfer of Movable assets by employer to employee at nominal price
- #12. Valuation of perquisite in respect of motor car
- #13. Free Transport provided by a transport undertaking to its employees
- #14. Free Lunch/refreshments provided
- #15. Travelling, touring and accommodation facility
- #16. Gift, Voucher or token
- #17. Credit Card
- #18. Club Facility
- #19. Tax on perquisite paid by employer
- #20. Sweat Equity Shares
- #21. Medical Facility
- #22. Employer’s contribution towards approved superannuation fund
- #23. Any other benefit or amenity by employer
- Deductions from Salary Income [section 16]
- Retirement Benefits
- Computation of Income tax on Salary
- TDS on Salary [Section 192]
- How to save Income tax on Salary Income - Tax Planning Tips
What is Salary and what does it include?
Salary is a compensation given by business/organisation to any person on employment for availing his/her service. It is typically paid on monthly basis at the end of the month.
Section 17(1) of the Income Tax Act, 1961 defines the term salary and it includes the following:
- Annuity or pension
- Fees, commissions, perquisites or profit in lieu of salary or in addition to salary
- Advance of Salary.
- Leave Encashment - Any payment received by an employee in respect of any period of leave not availed of by him.
- Annual accumulation to the balance of Recognized Provident Fund
- Transferred balance in a Recognised provident fund to the extent it is taxable, and
- Contribution by Central Government or any other employer to the account of employee under National Pension Scheme (NPS) referred to in section 80CCD.
Components of Salary
Salary can be divided into different components based on characteristics:
Allowances (Exempt and Taxable)
Allowances are fixed amount of money given to a employee in addition to the salary. They are given to cover expenses incurred by employee during the course of service (like conveyance allowance) or as a compensation for unusual conditions in employment (like underground allowance).
Some allowance are fully taxable, some are partially taxable and some are fully exempt from income tax.
As a salaried person you may be receiving various allowance as a part of your CTC. So, it is very important that full tax benefit of these allowance must be claimed. The following is the detailed list of allowances along with their taxability. Also, as a professional you must provide maximum benefit to your clients by taking various exemption into consideration.
Fully Taxable Allowances
Partially Taxable/Partially Exempt Allowances
Fully Exempt Allowances under section 10
Allowances exempted to Specific Persons/Government Employees
- Any allowance or perquisite paid by government to its employees posted outside India is fully exempt from Income Tax.
- Any Allowances paid to judges of Supreme Court/ High Court and Compensatory Allowance paid to judges under Article 222(2) of the Constitution is fully exempt from Income Tax.
- Salary and allowances received by a teacher /professor from SAARC member state (Subject to certain conditions) is fully exempt.
- Value of rent free official residential, value of conveyance facilities including transport allowance, Sumptuary allowance, Leave travel concession received by Chairman/Member of UPSC is fully exempt.
Valuation of Perquisites
Perquisites are benefits or privilege given by the employer to the employee in addition to salary/wages on the basis of his/her position. Perquisites are commonly given in kind (not in cash) by the employer.
For instance, if your employer has provided you a free domestic help for your household chores, then this additional benefit will be treated as perquisite in your hands.
Just like allowances, perquisites are also classified into fully taxable, partially taxable and fully exempt.
Taxable value of perquisites are added to the Salary income while calculating ‘Income from Salary’ and income tax is calculated.
#1. Valuation of Rent Free Unfurnished Accommodation
Some employers provide accommodation facility to their employees as an additional privilege. Accommodation may be owned by the employer or it may be taken on lease or rent by the employer. It may include giving place to stay in a house, a flat, farm house, in a hotel, service apartment, guest house or any other structure.
Valuation of rent free unfurnished accommodation is divided into two categories and taxability is determined on the basis of these categories:
Central and State Government Employees (Government Employee)
Private Sector Employees
For the purposes of calculating taxable value of perquisite, Salary Includes :
a) Basic Pay
b) Dearness Allowance
f) taxable part of all other allowances
g) any monetary payment chargeable to tax
But the above does not include :
a) Employer’s contribution to PF
b) Value of perquisites as per section 17(2)
c) retirement benefits
Mr. Aman is a Senior Content Manager at TaxFactor Consultancy in Pune. He gets following emoluments during F.Y. 2017-18.
