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Pay Commission: Need clarity on taxability of arrears
September, 10th 2008

The Central government had announced wage revision for the government employees recently. As a result, the employees expect to receive the arrears of salary (the increased wages) shortly. It is expected that a part of this increase would be paid in the current financial year and the balance may be paid in the next financial year. An issue arises as to the taxability of the income likely to be received by the employees.

The income chargeable to tax under the head salaries includes:

Salary due from an employer in the financial year, whether paid or not; salary paid or allowed to an employee in a financial year, even though not due; any arrears of salary paid or allowed to an employee in a financial year.

Therefore, an issue arises whether only the partial income that is received in the current financial year would be liable to tax or whether the entire income which the employee is likely to receive in the current financial year and the next financial year would be liable to tax now.

In this context, it is important to note the provisions of Section 192 of the Income-tax Act, 1961 (the Act), which specify the deduction of tax on salary by the employer. As per these provisions, an employer responsible for paying salary shall at the time of payment deduct income tax on the amount payable to the employee. It is pertinent to note that employer is required to deduct tax only at the time of payment of salary. Therefore, if no payment is made, no tax is required to be deducted by the employer.

By implication, if only partial payment is made in current financial year then the government is required to withhold tax only in respect of part amount paid in the current financial year.

However, an issue still remains that even if the balance portion which is not paid by the government and on which no tax is deducted, whether the said amount would still be liable to tax in the hands of the employees in the current financial year. This issue requires deliberations as to whether the phrase allowed to would cover the payment which is yet to be made to the employees and hence this requires further clarifications from the government.

It is also important to note that government employees are also entitled to relief u/s 89 in respect of salaries received in arrears in any one financial year which relates to earlier financial years. Briefly, relief is calculated by spreading the arrears over the past years to which they pertain i.e., the tax payer can get the benefit of relief at the time of the deduction of tax at source by requesting his employer concerned.

 
 
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