income tax
Published on 11 April 2025
Understanding the Impact of Income Tax Classification on Employment Income
Overview of Income Classification
Income from ordinary sources is categorized into five main heads:
- Income from employment (formerly known as salary)
- Income from house property
- Income from business (formerly termed income from business or profession)
- Capital gains
- Income from residuary sources (formerly recognized as income from other sources)
The total income from ordinary sources is combined with the total income from special sources to determine the taxpayer's overall total income.
Computation of Income from Employment
Gross Salary Calculation
Income from employment is calculated by taking the gross salary and subtracting permissible deductions. The income side of salary accounts for amounts due or received, whichever comes first. It also includes the value of perquisites and profit in lieu of salary.
Permissible Deductions
The following are the key permissible deductions that influence net taxable income:
- Professional taxes paid
- Transport allowance within prescribed limits
- Special allowances or benefits for expenses incurred solely in fulfilling job duties
- Compensation from a voluntary retirement scheme
- Gratuity received upon retirement or death
- Commuted pension amounts
- Pension received by gallantry awardees
Key Conditions for Deductions
According to paragraph 7.4 of the code, deductions for items (d), (e), and (f) above apply only if deposited into a “Retirement Benefit Account” or the “NEW PENSION SYSTEM TRUST.” Previously exempted amounts received from approved superannuation funds will also be treated under the same condition.
Paragraph 7.5 restricts tax-saving scheme contributions during the earning period to four approved avenues: provident funds, superannuation funds, life insurance schemes, and the New Pension System Trust. Earnings from these deposits are untaxed until withdrawal, at which point they are taxed at the assessee's marginal rate for that year.
Inclusion of Various Benefits
As outlined in paragraph 7.7 of the code, salary now includes:
- Value of rent-free or concessional accommodation provided by the employer, applicable to all employers, including the government
- Value of leave travel concessions
- Leave encashment upon retirement or otherwise
- Medical reimbursements
- Value of free or discounted medical treatment from the employer
Due to these modifications, other deductions such as House Rent Allowance (HRA), Leave Travel Allowance (LTA), Medical Allowance, and food coupons will not be permitted. Consequently, salary will be taxable without any additional deductions.
Example: Comparison of Current vs. New Provisions
Consider an example of Mr. A, retiring on March 31, 2012. His income details are:
- Basic Salary: ₹200,000
- Conveyance Allowance: ₹9,600
- House Rent Allowance: ₹108,000
- Leave Travel Allowance: ₹18,000
- Medical Allowance: ₹15,000
- Food Coupons: ₹5,000
- Children Educational Allowance (for 2 children): ₹84,000
He pays annual house rent of ₹120,000 in Chennai and has a house in Madurai with an EMI payment of ₹15,000 per month, which includes ₹160,000 in interest and ₹20,000 towards principal repayment. His retirement benefits include:
- Gratuity: ₹300,000
- Employee's contribution to Superannuation Fund (SPF): ₹350,000
- Employer's contribution to SPF: ₹300,000
- Superannuation balance: ₹600,000 (commutable up to ₹200,000)
- Leave encashment: ₹200,000
Tax Comparison
| Particulars | Under Present Act (Rs) | Under New Code (Rs) |
|---|---|---|
| Basic Salary | 200,000 | 200,000 |
| Conveyance Allowance (Exempted under sec 10(16)) | 9,600 | 0 |
| House Rent Allowance (Deductions under section 10(13A)) | 108,000 | 18,000 |
| Leave Travel Allowance | 18,000 | 0 |
| Medical Allowance | 15,000 | 0 |
| Food Coupons | 5,000 | 0 |
| Children Educational Allowance | 84,000 | 74,400 |
| Interest on Housing Loan | 150,000 | 0 |
| Gratuity (Withdrawn for daughter's marriage) | 0 | 300,000 |
| EPF (withdrawn for daughter's marriage) | 0 | 650,000 |
| Commuted value of superannuation (to repay housing loan) | 0 | 200,000 |
| Leave encashment (to repay housing loan) | 200,000 | 0 |
| Total Taxable Salary | 142,400 | 1,780,000 |
| Total Tax Payable | NIL | 240,000 |
Conclusion
The presented example highlights the impact of tax liabilities under the new code. The significant withdrawal of deductions for critical expenses—such as House Rent, Children Education, Leave Travel, and Medical expenses—will adversely affect middle-income salaried individuals.
The taxation of retirement benefits accumulated for future needs under the new code raises concerns regarding financial planning for employees nearing retirement. Disproportionate taxation, coupled with substantial withdrawals from retirement benefits, could disrupt financial stability.