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Salary Breakup, Components of Salary

Basic, HRA, LTA and other salary components

Salary is a remuneration received by an individual every month for services rendered by him for an organization. Any individual earning salary is required to furnish details of his income received to Income Tax department and pay tax. To compute his tax liability, an employee needs to understand the tax treatment of his salary and other allowances, deductions, tax rates and other taxation rules.
These details are captured in the employee’s salary slip, a note given to an employee every month.

Components of Salary for Income Tax Calculation

Salary slip is a note with details of the following components of salary:

Basic salary: Basic salary is a fixed income that is paid to an individual for services rendered by him for an organization. It is a base amount paid to the employee without including allowances, bonuses and reductions. Basic salary is the largest part of salary and is used as the basis for computing other components of salary such as Dearness Allowance, House Rent Allowances and other allowances.

House Rent Allowance: House Rent Allowance is provided by the employer to meet the cost of a rented house taken by an individual for his stay. Income Tax Act has a provision under which it allows an individual to claim deduction in respect of HRA received by him. The guidelines on computation of tax and exemption on HRA is covered under section 10(13A) of Income Tax Act and Rule 2A of Income Tax rules. Tax treatment of HRA is different in case of rented and self owned property subject to Income Tax rules.

HRA- Tax Exemption in case of rented house:HRA is eligible for deduction under section 10(13A) of Income Tax Act. The amount of deduction is limited to the lowest of the following:

  • Actual HRA received
  • 50% of salary [basic salary +DA] for individuals living in metro cities and 40% of salary for individuals living in non-metro cities
  • Actual rent paid less 10% of salary

Individual living in a self owned property is not eligible to claim any deduction on account of HRA. In this case, HRA received will be fully taxable in the hands of the employee.

Medical Allowance: Medical allowance is a fixed allowance paid by an employer to an employee regardless of whether he incurs expenditure on medical treatment or not. Individual is not required to produce any bills to claim fixed medical allowance. Medical allowance is fully taxable at marginal income tax rate as per the applicable Income Tax slabs. However, under Section 80 D of Income Tax Act, an individual can claim a tax exemption for medical expenditure of up to Rs. 15,000 as medical reimbursement by furnishing supporting bills and documents.

Conveyance Allowance: Conveyance allowance also known as transport allowance is offered to an employee to compensate for expenses incurred for commuting from their residence to their workplace. As per Section 10 of Income Tax Act, conveyance allowance of up to Rs. 19,200 per annum (Rs. 1,600 per month) is exempted from tax.

Leave Travel Allowance: Leave Travel Allowance is an allowance paid by an employer to his employees for expenses incurred on travelling within the country, while on leave. It also includes the travel expenses of immediate family members of an employee including parents, siblings, spouse and children. Leave travel Allowance is tax exempted subject to the conditions under Section 10(5) of Income Tax Act and Rule 2B of Income Tax rules. These conditions are as follows:

  • LTC can be claimed when an employee is on leave to travel to any place within India
  • Exemption of LTC is limited to the actual travel costs incurred by an employee. However, the exemption will is provided only if the following conditions are met:
    • In case employee has performed the journey by air, the amount of exemption shall not exceed the economy air fare of the national carrier by the shortest route to the place of destination.
    • In case the places of origin of journey and destination are connected by rail and air but employee has performed his journey by any other means of transport than air or rail, the exempted will be the amount not exceeding to the rail fare of first class air conditioned coach for the distance of journey by shortest route.
  • In case the place of origin and destination are not connected by rail, the amount of exemption will be calculated as under:

  • When public transport system exists: In case any recognized public transport is available, amount not exceeding the fare of first class or deluxe class of train or bus on the shortest route for the journey will be exempted.
  • When public transport system does not exist: In case of travel to place, where no public transport is available and the journey is undertaken by other means of transport, the amount of exemption will be equal to the fare of air conditioned first class rail for the nearest destination to the place of journey by the shortest route.
LTC rules:
  • An employee cannot claim exemption for LTA for travel before 1st October, 1989
  • Employee can avail exemption in respect of two journeys performed within the block of four calendar years commencing from the calendar year 1986
  • Employee can avail tax exemption for LTA for two surviving children born after 1st October, 1998. In case an employee has three children, he will get tax exemption on LTA for two children and no exemption will be available for the third child. However, the provision does not apply in case of multiple births after one child and if the child was born before 1st October, 1998
  • In case employee does not claim LTA in a particular block, he can carry forward it to next block and can use it in first year of next block.
  • As per Income Tax Act, employee is eligible to claim LTA only for travel within India. International travelling is not covered under such exemption.
  • LTA can only be availed for the actual travelling expenses incurred by employee. For example: If employer provides LTA of Rs. 25,000 and the employee incurs travel expenses of Rs. 20,000 during his vacation. In this case, employee will be eligible to claim LTA for Rs. 20,000 only. Travel cost includes the travel fare only and does not cover accommodation charges or food charges.