Basic Salary - ₹ 9,60,000
Bonus - ₹ 1,20,000
City Compensatory Allowance - ₹ 7,500
Hostel Expenditure Allowance for 2 children - ₹ 15,800
He is also provided with a house taken on lease by TaxFactor in Pune for his residential purposes. Lease paid by TaxFactor is ₹ 12,000 per month.
Calculate Value of Taxable Perquisite.
Salary for the purposes of determining taxable value is ₹ 10,96,100 [₹ 9,60,000 + ₹ 1,20,000 + ₹ 7,500 + ₹ 8,600 (₹ 15,800 - ₹ 300*2*12)].
Lease paid for 12 months = ₹ 144,000 [ ₹ 12,000 x 12]
Taxable value of perquisite is:
- 15% of ₹ 10,96,100 i.e. ₹ 1,64,415 or,
- lease rent paid i.e. ₹ 1,44,000
whichever is less.
Therefore, taxable value is ₹ 1,44,000.
Now, if the house was owned by the employer, then taxable value would be ₹ 1,64,415 being 15% of the Salary. (Population of Pune is more than 25 Lakh)
#2. Valuation of Rent Free Furnished Accommodation
Accommodation is furnished when basic things like, television, refrigerator, air-conditioners and other household appliances are provided.
Taxable value of rent free furnished accommodation will be calculated as follows:
Step 1 : Calculation value of perquisite assuming that accommodation is unfurnished
Step 2 : Add 10% (per annum) of the original cost of furniture, of owned by the employer or actual hire charges paid or payable for furniture (if taken on rent/lease by the employer).
Step 3 : Reduce the amount of rent, if any, recovered from the employee.
If accommodation is provided in hotel, the taxable value of perquisite will be lower of the following :
a) 24% of the Salary paid or payable or,
b) actual charges paid or payable to the hotel
However, if accommodation provided in hotel is on account of transfer of employee from one place to another and is not exceeding 15 days in aggregate, then nothing will be chargeable to tax.
#3. Perquisite in respect of free domestic help
Any benefit provided to the employer or his family by the employer in the form of sweeper, gardner, house maid, watchman or personal attendant will be taxable. The taxable value of this perquisite will be the actual cost borne by the employer. If employer has paid some amount from his/her pocket, then it will be reduced from the taxable value.
#4. Perquisite in respect of free gas, electricity or water supply
Value of taxable perquisite will be calculated as follows :
Step 1 : Find out cost to the employer
Step 2 : Subtract any amount recovered from employee
If gas electricity or water supply is purchased by employer from outside, then taxable value of perquisite will be amount paid or payable to the outside party. Any amount recovered from the employee will be reduced from this amount.
If gas electricity or water supply is supplied by employer from owned resources, then taxable value of perquisite will be manufacturing cost per unit incurred by the employer. Any amount recovered from the employee will be reduced from this amount.
#5. Free Education Facilities
Education facility provided at free of cost or at concessional rates to employee’s children or family member is taxable as perquisite. Taxable value is calculated as follows:
#6. Leave Travel Concession (LTC) in India
Leave Travel Concession (LTC) is an assistance given by employer to employee for traveling anywhere in India along with his/her family. It is is exempt under section 10(5) only if journey is performed in India.
To learn more about LTA / LTC, read this guide.
#7. Employee’s obligation met by employer
Any kind of amount paid by employer which otherwise would have been payable by employee is fully taxable.
#8. Amount paid for Life Insurance of Employee
Any amount paid by the employer to effect an assurance on the life of the employee will be taxable in the hands of employee.
#9. Interest Free loan or Loan at concessional rate of interest
Many employers especially banks provide loans to their employees at concessional rate of interest or interest free loan. This benefit received by the employees is chargeable to tax as perquisite in the hands of employee. It is taxable as follows :
Step 1 : Find out the ‘maximum outstanding monthly balance’ (of all the loans as on last day of each month)
Step 2 : Find out comparable interest rate charged by SBI on 1st April in which the loan was taken (as SBI would have charged for the same loan).
Step 3 : Compute interest for each month on the outstanding amount mentioned in Step 1 at the rate mentioned in Step 2. If loan is provided at concessional rate, then compute interest with differential interest rate.
Mr. Karthik was employed by Taxfactor. On 1st October 2017, company gives him housing loan of ₹ 40,00,000 at 4% per annum interest rate. The loan is to be repaid in monthly installments of ₹ 30,000 starting from 1st January 2018. The lending rate of SBI on similar loan on 1st April 2017 is 8.65% per annum.
The differential interest rate is 4.65% (8.65% - 4%).
