CruxIncome Tax Law and Practice

Salary needs an employer and an employee: a person who works under the employer's control and direction, under a contract of service. A professional paid by clients under a contract for services earns fees, not salary. The relationship may be past or future as well as present:

• salary from a former employer is charged too (s. 15(2)), so pension and arrears paid after the job ends are salary;
• a sum received from a person before joining his employment, or after leaving it, is profits in lieu of salary (s. 18(1)(b)).

A partner's salary, bonus or commission from his firm is not salary (s. 15(4)); it is business income, so far as the firm was allowed to deduct it (s. 26(2)(g)).

Salary includes (s. 16):

• wages, fees and commission, and any annuity or pension;
• gratuity, and payment for earned leave not taken;
• perquisites, and profits in lieu of or in addition to salary or wages;
• advance of salary;
• the taxable part of the yearly growth of a recognised provident fund balance, and of a balance carried into a fund when it is first recognised (s. 16(i)-(j); Schedule XI, Part A, paras 6 and 11);
• the employer's (or the Central Government's) contribution to the employee's account in the pension scheme of s. 124, and the Central Government's contribution to an Agniveer's corpus fund account (s. 125).

Each item may be partly exempt or deductible; the rest is taxed. Salary from two or more employers in a year is added together. Family pension, paid to the family of an employee who has died, is not their salary: it is income from other sources, with a deduction of one-third of it, capped at ₹25,000 in the default regime and ₹15,000 in the old (s. 93(1)(d)).

The three limbs (s. 15(1), (3)):

1. salary due in the tax year is taxed, paid or not;
2. advance salary, paid before it falls due, is taxed in the year received and left out when it later falls due;
3. arrears, salary of an earlier year paid now, are taxed in the year received, unless taxed earlier.

Two consequences:

• Salary given up after it has fallen due is still taxed, because it was due; only a waiver made before it falls due keeps it out.
• A loan from the employer is not salary, since it must be repaid; an advance of salary is.

Relief (s. 157). Where arrears or advance salary, salary for more than twelve months in one tax year, profits in lieu of salary, or arrears of family pension push income into a higher rate, the Assessing Officer grants relief on the employee's application, worked out as the rules provide. No relief is given on an amount for which the voluntary retirement deduction (s. 19(1), Sl. No. 12) has been claimed, for that year or any other (s. 157(2)).

An allowance is a fixed sum paid to meet an expense. It is taxable in full unless the Act exempts it: dearness allowance, a fixed medical allowance, a travelling allowance with no official journeys behind it and entertainment allowance are all fully taxable.

House rent allowance (Schedule III, Sl. No. 11). Part of it is exempt only if:

• the employer grants it specifically to meet rent for the house the employee lives in;
• the employee does not own that house; and
• he actually pays rent for it.

The exempt part is what the rules allow, having regard to where the house is: the least of the allowance received, the rent paid less a set percentage of salary, and a set percentage of salary that is higher in the largest cities. The rest is taxable.

Allowances for the job (Sl. No. 12). An allowance or benefit granted specifically to meet expenses incurred wholly, necessarily and exclusively in performing the duties of the job, such as travel on official tours or a uniform worn on duty, is exempt so far as it is actually spent for that purpose, if it is of a kind the rules name and is not itself a perquisite.

Personal allowances (Sl. No. 13). An allowance for personal expenses where the employee works or lives, or to make up a higher cost of living, such as one for children's education or for a posting in a remote area, is exempt to the extent the rules allow. An allowance for duties of a special nature qualifies only if it relates to the place of posting or residence.

Leave travel concession (Sl. No. 8). Travel concession or assistance that the employee receives, or is owed, for himself and his family, from his employer on going on leave to any place in India, or from his employer or former employer on going to any place in India after retirement or termination, is exempt:

• within the number of journeys and the amount per head that the rules fix, framed with regard to the Central Government's own scheme; and
• never above what the travel actually cost.

