Income from salaries in detail

In short

Salary income is what an employee earns from an employer under a contract of employment — basic pay, allowances, perquisites, retirement benefits and anything received "in lieu of" salary. It is governed by Sections 15 to 17 of the Income-tax Act, 1961 (with Rule 3 of the Income-tax Rules for valuing perquisites) and is the first and most heavily weighted computation head in every B.Com Taxation paper. It matters in practice because almost every organised-sector worker in India is taxed under this head through monthly TDS by the employer under Section 192, so payroll, Form 16 and the old-versus-new-regime choice are daily work for accountants and HR teams. It is examined in university papers (full computation sums), in CA/CS/CMA papers, and in placement rounds for payroll, audit, taxation and finance-shared-services roles at firms like Deloitte, EY, PwC, KPMG, Infosys BPM, TCS, Genpact and WNS. (The Income-tax Act, 2025 replaces the 1961 Act from 1 April 2026; the computation rules below are substantially carried over but section numbers change, so verify numbering against your prescribed syllabus year.)

Explained

Charge, basis and the employer–employee relationship

• Section 15 charges: salary due in the previous year (whether paid or not), salary paid or allowed before it became due (advance salary), and arrears paid in the year if not taxed earlier. Effectively "due or receipt, whichever is earlier".
• An employer–employee (master–servant) relationship is essential. Without it the receipt is not salary: partner's remuneration from a firm → business income; MP/MLA salary and a non-employee director's sitting fee → income from other sources; professional retainer fee → business/profession.
• Same sum is taxed once: advance salary taxed on receipt is not taxed again when it becomes due.
• Place of accrual: salary for service rendered in India is deemed to accrue in India (Section 9(1)(ii)), taxable even if paid abroad; Section 9(1)(iii) covers Government employees serving abroad.
• Foregone salary is still taxable (it is salary applied, not diverted); salary surrendered to the Central Government under the Voluntary Surrender of Salaries Act, 1961 is excluded.
• Section 16 deductions are the only deductions from gross salary; expenses incurred to earn salary are not deductible.

Section 17(1): what "salary" includes

1. Wages, basic pay, annuity or pension, gratuity;
2. Fees, commission, perquisites, or profits in lieu of or in addition to salary;
3. Advance salary; payment of leave encashment;
4. Employer's annual contribution to a recognised provident fund in excess of 12% of salary, and interest credited above the notified rate (9.5%);
5. Transferred balance in a recognised PF (taxable portion on conversion from an unrecognised fund);
6. Contribution by the Central Government or any other employer to the employee's NPS (Tier-I) account referred to in Section 80CCD.
7. "Salary" has different meanings for different computations — a frequent exam trap:
   • HRA, rent-free accommodation, retrenchment/VRS, PF limits: basic pay + dearness allowance *if it enters retirement benefits ("in terms of employment")* + commission as a fixed percentage of turnover; for RFA, also add bonus and all taxable allowances (exclude perquisites and employer PF contribution).
   • Gratuity (covered by the Payment of Gratuity Act, 1972): basic + full DA.
   • Entertainment allowance deduction u/s 16(ii): basic salary only.

Allowances — fully taxable, partly exempt, fully exempt

• Fully taxable: dearness allowance, city compensatory allowance, overtime, servant, warden, non-practising, medical, lunch, family, project, deputation, interim relief, fixed conveyance not linked to duty.
• Partly exempt:
  • HRA — Section 10(13A) + Rule 2A: least of actual HRA, rent paid − 10% of salary, and 50% of salary (Delhi, Mumbai, Kolkata, Chennai) or 40% (elsewhere). No exemption if the employee pays no rent or lives in own house; computed month-wise if pay, rent or city changes.
  • Section 10(14)(i) — exempt to the extent actually spent for duties: travelling, conveyance, daily, uniform, helper, academic research.
  • Section 10(14)(ii) — fixed limits regardless of spend: children education ₹100 per month per child (max 2 children); hostel ₹300 per month per child (max 2); transport allowance ₹3,200 per month for a blind/deaf-and-dumb/orthopaedically disabled employee; tribal area ₹200 per month; running allowance to transport employees 70% of the allowance subject to ₹10,000 per month.
• Fully exempt: foreign allowance/perquisites to a Government employee posted abroad, allowances of High Court and Supreme Court judges, allowances from the UN.
• Under the new regime (Section 115BAC), HRA and most 10(14) allowances are withdrawn; the retained ones are conveyance for duties, travel on tour/transfer, daily allowance and transport allowance for a disabled employee.