Special Allowance: Special Allowance is the amount paid to an employee over and above the salary paid. The allowance differs from company to company. Usually, Special Allowance is calculated as the residual element of salary that is left after allocations are made for all other components of total compensation such as HRA, LTA, transport allowance etc.

Bonus: Bonus is also termed as performance incentive which is usually paid once or twice in a year on the basis of the performance of the employee during the year. Bonus is fully taxable for employees.

Employee Contribution to Provident Fund: Provident fund is an investment fund that is funded by regular contribution by employees and employers. A contribution of 12% is deducted from the basic salary of the employee every month as a contribution to Provident Fund and an equivalent amount at 12% of the basic salary is contributed by the employer to the fund. The employee can withdraw its Provident Fund at the time of his retirement. Provident Funds returned an interest of 8.65 percent for FY 2016-17. Interest earned on PF is exempt from tax and the employee contribution to the fund is eligible for tax deduction under Section 80C of Income Tax Act.

Professional Tax: Professional tax also called as tax on employment is a tax levied by various state governments. Professional tax is deducted by the employer and paid to the state government. The maximum amount of professional tax levied is Rs. 2,500 per year and the same is eligible for tax deduction from the salary of the employee at the time of filing his tax return. Currently, professional tax is levied in the states of Karnataka, West Bengal, Andhra Pradesh, Telangana, Maharashtra, Tamil Nadu, Gujarat, Assam, Chhattisgarh, Kerala, Meghalaya, Orissa, Tripura, Jharkhand, Bihar and Madhya Pradesh.

Difference between Gross Salary, CTC and take home salary (or in hand salary)

How CTC is different from take home salary

Generally, individuals find a significant difference between their take home salary (net salary) and gross salary (as mentioned by the employer at the time of starting his services). The confusion is further increased when few employers offer a total compensation package popularly known as cost to the company at time of joining the organization. The total compensation package can be significantly higher than the Gross Salary of the employee. Similarly, Gross salary of the employee is always higher than the Net Salary of Take Home Salary of an employee. There are several components of compensation package of an employee that contribute to these differences. Hence, it is important to understand the practical definition and components of Cost to the Company (CTC), Gross Salary and Net Salary to appreciate their differences and monetary implications for an employee.

Cost To Company (CTC)

CTC is the total compensation package offered to an employee that includes all expenditure an employer expects to incur on an employee during the year. This includes direct monetary benefits, non monetary benefits and employer contribution to various savings schemes on behalf of the employee. Hence, CTC includes all the direct and indirect expenses incurred by the employer in the course of providing employment to employee.

CTC = Direct benefits (monetary) + Indirect benefits (non monetary) + Savings contribution (contribution to PF)

Direct Benefits Indirect Benefits Savings Contribution
Basic salary Interest free loans Superannuation benefits
DA Food coupons/ Subsidized meals Employer Provident Fund (EPF)
Conveyance Allowance Company leased accommodation Gratuity
House Rent Allowance Medical life Insurance premium paid by employer
Medical Allowance Income tax savings
Leave Travel Allowance Office space rent
Incentives or bonus
Compensation allowance or special allowancee

Gross Salary

Gross Salary refers to the total monetary benefits and allowances paid to an employee before any deductions for tax and some savings. Gross salary of an individual includes:

  • Basic salary or wages, pension, leave encashment, salary arrears, salary advances, overtime amount etc.
  • Allowances such as HRA, Dearness Allowance, Medical Allowance, Children Education Allowance, Children Hostel Allowance, Conveyance Allowance and Special Allowance.
  • Perquisites such as House Rent Accommodation, Motor Car Facility, facility of gardener, sweeper, electricity etc.
  • Benefits received as a replacement of salary that is Retrenchment Compensation (generally paid at the time of termination or retrenchment)
  • Pension received from former employer (if any)

Salary components not covered under gross salary:

  • Gratuity (Retirement or Death)
  • Medical Reimbursement
  • Leave Travel Concession
  • Uniform Allowance
  • Leave Encashment at the time of retirement under Section 10 (10AA)
  • Free meals or refreshment provided during office hours
  • Provident fund contribution by employer

Take home salary or in hand salary

Take home salary is the monthly amount or the take home salary that an individual receives in his bank account. This amount is generally lesser than the total compensation and even lesser than the Gross Salary of the employee on a monthly basis and is arrived at after subtracting income tax, contribution to PF and other deductions, if any from the Gross Salary.

Steps to compute Take Home Salary:

  • Compute Gross Salary: Gross Salary is calculated by deducting the following from Cost to the Company: Employer’s Contribution to PF account (EPF), the amount of gratuity and any other expenses included by the employer while calculating cost to the company.
  • Compute Taxable Income: Taxable income is computed after deducting all allowances such as HRA, Conveyance Allowance, and Medical Allowance and tax saving investments etc up to their tax exempt limit
  • Calculate Income Tax: The next step is to calculate your income tax liability or the amount of tax paid by you. Income tax is computed based on Income Tax Slabs after accounting for available tax exemptions under various sections of Income Tax Act as prescribed for the relevant Financial Year. To compute your tax liability, refer to Income Tax Slabs for FY17-18.
  • Compute Net or Take Home Salary: Take Home Salary is the salary left after deducting tax liability from the Gross Salary.