Maximum monthly outstanding amount on last day of each month and interest @ 4.65% :
31st October 2017 - ₹ 40,00,000 x 4.65% x 1/12 = ₹ 15,500
30th November 2017 - ₹ 40,00,000 x 4.65% x 1/12 = ₹ 15,500
31st December 2017 - ₹ 40,00,000 x 4.65% x 1/12 = ₹ 15,500
31st January 2018 - ₹ 39,70,000 x 4.65% x 1/12 = ₹ 15,384
28th February 2018 - ₹ 39,40,000 x 4.65% x 1/12 = ₹15,268
31st March 2018 - ₹ 39,10,000 x 4.65% x 1/12 = ₹ 15,151
Therefore, total taxable perquisite is ₹ 92,303 for F.Y. 2017-18.
#10. Perquisite in respect of use of movable assets :
If as an employee you or your family member are using any movable assets other than laptop/computer or car which belongs to your employer, then it will be treated as perquisite. It will be taxed as follows :
If asset is owned by employer, taxable value will be 10% per annum of actual cost of asset less any amount recovered from the employee.
If asset is taken on hire, taxable value will be amount of rent or hire charges paid or payable less any amount recovered from the employee.
#11. Transfer of Movable assets by employer to employee at nominal price
Some employees transfer the ownership of movable assets like computers/laptop, motor car etc to the employee nominal price after certain period of time. This benefit derived by employee is treated as perquisite and is taxable. The value of taxable perquisite will be calculated as follows:
#12. Valuation of perquisite in respect of motor car
#13. Free Transport provided by a transport undertaking to its employees
Taxable value of the perquisite will be calculated at the price at which services are offered by the employer to the general public as reduced by amount recovered from the employee, if any.
#14. Free Lunch/refreshments provided
Lunch, dinner or refreshment facility provided by the employer free of cost is chargeable to tax. Taxable value will be calculated as follows:
Find out the cost to the employer in excess of Rs. 50 per meal
Less : Amount recovered from the employee.
For instance, if your employer is providing you lunch of Rs. 150 per meal at Rs. 40 per meal, then Rs. 60 per meal (150 - 50 - 40) will be taxable as perquisite in your hands.
a) Food and non-alcoholic beverages provided during working hours in remote area or in an offshore installation are exempt.
b) Tea, Coffee or Non-Alcoholic beverages and Snacks during working hours are tax free perquisites.
#15. Travelling, touring and accommodation facility
Taxable value of perquisite shall be expenditure incurred by the employer less amount recovered from employee.
If such facility is maintained by the employer, and is not available uniformly to all employees, the value of benefit shall be taken to be the value at which such facilities are offered by other agencies to the public.
#16. Gift, Voucher or token
The value of gift, voucher or token received by employee on ceremonial occasions or otherwise in excess of Rs. 5,000 aggregating during the year shall be taxable as perquisite.
#17. Credit Card
Expenditure incurred by the employer in respect of credit card used by the employee or any member of his household less amount recovered from the employee is a taxable perquisite.
However, credit card used for official purposes will not be taxable provided proper record is maintained by the employer.
#18. Club Facility
Expenditure incurred by the employer towards annual or periodical fees less amount recovered from the employee is a taxable perquisite.
Initial one time deposits for corporate membership paid by the employer is exempt from tax.
Expenses incurred on club facilities for the official purposes are exempt from tax.
Use of health club, sports and similar facilities provided uniformly to all employees is exempt from tax.
#19. Tax on perquisite paid by employer
Tax paid by the employer on behalf ofthe employee on non-monetary perquisite provided to the employee is exempt from tax.
Taxable value of perquisite will be Fair Market value of shares or securities on the date of exercise of option by the assessee less amount recovered from the employee in respect of such shares.
#21. Medical Facility
Medical Facility in India - Expenses incurred or reimbursed by the employer for medical treatment of employee, his/her spouse, children, dependent parents, brothers and sisters in any of the following hospital is exempt from tax :
a) Hospital managed by the employer
b) Hospital maintained by the Government or Local Authority or any other hospital approved by Central Government.
c) Hospital approved by the Chief Commissioner having regard to the prescribed guidelines for treatment of the prescribed diseases.
Medical insurance premium paid or reimbursed by the employer is not chargeable to tax.
