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ANALYSIS OF DEDUCTION UNDER INCOME TAX

Karan Sharma

A043

Abstract

Income Tax is a compulsory obligation which is levied on every citizen, based on their
paying capacity, age, and gender. In order to provide relief to the assessee from payment of
taxes, the tax law has certain provisions for deduction and exemptions, which decreases the
overall tax liability. In deduction, the amount is first included in the income of the taxpayer
and then the deduction is allowed as per the rules. It forms part of gross total income (GTI)
but any person can avail its benefit by satisfying certain conditions mentioned in the Act. On
the other hand, an exemption is the income which is not charged to tax. The exemption is not
a part of gross total income. One of the example of exemption is agricultural income which
does not form part of gross total income. In this paper the author tries to exhibit the basic
concepts and difference between exemption and deduction. The author also analyse the
different sections related to deduction in salary which are available to employee.

Key words: Income, salary, exemption, deduction, gross total income, employer, employee,
allowance.

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CHAPTER - 1

INTRODUCTION

The Central Government has been empowered by entry 82 of the Union list of schedule VII
of the Constitution of India to levy tax on all income other than agricultural income. The
Income Tax Law comprises The Income Tax Act 1961, Income Tax Rules 1962,
Notifications and Circulars issued by Central Board of Direct Taxes (CBDT), Annual
Finance Acts and Judicial pronouncements by Supreme Court and High Courts. The
government imposes a tax on taxable income of all persons who are individuals, Hindu
Undivided Families (HUFs), companies, firms, association of persons, body of individuals,
local authority and any other artificial judicial person. Levy of tax is separate on each of the
persons. The levy is governed by the Indian Income Tax Act, 1961. The Indian Income Tax
Department is governed by CBDT and is part of the Department of Revenue under the
Ministry of Finance, Govt. of India. Income tax is a key source of funds that the government
uses to fund its activities and serve the public.
In the present paper an attempt has been made to study the basic concepts of taxation and
deduction provided by government in salary to reduce the burden.
The author chooses this topic because income tax is one of the major sources of income for
the government and liability for citizens. The government provide various exemptions and
deductions as to lower down the burden. Income tax deductions offer a gamut of
opportunities for saving tax for the salaried class. As a taxpayer, it is important to study and
analyse the deduction and make the reader aware about the provisions so that one can save
tax on his income. In this paper, the researcher has divided the project into four chapters. The
first chapter outlines the basic concepts required to be understand deduction; second chapter
analyze the deduction in salary income; third chapter deals with comparative study followed
by a conclusion.
DEDUCTION

Chapter-VI A of the Income Tax Act, 1961 deals with deductions. Deduction means the
amount that will be subtracted from the gross amount. As per Income Tax Act, deductions are
the payments or investments made by the assessee through which a specific amount or
percentage is reduced from their gross total income to arrive at total taxable income. If GTI is
nil, then no deduction is allowable, or the amount of deduction cannot exceed GTI i.e.
deduction is allowable only to the extent of gross total income.

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These are allowed to the taxpayer only if he claims deductions for the investments he has
made in particular instruments. In this way, such an income form part of the gross total
income of the taxpayer and then the deductions are allowed to arrive at total income.

PERSON

According to S. 2 (31), the income of the following persons is assessed:

1) Individual; it includes a male, female, minor child and a lunatic;

2) Hindu Undivided Family (HUF);

3) Company;

4) Firm;

5) Association of Persons or Body of Persons, whether incorporated or not.;

6) Local authorities;

7) Every Artificial Juridical persons not falling within any of the above categories.

INCOME-

In order to tax the income of a person the term itself is designed under the Income Tax Act.
As per the Act the term Income includes:

 Profits and gains of Business or Profession: This includes income from carrying on a
business or income earned by doing any profession.
 Dividend:
 Profit in lieu of Salary, perqusite: This includes any amount received by an employee
from his employer other then the salary amount.
 Allowances granted to the assesse to meet his expenses incurred for performance of
his duties: This includes allowances such as HRA, Medical allowance, etc given by an
employer to his employee.
 Any capital gains: This means any profit dericed on sale of any capital asset.
 Winning from lotteries, crossword puzzles, races, card game, T.V. Show, etc.
 Any sum received for fund created for welfare of employees.

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The definition of income says that it can be received in cash or in kind. More over the Income
Tax Act does not make distinction between legal source of income and illegal source of
income. This means that gambling, smuggling income is also chargeable to tax under the
Income Tax act. More over gifts of personal nature for eg. birthday/ marriage gifts are not
treated as income.

Heads of Income:
In the Income Tax any income earned by a person is broadly categorised into five heads of
income. Any income earned to be taxed must come under any of the five heads of income.
The five heads of income are:
1. Income under Head Salaries: This head taxes the income earned by an individual as
salary from any firm or organisation.
2. Income from House Property: This head taxes rental income received by any person
from way of renting of any immoveable property.
3. Profits and Gains of Business or Profession: This head of income broadly covers income
earned by a person as a result of some business or professional set‑up by him.
4. Capital Gains: This head of income taxes the income earned on sale of any investment in
form of gold, precious ornaments, shares, etc or immoveable property.
5. Income from other Sources: This head of income covers any income which is not
chargeable to tax under any of the above heads of income. Any income including gambling or
profit/loss on running of race horses, camels, interest income, etc are chargeable to tax under
this head of income.