Perquisites — Section 17(2) and Rule 3

• Meaning: any benefit or amenity in cash or kind, over and above salary, provided by virtue of employment. Taxable for all employees: rent-free/concessional accommodation, any obligation of the employee met by the employer, life insurance premium paid, ESOP/sweat equity, employer contribution above ₹7.5 lakh (17(2)(vii)) with its annual accretion (17(2)(viia)), and any other fringe benefit notified.
• Taxable only for "specified employees": motor car, gas/electricity/water from the employer's own source, free/concessional education, domestic servants engaged by the employer. A specified employee is a director, or an employee holding 20% or more of the equity voting power, or one whose salary (excluding non-monetary perquisites, after Section 16 deductions) exceeds ₹50,000.
• Rent-free accommodation (Rule 3(1), revised w.e.f. 1 September 2023):
  • Government employee: licence fee fixed by the Government, less rent recovered.
  • Non-Government, owned by employer (2011 census population): 10% of salary where population exceeds 40 lakh; 7.5% where 15–40 lakh; 5% otherwise.
  • Taken on lease/rent: lower of actual rent paid by the employer or 10% of salary.
  • Hotel (beyond 15 days on transfer): lower of 24% of salary or actual charges. Furniture: add 10% p.a. of cost, or actual hire charges. Always deduct rent actually recovered from the employee.
• Motor car (Rule 3(2)), employer's car, partly official and partly personal, employer bears running cost: ₹1,800 per month (engine up to 1.6 litre) or ₹2,400 per month (above 1.6 litre), plus ₹900 per month if a driver is provided. Wholly official use with logbook and certificate → nil. Wholly personal → actual running and maintenance + 10% p.a. of cost + driver's salary − amount recovered.
• Concessional loan: interest at the SBI rate as on the first day of the previous year on the maximum monthly outstanding balance, less interest charged; exempt if the aggregate original loan does not exceed ₹20,000 or is for specified medical treatment.
• Other common items: free education in an employer-maintained institution exempt up to ₹1,000 per month per child; free meals at the workplace exempt up to ₹50 per meal (not available where the new regime is opted, per the amended Rule 3(7)(iii)); tea/snacks exempt; gifts in kind up to ₹5,000 per year exempt; credit card and club expenses exempt for official use with records; employer's medical facility in its own or a notified hospital and group health insurance premium exempt (the old ₹15,000 medical reimbursement exemption was withdrawn from AY 2019-20).
• ESOP: perquisite on exercise = FMV on exercise date − amount paid; the later sale is a capital gain (separate head).

Retirement benefits

• Gratuity (Section 10(10)): Government employees fully exempt. Covered by the 1972 Act: least of actual gratuity, 15/26 × last drawn salary (basic + DA) × completed years (part exceeding 6 months rounded up), and ₹20,00,000. Not covered: least of actual, ½ month's average salary of the last 10 months × completed years (ignore fractions), and ₹20,00,000. The monetary ceiling is a lifetime aggregate.
• Pension (Section 10(10A)): uncommuted (monthly) pension is fully taxable as salary. Commuted pension: Government/statutory corporation employees fully exempt; others exempt to 1/3 of the full commuted value if gratuity is also received, otherwise 1/2. Family pension is not salary — taxed under other sources with a deduction u/s 57(iia) of 1/3 or ₹15,000, whichever is less (₹25,000 under the new regime from AY 2025-26).
• Leave encashment (Section 10(10AA)): at retirement, Government employees fully exempt; others, least of actual received, 10 months' average salary, cash equivalent of unavailed leave at a maximum of 30 days per completed year of service, and the notified ceiling ₹25,00,000. Encashment during service is fully taxable (relief u/s 89 available).
• Retrenchment compensation (10(10B)): exempt up to the amount under the Industrial Disputes Act, 1947 or ₹5,00,000, whichever is less. VRS (10(10C)): exempt up to ₹5,00,000, once in a lifetime, under a scheme satisfying Rule 2BA.
• Provident fund: Statutory PF — fully exempt. Recognised PF — employer contribution exempt up to 12% of salary, interest exempt up to 9.5%, lump sum exempt u/s 10(12) after 5 years of continuous service. Unrecognised PF — on withdrawal, employer's share + interest on it is taxable as salary (profits in lieu), interest on own contribution under other sources. Interest on the employee's own contribution above ₹2.5 lakh a year (₹5 lakh where the employer makes no contribution) is taxable.
• Section 17(2)(vii): aggregate employer contribution to RPF + approved superannuation fund + NPS exceeding ₹7,50,000 in a year is a perquisite, with the accretion on the excess taxable u/s 17(2)(viia).