Family means the spouse and children, and parents, brothers and sisters wholly or mainly dependent on him (Schedule III, Note 2).

Allowances abroad. Allowances and perquisites the Government pays a citizen of India for service outside India are exempt (Sl. No. 9).

Default regime. House rent allowance and leave travel concession are fully taxable, and so are the allowances of Sl. Nos. 12 and 13 except those the rules keep (s. 202(2)(a)(i)-(ii)). No exemption that another law gives for allowances or perquisites applies either (s. 202(2)(c)).

A perquisite is a benefit in cash or kind that the employer gives beyond pay. Section 17(1) sets out who is taxed on what:

Obligations and amenities. An obligation is a bill that is the employee's own: his rent, his electricity bill, his children's school fees, or the income tax on his salary that the employer bears. Paid by the employer, it is a perquisite for every employee. An amenity is something the employer itself provides, such as a servant it engages or gas, electricity or water it supplies; given free or cheap, it is taxed only in the hands of a specified employee.

A specified employee is:

• a director of the employer company;
• a person with a substantial interest in it: the beneficial owner of shares, other than shares with a fixed rate of dividend, carrying at least 20% of the voting power (s. 2(79)); or
• an employee whose income under this head paid in money, from one or more employers, exceeds the amount the rules fix.

Valuation. The Act sets the categories; the rules value each benefit (the prescribed manner). The Act itself fixes two measures: accommodation at a concession is taxed on its value above the rent the employee pays or owes, and shares or securities on their fair market value on the date he exercises the option, less what he paid (s. 17(4)(h)).

Motor car. A car used only for the employer's work gives the employee no benefit, and the employer's spending on a vehicle for his journeys between home and the place of work is not a perquisite (s. 17(2)(e)). Private use of the employer's car, and the running cost of the employee's own car met by the employer, are valued under the rules.

Medical benefits that are not perquisites (s. 17(2)-(3)):

• medical treatment of the employee or his family in a hospital the employer maintains;
• the employer's payment for what the employee spent on treating himself or his family in a hospital run by the Government or a local authority, or approved by the Government for its own employees, or, for prescribed illnesses, in a hospital the Principal Chief Commissioner or Chief Commissioner approves;
• premium the employer pays to insure the employee's health under a scheme approved for s. 30(c), and his refund of premium the employee paid for himself or his family under a scheme approved for s. 126;
• the employer's spending on treatment abroad of the employee or his family, with travel and stay abroad for the patient and one attendant: treatment and stay only so far as the Reserve Bank permits, and travel only if the employee's gross total income, before adding it, is within a prescribed amount.

Where the employer, by its own choice, pays the tax on a perquisite not given in money, that payment is not taxed as the employee's income (Schedule III, Sl. No. 10).

Gratuity is a lump sum an employer pays for long service. It is salary (s. 16(c)); gratuity received while still in service is taxable in full. When it is received on retirement, on incapacity before retirement or on termination, s. 19(1) gives a deduction that depends on the employee:

Under the Payment of Gratuity Act, the amount is 15 days' wages for each completed year of service, a part year above six months counting as a year, with a month's wages spread over 26 days: 15/26 × last monthly wages × years of service, up to that Act's ceiling under its section 4(3). Wages there are basic pay and all dearness allowance.

Any other employee deducts the least of:

1. the gratuity received;
2. the limit the Central Government notifies with regard to its own employees, less gratuity exempted in earlier years; gratuity from several employers in one year shares this one limit (s. 19(2)(a));
3. half a month's average salary for each completed year of service: ½ × A × B, with A the average salary of the ten months immediately before the month of retirement and B the completed years.

Salary here takes in dearness allowance only where the terms of employment count it, and leaves out every other allowance and every perquisite (s. 19(2)(b)).

Gratuity on death, received by the employee's widow, children or dependants, is exempt up to the amount worked out under whichever of Sl. Nos. 3-6 applies to him (Schedule III, Sl. No. 38).

