What is arrears?
Salary arrears in income tax calculations is the outstanding amount that remains unpaid and is carried forward to the next year or salary cycle. When an employee receives a salary hike, but the updated salary is not paid immediately, the due amount is later paid as arrears. However, salary arrears increase the tax liability for individuals. This article explores the meaning of arrears, how to calculate arrears in salary, and its impact on income tax. It also provides insights into ways to save taxes on salary arrears.
Let us understand what arrears are. Arrears refer to overdue payments that should have been made earlier. With regards to salary, arrears indicate the salary paid to an employee for a previous month instead of the current month.
Consider an employee who receives a salary hike in May, effective from March. In this case, the employee will receive the hiked salary amount for March and April along with the salary for May. The amount received for March and April is referred to as arrears.
What is arrears in salary?
Salary arrears are amounts an employee was entitled to receive but were unpaid or pushed forward to a later date or payroll cycle. Arrears typically arise when an employee gets a salary increase or increment but starts receiving the updated salary in a subsequent month.
The difference between the new and old salaries for previous months is paid later in the form of arrears after the salary restructuring. So, arrears in salary represent the unpaid portion of an employee's earnings. The employee receives the differential amount along with his current month's salary.
How to calculate arrears in salary?
Arrear salary calculation considers the delayed or unpaid portion of an employee's earnings. Here's a simple example to illustrate the calculation process:
Let's assume an employee receives a salary hike of Rs.30,000/- in January, but the increment is reflected in March due to salary restructuring and backend processing. So, the employee would receive an arrear amount of Rs.60,000/- in April. This includes Rs.30,000/- for January and Rs.30,000/- for February, along with the increased salary.
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Relief u/s 89(1) for salary arrears
Now that you know about arrears and its meaning, let's find out about the relief u/s 89(1). Relief under Section 89(1) for salary arrears is a tax provision under the Income Tax Act of 1961 that prevents individuals from paying higher taxes on arrears due to delayed payments. If your total income for the current financial year includes past dues received, this relief ensures you won't have to pay extra taxes if you were in a lower tax bracket during the year you earned the amount.
To avail of this relief, you must provide details of your salary arrears to your current employer using Form 10E. By doing so, your employer can calculate the accurate tax deduction considering the Section 89(1) relief. This helps reduce your overall tax liability and ensures fair taxation based on your income in the relevant year rather than the year you received the amount.
Reporting salary arrears in income tax returns
When filing your income tax return, you must report any salary arrears you received. Salary arrears can impact your income tax liability, so it's essential to understand the reporting requirements to comply with tax regulations.
To claim relief under Section 89(1) for salary arrears, it is mandatory to submit Form 10E before filing your income tax return. The income tax department made this compulsory starting from the assessment year 2015-16 (financial year 2014-15). Failing to submit Form 10E when claiming Section 89(1) relief may result in a notice from the tax department asking you to submit Form 10E.
Case studies and examples
Case 1: Commissioner of Income Tax and P. Surendra Prabhu, 21 Sept (2005)
In this case, the taxpayer received a sum of salary arrears. That resulted in their total income being assessed at a higher rate. The taxpayer applied under Section 89 of the Income Tax Act, seeking relief. As per the Section, the Assessing Officer (AO) granted the prescribed relief upon receiving the application. This case highlights the importance of applying for relief when salary arrears affect tax liability.
Case 2: K.C. Joshi v. Union of India and Ors, 23 April (1985)
In this case, the issue was whether the employer could deduct income tax while making lump sum payments of back wages and compensation. The court referred to Section 192 of the Income Tax Act. The section allows for income tax deduction at the time of payment. However, the court also emphasised that the appellant would be entitled to relief under Section 89(1). This case emphasises the applicability of Section 89(1) relief when receiving lump sum payments that include salary arrears.
The taxpayers were eligible for relief under Section 89(1) in both cases. The section provides relief when salary or other payments are made in arrears or in advance.
Professional guidance and consultation
Seek Professional Help - Consult a tax expert or chartered accountant for salary arrears, income tax, and associated tax issues.
Understand Tax Laws - Familiarise yourself with relevant tax laws, especially Section 89(1), which relieves salary arrears in income tax. Knowing the provisions and conditions will help make informed decisions and take advantage of tax benefits.
Complete Form 10E - To claim Section 89(1) relief for salary arrears, filling out Form 10E is mandatory. Ensure you submit the form online on the Income Tax portal before filing your income tax return. Failure to comply can lead to non-compliance notices and delayed refunds.
Maintain Records - Systematically record all relevant documents like payslips, salary certificates and Form 10E. Proper records will substantiate your claims, ensuring a smooth tax filing process.
Stay Updated - Be aware of any changes to tax laws and regulations. Tax rules are subject to amendments, so staying informed will help maximise your tax savings.
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Conclusion
Hope now you know about salary arrears and its meaning. Salary arrears refer to unpaid salary pushed to the next year or salary cycle. This occurs when an employee receives a raise, but the updated salary is not immediately paid, so the due amount is paid later as arrears. However, salary arrears can increase your tax liability. One way to maximise your savings is by using Section 89(1) of the Income Tax Act. This provision provides relief for income received in arrears. To profit from this relief, you must fill out Form 10E and submit it before filing your income tax return. Doing so can ensure accurate tax deductions and reduce your overall tax liability.
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This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. ("Bank") or its employees. Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empanelled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees, and contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.
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