Section 17(3) profits in lieu of salary, deductions and the regime choice

• Profits in lieu of salary: compensation on termination or modification of employment terms; payment from an unrecognised PF/superannuation fund (employer's share and interest thereon); keyman insurance sum received; any sum received before joining or after cessation of employment.
• Section 16 deductions: 16(ia) standard deduction — ₹50,000 under the old regime, ₹75,000 under the new regime (from AY 2025-26), limited to the salary amount; 16(ii) entertainment allowance — Government employees only, least of ₹5,000, 20% of basic salary, actual; 16(iii) professional tax — actually paid in the year, State ceiling ₹2,500 p.a.; if paid by the employer it is first added as a perquisite and then deducted.
• New regime (115BAC) is the default from AY 2024-25; the old regime must be opted for. A salaried person with no business income may switch every year while filing within the due date (Form 10-IEA to opt out); a taxpayer with business income may switch out only once.
• Under the new regime, allowed: standard deduction, 80CCD(2) employer NPS contribution (14% of salary for all employers from AY 2025-26), 80CCH (Agniveer), 80JJAA; and Sections 10(10), 10(10A), 10(10AA), 10(10C) exemptions continue. Withdrawn: HRA, LTA, 16(ii), 16(iii), interest on self-occupied house property u/s 24(b), and Chapter VI-A deductions such as 80C, 80D, 80CCD(1B), 80E, 80G, 80TTA.
• Compliance: employer deducts TDS monthly u/s 192 and issues Form 16; the employee declares exemptions/deductions in Form 12BB, other-employer salary in Form 12B, and other TDS/TCS credits in Form 12BAA (from October 2024); other income can be reported to the employer u/s 192(2B). Relief u/s 89 with Form 10E spreads arrears/advance salary over the years to which they relate.

Key points

• Section 15 - salary taxed on due or receipt, whichever is earlier; arrears on receipt if not taxed before.
• Employer–employee relationship - without it the income is business income or other sources, not salary.
• Section 17(1) - inclusive definition: pay, pension, gratuity, fees, commission, perquisites, leave encashment, excess PF credits.
• Meaning of "salary" - basic + DA (if in terms) + turnover commission for HRA/RFA/PF; basic + full DA for covered gratuity; basic only for 16(ii).
• HRA - least of actual HRA, rent − 10% of salary, 50%/40% of salary; metros are only Delhi, Mumbai, Kolkata, Chennai.
• Standard deduction - ₹75,000 (new regime) or ₹50,000 (old), capped at the salary itself.
• Professional tax - deductible on payment basis, maximum ₹2,500 per year, old regime only.
• Rent-free accommodation - 10%/7.5%/5% of salary by city population (2011 census) for employer-owned houses, since 1 September 2023.
• Specified employee - director, 20% or more voting power, or monetary salary above ₹50,000; car, servant, education and utility perquisites apply to them.
• Motor car - ₹1,800 or ₹2,400 per month by engine capacity, plus ₹900 for a driver, for mixed use.
• Gratuity - 15/26 × last salary × years, ceiling ₹20 lakh (covered employees); fully exempt for Government staff.
• Leave encashment - 30 days per completed year, 10 months' average salary, ₹25 lakh ceiling for non-Government employees.
• Commuted pension - 1/3 exempt with gratuity, 1/2 without; uncommuted pension always fully taxable.
• Recognised PF - employer contribution above 12% of salary and interest above 9.5% are taxable; ₹7.5 lakh aggregate cap u/s 17(2)(vii).
• Profits in lieu (17(3)) - termination compensation, keyman insurance, unrecognised fund payouts, pre/post-employment sums.
• Section 89 relief - recomputation of tax on arrears across relevant years, claimed in Form 10E before filing.
• New regime default - salaried taxpayers may still switch yearly via Form 10-IEA; HRA, LTA and 80C are lost but slabs are lower.
• Section 192/Form 16 - employer TDS monthly on estimated salary; Form 12BB and 12BAA feed the estimate.

Formulas and examples

Example 1 — HRA (Mumbai). Basic ₹60,000 p.m., DA (in terms) ₹10,000 p.m., HRA ₹25,000 p.m., rent paid ₹30,000 p.m.