Payment for earned leave not taken is salary (s. 16(h)). Encashed during service, it is taxable in full. On retirement, by superannuation or otherwise:

• a Central or State Government employee deducts the whole amount (Sl. No. 13);
• any other employee deducts the least of four amounts (Sl. No. 14):
  • the cash value of the earned leave at his credit, counting not more than 30 days for each year of actual service;
  • ten times his average monthly salary for the ten months immediately before retirement;
  • the limit the Central Government notifies, less leave salary exempted in earlier years, one limit for all employers in a year (s. 19(2)(f));
  • the amount received.

Salary has the same meaning as for gratuity (s. 19(2)(b)).

Uncommuted pension, paid month by month, is salary and taxable in full for every pensioner (s. 16(b)); the standard deduction applies to it. Commuted pension is a lump sum taken in exchange for giving up part of the pension:

• a pension commuted under the Central Government's civil pension commutation rules, or a similar scheme for Union civil and defence posts, the all-India services, the defence services, State civil services, local authorities or corporations set up by a Central, State or Provincial Act, is deducted in full (Sl. No. 7);
• any other employee deducts the commuted value of one-third of the pension he would normally get if he also receives gratuity, or of one-half if he does not; the commuted value rests on his age, his health, the interest rate and recognised mortality tables (Sl. No. 8);
• commutation from an insurer's pension fund of the kind in Schedule VII, Sl. No. 3 is deducted in full (Sl. No. 9).

Exempt pensions (Schedule III):

• pension of a person who served the Central or a State Government and won the Param Vir Chakra, Maha Vir Chakra, Vir Chakra or a notified gallantry award, and family pension of his family (Sl. Nos. 14-15);
• family pension of the widow, children or nominated heirs of a member of the armed forces, paramilitary included, who died in the course of operational duties, on prescribed conditions (Sl. No. 16);
• disability pension, both elements, of a member of the armed forces, paramilitary included, invalided out because of a disability caused or worsened by that service and not retired on superannuation or otherwise (Sl. No. 38A, inserted by Finance Act, 2026, section 123).

• A statutory provident fund (SPF) is a fund to which the Provident Funds Act, 1925 applies.
• A recognised provident fund (RPF) is one the income-tax authorities have recognised under Schedule XI, Part A.
• An unrecognised provident fund (URPF) is any other employer's fund.
• The public provident fund is a fund the Central Government sets up and notifies, open to any individual.

Deposits in the public provident fund, in the name of the depositor, his spouse or child, count for s. 123 in the old regime (Schedule XV, para 1(e)); payments from a Central Government fund notified for the purpose are exempt (Schedule II, Sl. No. 3).

Large contributions. In an SPF, RPF or notified Central Government fund, the year's interest is taxable so far as it relates to the member's own contributions made from 1 April 2021 above ₹2,50,000 a year, or ₹5,00,000 where no employer pays into that fund (Schedule II, Sl. Nos. 3-4); the rules compute the amount.

RPF balance (Schedule XI, Part A, para 8). The accumulated balance is excluded if:

• he served the employer continuously for five years or more, counting service with earlier employers whose fund balances were moved in; or
• his service ended sooner through ill-health, the contraction or closure of the employer's business, or another cause beyond his control; or
• on joining a new employer, the balance is moved to the new employer's recognised fund (to that extent); or
• the whole balance is moved to his account in the notified pension scheme of s. 124.

Otherwise the fund is treated as never recognised: the tax for each year of membership is worked out again on that footing, and the extra tax is payable in the year the balance becomes payable (para 9).

Approved superannuation fund. The employer's contribution is taxed only so far as it takes the aggregate of s. 17(1)(h) above ₹7,50,000; the employee's own contribution counts for s. 123 in the old regime (Schedule XV, para 1(g)). A payment from the fund is exempt (Schedule II, Sl. No. 8) when it is made:

• on the death of a beneficiary;
• to an employee, instead of or in commutation of an annuity, on retiring at or after a specified age or on becoming incapacitated before it;
• as a refund of contributions on a beneficiary's death;
• as a refund of contributions to an employee who leaves otherwise than by such retirement or incapacity, so far as it does not exceed contributions made before this Act came into force, with interest; or
• by transfer to his account in a notified pension scheme of s. 124.