Other Taxable and Non Taxable Salary Benefits

Retirement Benefits

In addition to salary and various allowances, the employer also provides various retirement benefits to an individual available at the time of leaving the organization or at the time of retirement from work at retirement age or at the time of taking VRS. Such benefits available are as follows:

Leave encashment

Leave encashment policy is a subject matter of a company policy and may differ from company to company. Company’s policy may allow individuals to carry forward their unused leaves to the next year or may require the employees to utilize their leaves in same year. In certain case, company may allow an individual to encash the unused leaves up to a certain limit at different points of employment including:

  • At the time of retirement (including VRS)
  • Separation of the employee form the organization on account of resignation or termination
  • During the period of employment

Tax treatment of encashment of unused leave differs for government and non-government employees under Section 10 (10AA) of Income Tax Act.

Tax on leave encashment

Case I - leave encashment during the period of employment

Leave encashment received during continuation of service is taxable in the year of such encashment irrespective of whether the employee is a government employee or not.

Case II - Leave encashment at the time of retirement

Leave encashment of accumulated leave at the time of retirement is fully tax exempted in case of government employees.

However, in the case of non government employees, leave encashment of accumulated leaves at the time of retirement in is exempted from tax up to a certain limit. Under section 10 (10AA) (ii) the amount of tax exemption is estimated at least of the following:

  • Period of earned leave in months X Average monthly salary
  • Average monthly salary X 10
  • Rs. 300,000 as specified by government
  • Leave encashment actually received

Leave encashment policy varies from company to company and depending on company policies may be computed by one of the following methodology

  • Number of completed years of service
  • Number of days of leave entitlement for each year of service as per service rules
  • Gross total leave in days
  • Period of earned leave
  • Period of leave in months

Average monthly salary here means average salary drawn in past ten months immediately preceding retirement. Salary for the purpose of computation of leave encashment includes the following:

  • Basic salary
  • Dearness Allowance
  • Commission based on fixed percentage of turnover achieved by employee

Salary for the purpose of calculation of leave encashment does not include any other allowance and perquisites.

Pension

After retirement, an individual is entitled to receive a fixed monthly amount known as pension from his employer in consideration of his past service. Pension is taxable at the marginal tax rate as per applicable Income Tax slabs.

Types of pension and their tax treatment:

Commuted pension: A portion of the pension received in lump sum by an individual at the time of his retirement is referred to as commuted pension. Commuted pension received by a government employee is tax exempted. However, commuted pension received by a non- government employee is exempted up to a certain limit, calculated as follows:

  • If an individual receives gratuity along with the commuted pension, one third of the commuted pension received will be tax exempted.
  • If an individual does not receive gratuity, half of the commuted pension received will be tax exempted.

Un-commuted pension: Pension that is received by an individual periodically is referred to as Un-commuted pension. Un-commuted pension is taxable as per the Income Tax slabs applicable to the employee. Un-commuted pension is taxable in the hands of both government and non- government employees.

Pension received by family member: Tax treatment of pension received by family member after the death of the pensioner as a lump sum amount, is tax exempted.
Un-commuted pension received by family member at regular intervals is tax exempted up to a specified limit. The tax exemption is limited to one third of the amount received or Rs. 15,000, whichever is less.

Gratuity

Gratuity is a monetary reward paid by an employer to an employee for services rendered by him. Usually, an employee becomes eligible for gratuity after successful completion of 5 years of his services in one organization. However, if an employee dies before completing 5 years of service in an organization, the number of years of services to be entitled for gratuity gets relaxed to 1 year. Gratuity is payable to the eligible employees at the time of retirement or death or retrenchment or resignation.
Tax treatment of gratuity differs based on category of employees.

Gratuity in case of government employees and employees of local authority: Gratuity received by a government employee is tax exempted under Section 10 (10)(i) of Income Tax Act. However, employees of statutory corporations are not included in this category and are not eligible for tax exemption under this category.

Exemption of gratuity in case of non- government employees is different for two categories of employees.

  • Exemption of gratuity in case of employees covered by the Payment of Gratuity Act, 1972
  • Exemption of gratuity in case of employees not covered by the Payment of Gratuity Act, 1972
Exemption in respect of gratuity in case of employees covered by the Payment of Gratuity Act, 1972

Tax exemption is limited to lower of the following points:

  • 15 days of salary x years of service (15 days salary= last drawn salary X 15/26
  • Rs. 10,00,000 Gratuity received
Exemption in respect of gratuity in case of employees not covered by the Payment of Gratuity Act, 1972

Tax exemption is limited to the lower of the following:

  • Half month’s average salary for each year of completed year of service that is [Average Monthly Salary * 1/2] x completed years of service (Average monthly salary is computed on the basis of average of salary for 10 months immediately preceding the month of retirement.
  • Rs 10,00,000
  • Gratuity received
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