Medical Facility Outside India - Any expenditure incurred or reimbursed by the employer for medical treatment of the employee or his family member outside India is exempt to the extent of following (subject to certain conditions):
a) Expenses on medical treatment - exempt to the extent permitted by RBI
b) Expenditure incurred on travelling of patient and one attendant- exempt, only if Gross Total Income (before including the travel expenditure) of the employee, does not exceed Rs. 2,00,000.
c) Expenses on stay abroad for patient and one attendant - exempt to the extent permitted by RBI.
#22. Employer’s contribution towards approved superannuation fund
Employer’s contribution towards approved superannuation fund in excess of Rs. 1,50,000 per year is chargeable to tax in the hands of employee.
#23. Any other benefit or amenity by employer
This head is residual head. Any benefit or privilege provided by the employer not falling into any of the preceding heads, will be taxable under this head.
Taxable value of perquisite shall be computed on the basis of cost to the employer (under an arm’s length transaction) less amount recovered from the employee. However, expenses on telephones including a mobile phone incurred by the employer on behalf of employee shall not be treated as taxable perquisite.
Deductions from Salary Income [section 16]
Salary Income will be computed after deducting following amounts:
a) Standard deduction [w.e.f. FY 2018-19] - A standard deduction of Rs. 40,000 or amount of salary whichever is less.
b) Entertainment Allowance - This is first included in the salary income and then deduction is given. Entertainment Allowance deduction is allowed only to Government employee. The least of following will be allowed as deduction :
- Rs. 5,000;
- 20% of basic salary
- Actual amount of Entertainment allowance
c) Professional Tax - Actual amount of tax on employment or professional tax paid is allowed as deduction. However, if professional tax is paid by the employer on behalf of its employee then it is first included in the salary as a perquisite and then allowed as deduction.
It is said that, ‘As you sow, so shall you reap’. In the same way, if you save for future, you retirement will be stress free. What you have invested and saved during your active professional life will help you living a better retirement life. Following are the list of benefits you can get at the time of your retirement and their taxability:
#1. Leave encashment
There may be unused leave accumulated to the credit of the employee during the course of his/her employment. Encashment of the leave by surrendering the leave standing to one's credit is known as 'leave salary'. The tax treatment of leave salary is different for government and private sector employees.
Gratuity is a monetary benefit given to the employee at the time of his/her retirement. Gratuity is taxable in following manner :
Pension will be taxable as follows :
Commuted Pension which is lump sum payment received at the time of retirement. Un-commuted pension which is monthly pension received by employee after retirement.
#4. Voluntary Retirement
Any amount received by way of Voluntary Retirement Scheme will be treated as follows:
Least of the following is exempt from tax:
a) Actual amount received as per the guidelines i.e. least of the following:
- 3 months salary for each completed year of service
- Salary at the time of retirement x No. of months of services left for retirement; or
b) Rs. 5,00,000
#5. Employees Provident Funds
The tax treatment of contribution made to various provident funds are described as below :
Salary = Basic + Dearness Allowance (to the extent it forms part of retirement benefits) + commission received as a fixed percentage of turnover
Payment from recognized provident fund shall be exempt in the hands of employees in following circumstances:
a) If employee has rendered continuous service with his employer (including previous employer, when PF account is transferred to current employer) for a period of 5 years or more,
b) If employee has been terminated because of certain reasons which are beyond his control (ill health, discontinuation of business of employer, etc.)
Computation of Income tax on Salary
Add : Dearness Allowance
Add : Annuity
Add : Bonus
Add : Commission
Add : Arrears of Salary
`Add : House Rent Allowance
Add : Leave Travel Allowance
Add : Perquisites
Less : Perquisites Exempted
Add : Other Allowances
Less: Allowances Exempted
Add : VRS/Retrenchment Compensation
Add : Gratuity
Less: Gratuity Exempted
Add : Leave Encashment
Less : Amount Exempted
Add : Pension
Less: Pension Exempted
Add : Employers Contribution (in excess of 12% salary of employee)
Add : Interest on PF in excess of the notified amount
Deductions under section 16
Less : Entertainment Allowance
Less : Professional Tax paid
Income chargeable to tax under Salaries
How to calculate Income tax on Salary with Example
Mrs. Aarya is a employee of TaxFactor Consultancy. She receives following emoluments during F.Y. 2017-18.
Salary - ₹ 8,96,800
Bonus - ₹ 3,800
Child Education Allowance - ₹ 6,000
Entertainment Allowance - ₹ 2,800
Free domestic help - ₹ 12,000 (₹ 8,000 is paid by Aarya)
Free domestic gas and Electricity - ₹ 8,600
She has declared investments under section 80C of ₹ 1,25,000 and under section 80D of ₹ 15,000.