Pension scheme of s. 124 (the National Pension System). The employer's contribution to the employee's account is salary (s. 16(k)), and it is deducted from gross total income up to 14% of salary where the employer is the Central or a State Government and 10% for other employers, 14% for every employer in the default regime (s. 124(1)-(2)); salary here takes in dearness allowance only where the terms of employment count it, and no other allowance or perquisite (s. 124(13)(b)). On closure of the account or opting out, up to 60% of the amount then payable is exempt (Schedule II, Sl. No. 6); a partial withdrawal is exempt up to 25% of his own contributions (Schedule III, Sl. No. 4).

Agniveer Corpus Fund. The Central Government's contribution is salary (s. 16(l)) and deducted in full (s. 125(2)); payments from the fund to the Agniveer or his nominee are exempt (Schedule II, Sl. No. 7).

Profits in lieu of salary include (s. 18(1)):

• compensation due or received from the employer or a former employer when the employment ends or its terms and conditions are changed;
• any sum due or received from a person before joining his employment or after leaving it;
• any other payment due or received from the employer or a former employer;
• a payment from a provident or other fund, except the employee's own contributions and the interest on them;
• a sum received under a Keyman insurance policy, with the bonus on it.

Left out (s. 18(2)): qualifying payments from an SPF, RPF or approved superannuation fund (Schedule II, Sl. Nos. 3, 4 and 8), and house rent allowance (Schedule III, Sl. No. 11). Compensation in connection with the end or change of an employment received from anyone other than the employer is income from other sources (s. 92(2)(j)).

Retrenchment compensation (Sl. Nos. 10-11). Compensation a workman receives on retrenchment, under the Industrial Disputes Act, 1947, another law, standing orders, an award, a contract of service or otherwise, earns a deduction of the least of:

1. the compensation received;
2. the amount worked out under section 25F(b) of the Industrial Disputes Act, 1947; and
3. the amount the Central Government notifies, which may not be less than ₹50,000.

It is deducted in full if paid under a scheme the Central Government approves for the special protection of workmen. Compensation on the closing down of the undertaking counts as retrenchment compensation, and so does compensation on a transfer of its ownership or management to a new employer where the workman's service is interrupted, his new terms are less favourable, or the new employer is not bound to treat his service as continuous (s. 19(2)(c)). "Employer" and "workman" carry their Industrial Disputes Act meanings (s. 19(2)(d)).

Voluntary retirement (Sl. No. 12). Compensation received or receivable on voluntary retirement or termination of service under a scheme of voluntary retirement (for a public sector company, voluntary separation) is deducted up to ₹5,00,000. Conditions (s. 19(2)(e), (h)):

• the employer is a public sector or other company, an authority set up under a Central, State or Provincial Act, a local authority, a co-operative society, a university, an Indian Institute of Technology, the Central or a State Government, or a notified institution of national or State importance or institute of management;
• the scheme is framed under the official guidelines, which include tests of economic viability;
• once allowed for one tax year, the deduction is not allowed for any other year; and
• no deduction is allowed on an amount for which relief under s. 157 has been allowed.

Income under the head is gross salary less the deductions of s. 19(1). Two concern every employee, and entertainment allowance, which the 1961 Act let some deduct, now has no deduction:

• The standard deduction is one deduction for the head, however many employers there are; pensioners get it too.
• Professional tax the employer pays for the employee is first added as a perquisite (s. 17(1)(f)) and then deducted.
• The deductions for gratuity, commuted pension, leave salary, retrenchment and voluntary retirement compensation apply in both regimes: s. 202(2) does not withdraw them.