• Salary for HRA = (60,000 + 10,000) × 12 = ₹8,40,000.
• Actual HRA = ₹3,00,000 | Rent − 10% salary = 3,60,000 − 84,000 = ₹2,76,000 | 50% of salary = ₹4,20,000.
• Exempt = ₹2,76,000; taxable HRA = ₹24,000.

Example 2 — Gratuity (covered by the Act). Last drawn basic ₹52,000 + DA ₹8,000 = ₹60,000 p.m.; service 26 years 7 months → 27 years; gratuity received ₹22,00,000.

• 15/26 × 60,000 × 27 = (16,20,000 × 15) ÷ 26 = ₹9,34,615.
• Exempt = least of 22,00,000 / 9,34,615 / 20,00,000 = ₹9,34,615; taxable = ₹12,65,385.

Example 3 — Full computation, old versus new regime (AY 2026-27, age below 60, Pune). Basic ₹12,00,000; DA (in terms) ₹2,40,000; HRA ₹4,80,000 with rent paid ₹4,20,000; employer RPF contribution 12% of basic + DA; professional tax ₹2,500; 80C ₹1,50,000; 80D ₹25,000.

• *Old regime:* salary for HRA = ₹14,40,000 → exemption = least of 4,80,000 / (4,20,000 − 1,44,000 = 2,76,000) / 40% = 5,76,000 → ₹2,76,000; taxable HRA ₹2,04,000. Employer PF at 12% is exempt.
• Gross salary = 12,00,000 + 2,40,000 + 2,04,000 = ₹16,44,000; less standard deduction 50,000 and PT 2,500 = ₹15,91,500; less 80C and 80D = total income ₹14,16,500.
• Tax = 12,500 + 1,00,000 + 30% × 4,16,500 (= 1,24,950) = ₹2,37,450 + 4% cess ₹9,498 = ₹2,46,948.
• *New regime:* HRA fully taxable → gross salary ₹19,20,000; less standard deduction ₹75,000 = total income ₹18,45,000.
• Tax = 0 (to 4L) + 20,000 (4–8L) + 40,000 (8–12L) + 60,000 (12–16L) + 20% × 2,45,000 (= 49,000) = ₹1,69,000 + 4% cess ₹6,760 = ₹1,75,760.
• New regime saves ₹71,188 — here the lower slabs beat the ₹4,28,500 higher total income (₹4,53,500 of forgone exemptions and deductions, less the extra ₹25,000 standard deduction).

Example 4 — Rent-free accommodation (Bengaluru, population above 40 lakh). Basic ₹9,00,000, DA in terms ₹90,000, bonus ₹60,000, other taxable allowances ₹50,000; flat owned by the employer, furniture costing ₹2,00,000 provided; employee pays ₹3,000 p.m.

• Salary for RFA = 9,00,000 + 90,000 + 60,000 + 50,000 = ₹11,00,000 → 10% = ₹1,10,000.
• Furniture = 10% × 2,00,000 = ₹20,000; rent recovered = ₹36,000.
• Perquisite = 1,10,000 + 20,000 − 36,000 = ₹94,000.

Example 5 — Retirement bundle (non-Government, retired 31 December 2025, 24 years 8 months of service). Average monthly salary (last 10 months) ₹70,000; leave availed 220 days; leave encashment received ₹12,00,000; monthly pension ₹30,000, of which 60% commuted for ₹18,00,000; gratuity also received.

• Leave credit at 30 days × 24 completed years = 720 days − 220 availed = 500 days → cash equivalent = (500 ÷ 30) × 70,000 = ₹11,66,667.
• Exempt = least of 12,00,000 / (10 × 70,000 = 7,00,000) / 11,66,667 / 25,00,000 = ₹7,00,000 → taxable leave encashment ₹5,00,000.
• Full commuted value = 18,00,000 ÷ 0.60 = ₹30,00,000; exempt 1/3 = ₹10,00,000 → taxable commuted pension ₹8,00,000.
• Uncommuted pension = 40% × 30,000 = ₹12,000 p.m. × 3 months (Jan–Mar) = ₹36,000 fully taxable.