Further, she has also received interest income of ₹ 10,600 during the year.
Calculate her tax liability for F.Y. 2017-18 (i.e. A.Y. 2018-19)
Add : Child Education Allowance
Less: Exemption (₹ 100 per month per child)
Add : Bonus
Add : Entertainment Allowance
Add : Free Domestic Help
Add : Amount recovered from employee
Add : Free gas and Electricity
Deductions under section 16
Less : Entertainment Allowance
Less : Professional Tax paid
Income chargeable to tax under Salaries
Income from Other Sources
Gross Total Income
Chapter VI - A Deduction
Net Taxable Income
Total Income Tax Payable by Aarya
TDS on Salary [Section 192]
If your salary exceed or is likely to exceed the basic exemption limit in the financial year, then tax has to be deducted at source by the employer.
The employer, at the time of payment of salary, will deduct at source income tax on salary. The TDS on salary is made on the basis of average rate of income tax.
For instance, Mr. Sai is earning ₹ 80,000 per month as salary. He made investments under section 80C to the tune of ₹ 1,40,000 during the year. Therefore, his net taxable income for the year will be ₹ 8,20,000 [9,60,000 less 1,40,000]. Total tax payable on this amount will be ₹ 78795 [76,500 + 2295 (cess)].
The average rate of tax will be calculated as under :
(Total tax payable / Total Income) *100 i.e. (78,795 / 9,60,000)* 100 = 8.21%.
Therefore, every month tax of ₹ 6,560 [ ₹ 80,000 * 8.21%] will be deducted as TDS on salary from Mr. Sai's salary.
The tax calculated above will be based on the slab rates prevailing during the year under consideration and can be different for different year.
If you want to check whether, the TDS on salary has been deposited by the employer, you can do by viewing Form 26AS.
How to save Income tax on Salary Income - Tax Planning Tips
Everyone knows that, its hard to save income tax on salary income. Like businessman, salaried person cannot claim expenses from their income. There are limited avenues to save income tax on salary and most of the time these limited options are not fully utilized. Therefore, following points should be kept in mind, if you want to save income tax on salary :
#1. When discussing the terms of employment, make sure that dearness allowance and dearness pay always forms part of basic salary. This will reduce the tax burden on house rent allowance, gratuity, commuted pension and also on Employer's contribution to the recognized provident fund.
#2. Full utilization of section 80C, 80CCC and 80CCD(1) limit of ₹ 1,50,000. Most people don't utilize this age old method of saving tax by investing in various instruments. Apart from Life Insurance Premium and Provident Fund contribution, following deductions can be claimed under section 80C :
- Principal installment of repayment of Housing loan;
- Stamp duty, registration fees and other expenses incurred at the time of construction or purchase of house property;
- Any sum paid as tuition fees for full time education of any two children;
- Subscription to National Savings Certificates and accrued interest on it;
- Deposit in Sukanya Samriddhi Account;
- Contribution to pension fund (section 80CCC);
- Contribution to National Pension System (NPS) by the employee [section 80CCD(1)];
- An additional deduction up to₹ 50,000 can be claimed by employee under section 80CCD(1B) in respect of contribution to National Pension System (NPS). This is in addition to the ₹ 1,50,000 limit;
- Deduction up to ₹ 50,000 can be claimed in respect of interest on loan taken for residential house property under section 80EE. The main conditions for claiming deduction under this section is that loan should be sanctioned between 1st April 2016 and 31st March 2017, loan amount should be less than ₹ 35 lakh and property value should be ₹ 50 lakh;
- Salaried person can also claim deduction in respect of certain donations made for scientific research or rural development under section 80GGA;
- Deduction can be claimed in respect of donation made to political parties under section 80GGC. No deduction for cash donations;
#3. If you are paying rent but not receiving House Rent Allowance from your employer, you can claim deduction of rent paid under section 80GG by furnishing form 10BA.
#4. Uncommuted pension is always taxable, so it is always preferable to receive commuted pension. Commuted pension is fully exempt in case of government employee and partially exempt from non-government employees.
#5. To claim leave travel exemption, please submit the copy of air tickets or rail tickets as evidence of journey.
#6. To substantiate the exemption claimed on house rent allowance, rent agreement, rent receipts or bank statement should be documented.