1. Settle the regime: the default regime applies unless the employee opts out (U5).
2. Take each item for the months it fell due, or was received earlier.
3. Show only the taxable part of each partly exempt item. The 2025 Act gives the retirement reliefs as deductions in s. 19(1); showing the net figure gives the same income.
4. The total is gross salary; subtract the standard deduction and, in the old regime, professional tax.

The annual value of a building, with any land attached to it, is charged in the hands of its owner (s. 20(1)). Three conditions:

1. Building or land appurtenant to it. Bare land is not house property; rent from it falls under other sources.
2. Ownership. The charge falls on the owner, not on the occupier. A tenant who sublets is not the owner, so his income from subletting is not house property income.
3. Not used for his own business. A part the owner occupies for his own business or profession, whose profits are chargeable to tax, is left out (s. 20(2)).

Rent from letting a residential house is always taxed here, never as business income of its owner (s. 26(4)). Some income from buildings is kept out of this head's tax: income from a farm building that meets the tests of s. 2(5)(c) is agricultural income, which is exempt (Schedule II, Sl. No. 1), and a registered political party's house property income is exempt on the conditions of Schedule VIII, Sl. No. 1. The annual value of one palace occupied by a former Ruler, exempt under s. 10(19A) of the 1961 Act, stays exempt on that clause's conditions (Schedule III, Sl. No. 39).

Deemed owners (s. 25). Each of these is treated as the owner:

• an individual who transfers a property without adequate consideration to a minor child (not a married daughter) or to his spouse (not under an agreement to live apart);
• the holder of an impartible estate, for every property in it;
• a member of a co-operative society, company or association to whom a building is allotted or leased under its house-building scheme;
• a person allowed to take or keep possession of a building in part performance of a contract under section 53A of the Transfer of Property Act, 1882;
• a person who acquires rights in a building by a sale, exchange or lease of at least twelve years, or by any arrangement (such as buying shares in a society) that gives him the enjoyment of it; a lease from month to month, or for a year or less, does not count.

Composite rent. Where a building is let together with machinery, plant or furniture:

• if the two lettings cannot be separated, the whole income is income from other sources, unless it is business income (s. 92(2)(g));
• if they can, the rent for the building is taxed here and the hire of the machinery, plant or furniture falls under other sources, unless it is business income (s. 92(2)(f)).

Where the rent also pays for services (a lift, security, power), the part for the building is house property income and the part for the services is not.

The annual value is the higher of (s. 21(1)):

• the expected rent, the rent the house could reasonably fetch from year to year: the higher of the municipal value (the local authority's valuation for its taxes) and the fair rent (what similar houses nearby fetch), but not more than the standard rent where a rent control law fixes one; and
• the actual rent received or receivable for the period it is let.

Two rules shape the actual rent:

1. Unrealised rent is left out, on conditions the rules set (s. 21(4)). The conditions laid down so far, in rule 4 made under the 1961 Act, are that the tenancy is genuine; the defaulting tenant has left, or steps have been taken to evict him; he occupies no other property of the owner; and the owner has taken all reasonable steps to recover the rent, legal action included, or satisfies the Assessing Officer that legal action would be useless.
2. Vacancy. If the house was let but lay vacant for part or all of the year, and the actual rent falls below the expected rent because of that vacancy, the actual rent is the annual value (s. 21(2)). To test it, work out the rent for the full year, less unrealised rent: if that reaches the expected rent, the shortfall is due to vacancy.

From the gross figure deduct the municipal taxes, service taxes included, that a local authority levies on the house and the owner pays during the year, whatever year they relate to (s. 21(3)). The result is the net annual value, on which the 30% is worked out.

A house, or part of one, has a nil annual value if the owner lives in it, or cannot actually live in it for any reason (s. 21(6)). Two limits (s. 21(7)):

• only two houses get the nil value, and the owner specifies which;
• the nil value is lost for a house, or the part of it, let at any time in the year, or from which he gets any other benefit.