Where it is used

• Payroll and HR shared services (Infosys BPM, TCS, Genpact, WNS, ADP, Darwinbox, Zoho Payroll, greytHR) — monthly TDS computation u/s 192, Form 16 and Form 24Q generation, perquisite valuation, regime declaration.
• Audit and tax advisory (Big Four, mid-tier CA firms) — verifying employer TDS compliance, perquisite disclosures, Section 10 exemption claims, expatriate and secondment taxation.
• Compensation structuring — designing CTC with HRA, NPS under 80CCD(2), car lease, meal cards and ESOPs; after the new regime became the default, structuring has shifted away from allowance-heavy pay.
• Banking and lending — Form 16 and salary slips are the core income proof for home and personal loan underwriting at SBI, HDFC Bank and NBFCs.
• Retirement benefit administration — EPFO, gratuity trusts, superannuation funds and NPS points of presence applying Sections 10(10), 10(10A), 10(10AA) and 10(12).
• Individual return filing and ITR-1/ITR-2 preparation — ClearTax, Quicko, TaxBuddy and CA practices, including Section 89 relief and Form 10E for arrears after Pay Commission revisions.

Interview questions

• Q: When is salary taxable — on accrual or on receipt? A: On whichever is earlier: salary due during the previous year or salary paid/allowed before it was due; arrears are taxed on receipt if not already taxed.
• Q: Why is a partner's remuneration not salary? A: A firm and its partner cannot have a master–servant relationship, so it is taxed as business income u/s 28(v) in the partner's hands.
• Q: What are the three limits for HRA exemption? A: Actual HRA received, rent paid minus 10% of salary, and 50% of salary for Delhi/Mumbai/Kolkata/Chennai or 40% elsewhere — the least is exempt.
• Q: Does "salary" mean the same thing throughout the chapter? A: No — for HRA, RFA and PF it is basic + DA in terms + turnover commission; for covered gratuity it is basic + full DA; for entertainment allowance it is basic only.
• Q: Who is a specified employee and why does it matter? A: A director, an employee holding 20% or more of the voting power, or one with monetary salary above ₹50,000; car, domestic servant, free education and employer-supplied utilities are taxable only in their hands.
• Q: How is rent-free accommodation valued for a private-sector employee after the 2023 amendment? A: For an employer-owned house, 10%, 7.5% or 5% of salary depending on whether the 2011 census city population exceeds 40 lakh, is 15–40 lakh, or is below 15 lakh, less rent recovered.
• Q: Is uncommuted pension exempt? A: No — monthly pension is fully taxable as salary for everyone; only commuted pension gets exemption u/s 10(10A).
• Q: An employee receives ₹30 lakh gratuity after 30 years. How much is taxable? A: Exemption is the least of the actual amount, 15/26 × last salary × 30, and the ₹20 lakh lifetime ceiling — so at least ₹10 lakh is taxable.
• Q: Which salary deductions survive under the new regime? A: The ₹75,000 standard deduction and employer NPS contribution u/s 80CCD(2) up to 14% of salary; HRA, LTA, entertainment allowance, professional tax and 80C-type deductions do not.
• Q: How is an ESOP taxed for a salaried employee? A: The difference between fair market value on the exercise date and the exercise price is a perquisite taxed as salary; the gain on later sale is a capital gain.
• Q: What is relief u/s 89 and how is it claimed? A: It removes the extra tax caused by receiving arrears or advance salary in one year, by recomputing tax as if the income belonged to the years it related to; claimed by filing Form 10E before the return.
• Q: When does an employer's provident fund contribution become taxable? A: Contribution above 12% of salary and interest credited above 9.5% are taxable annually, and aggregate employer contributions to PF, superannuation and NPS above ₹7.5 lakh are a perquisite u/s 17(2)(vii).

Common mistakes

• Using the wrong definition of "salary" in a formula — adding full DA where only DA "in terms of employment" counts, or including perquisites in salary for RFA.
• Computing HRA exemption on an annual basis when pay, rent or city changed during the year, instead of month-wise.
• Claiming HRA, LTA, 80C or professional tax under the new regime, or forgetting that the new regime is now the default.
• Rounding gratuity service years in the "not covered" case — fractions are ignored there, while the covered case rounds up any part exceeding six months.
• Forgetting that the ₹20 lakh gratuity and ₹25 lakh leave encashment ceilings are lifetime aggregate limits, not per-employer limits.
• Taking the amount received as the full commuted value of pension instead of grossing it up by the fraction commuted before applying the 1/3 or 1/2 exemption.
• Deducting professional tax on a due basis, or omitting it as a perquisite first when the employer pays it; and deducting personal expenses from salary, which Section 16 does not permit.

Related topics

Income tax basics · TDS and tax filing basics · Capital gains · Business income and presumptive taxation · Corporate tax basics · Deductions under Chapter VI-A and tax planning