With a nil value there is nothing to take municipal taxes or the 30% from; only interest remains, within the ceiling of sub-topic 4, so the result is usually a loss.

Part let, part lived in. Treat the let part as a let-out house and give the part the owner lives in a nil value, dividing the municipal value, fair rent, taxes and interest between the parts.

A deemed let-out house is a third or further house the owner keeps for himself. It is valued at its expected rent, as if let (s. 21(1)(a)), and its municipal taxes, the 30% and its full interest come off, with no ceiling.

Choosing the two. Work out the total for each possible choice (the deemed let-out house's income less the interest allowed on the other two) and take the lowest. With no loans, the house with the lowest net annual value is the one to treat as let out.

Unsold houses of a builder. A house held as stock-in-trade and not let at any time in the year has a nil annual value up to two years from the end of the financial year in which its completion certificate is obtained (s. 21(5), as amended by Finance Act, 2026, section 37).

Only the 30% and interest, current and pre-construction, come off the net annual value (s. 22(1)(a)-(c)); repairs, insurance, ground rent and collection charges are not deducted separately.

1. Standard deduction: 30% of the net annual value, however much or little is spent (s. 22(1)(a)). It is nil for a house with a nil value.
2. Interest on borrowed capital (s. 22(1)(b)): interest payable for the year, paid or not, on money borrowed from any lender to buy, build, repair, renew or rebuild the house, including interest on a new loan taken to repay the first. Interest includes a service fee or other charge for the loan (s. 2(59)). Repayment of principal is not deducted here; in the old regime it may count for s. 123 (Schedule XV, para 3).

Pre-construction interest (s. 22(1)(c)). Interest for the period from the date of borrowing to 31 March before the tax year of purchase or completion is not deducted as it accrues. Reduce it by any part already allowed under another provision (s. 22(3)), then deduct it in five equal yearly instalments, starting with the year of purchase or completion.

Ceiling for self-occupied houses (s. 22(2), (4), (5)). For the houses of s. 21(6), current interest and the pre-construction instalment together (Finance Act, 2026, section 38) may not exceed:

• ₹2,00,000 if the money was borrowed to buy or build the house, the purchase or construction is finished within five years from the end of the tax year of borrowing, and the owner furnishes the lender's certificate of the interest payable on the loan and on any new loan that repaid it;
• ₹30,000 in any other case, such as a loan for repairs, renewal or rebuilding, a completion after five years, or no certificate.

The ₹2,00,000 is one limit for both self-occupied houses together. A let-out or deemed let-out house has no ceiling.

Interest payable outside India gets no deduction at all where no tax has been paid or deducted at source on it and no agent in India answers for it (s. 22(6)). This holds in both regimes.

Default regime. The current-interest deduction is withdrawn for the houses of s. 21(6) (s. 202(2)(a)(v)). Read as written, the clause leaves the pre-construction instalment on such a house, within the ceiling. On a let-out house both deductions stay in full.

Arrears of rent received from a tenant, and unrealised rent recovered later, are income from house property of the year of receipt (s. 23(1)), even if the assessee no longer owns the house (s. 23(2)). A flat 30% of the amount is deducted (s. 23(3)), and nothing else: no municipal taxes and no interest.

Co-owners whose shares are definite and ascertainable are not assessed as an association of persons. Each co-owner's share of the income is computed separately under these rules and included in his own total income (s. 24(1)). Each gets the nil value for a house he occupies, as if he alone were entitled to it (s. 24(2)), and applies the interest ceiling to his own share of the interest.

Add any arrears or unrealised rent recovered, less 30%, and total the houses.

A loss under this head can reduce income under other heads by up to ₹2,00,000 in the year (s. 109(1)(b)); the rest is carried forward for up to eight tax years, against house property income only (s. 110). In the default regime it cannot be set off against any other head and is not carried forward (s. 202(2)(b)(ii), (3)).