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CHAPTER - 2

CURRENT POSITION AS PER STATUTE

The scope of the word “Salaries” under the Income tax Act is very wide. It comprehends
every payment, due or received, by an employee from an employer or former employer on
account of services rendered. Every non-monetary benefits and perquisites are valued in
accordance with specified rules and assessed to tax. Any income from salary is taxed either
on due basis or on receipt basis, whichever is earlier. Even the arrears of salary, if not taxed
in relevant earlier years, will be assessed in the previous year in which they are received.
Similarly, where salary is received in advance, it will be taxed in the previous year of receipt
and not in the previous year in which it will accrue to the employee. However, such salary
received in advance will not be taxed again when it will accrue to the employee to avoid
double taxation of the same income. However, relief has been provided to mitigate any
increased tax liability that may result due to charge on salary on receipt basis.

Salary income of an employee is to be computed in accordance with the provisions laid down
in sections 15, 16 and 17. Section 16 gives deductions to be allowed out of incomes taxable
under this head. Section 17(1) defines the word ‘salary’ as mentioned in section 15. Section
17(2) and 17(3) further define the terms perquisites and profits in lieu of salary.

According to Section 17(1) salary includes the following amounts received by an employee
from his employer, during the previous year

1. Wages;

2. any annuity or pension; (Family pension received by heirs of an employee is taxable

under income from other sources);

3. any gratuity;

4. any fees, commission, perquisites or profits in lieu of or in addition to any salary or

wages;

5. any advance of salary;

6. any payment received by an employee in respect of any period of leave not availed of
by him; (Leave encashment or salary in lieu of leave);

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7. the portion of annual accretion in any previous year to the balance at the credit of an
employee participating in a recognised provident fund to the extent it is taxable

8. transferred balance in a recognised provident fund to the extent it is taxable

9. the contribution made by the Central Government in the previous year, to the account
of an employee under a pension scheme referred to in Section 8OCCD.

CONDITION FOR CHARGEABILITY OF SALARY: RELATIONSHIP OF

EMPLOYER AND EMPLOYEE IS ESSENTIAL:

The touchstone of chargeability of an amount as salary is the relationship of an employer

employee between the person making the payment and the person receiving such payment. It
is a cardinal principal that any amount chargeable to tax under the head salaries must come to
the assessee only from or on behalf of his employer or former employer and that too only
account of employment or services rendered by him to the employer and not by virtue of
personal considerations.

Salary is a payment for services rendered. There must be a master at whose command
services are rendered, and a servant who renders the services. Only those payments can be
charged as salaries which are paid or due to the employee for services rendered. Payments
made by an employer on account of personal consideration cannot be taxed as salaries.1

Employer may be any entity, eg. A local authority, or a company, or any other public body or
association, or central or state government, or foreign government or any other private
employer like a firm, HUF, AOP, company or even an individual.

EMPLOYMENT IS DISTINCT FROM PROFESSION

If employment is merely incidental to the exercise of a profession, the gains from such
employment are not chargeable to tax under the head, “salaries”. 2 For example, movie artists
sign short term contracts for acting in movies. Such an engagement cannot be considered as
an employment, but it is merely an engagement in the course of exercising a profession. The
position is different when a professional permanently accepts an employment and exchanges
his profession for service. The remuneration in that case is chargeable to tax under the head
salaries.

1
Behram A Palkhivala, The law and practice of Income Tax , 601-602 (LexisNexis ,10th ed.)
2
Behram A Palkhivala, The law and practice of Income Tax , 604 (LexisNexis ,10th ed.)

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SALARY AND WAGES

Conceptually, there is no difference between salary and wages. Both are compensation for
work done or services rendered, though ordinarily salary is paid in connection with services
of non manual type of work, while wages are paid in connection with manual services.3

THE RELATIONSHIP OF THE PRINCIPAL AND THE AGENT MAY OR MAY

NOT BE OF AN EMPLOYER AND EMPLOYEE:

If agent has to work under the direct control and supervision of the principal and has no
discretion of his own in the performance of his duties, he is deemed to be an employee and
the remuneration payable to him in such a case is chargeable to tax under the head salaries.
On the other hand, if the principal exercises only a supervisory control in respect of work
entrusted to the agent and the agent has wide discretion of his own in the execution of the
policies of the principal, the presumption is that the agent is not employee. The remuneration
payable to the agent in such a case is liable to be taxed under the head, “profits and gains of
business of profession”. However, no firm rule can be laid down in this regard and each case
must be evaluated on its own facts and merits.

STANDARD DEDUCTION

A standard deduction is a flat amount that applies to all qualified taxpayers. An itemized
deduction requires calculations, proof of a qualifying expense, and time to fill out extra forms
at tax time. It is the portion of income that is not subject to tax and that can be used to reduce
a taxpayer's tax bill.

The Finance Minister, in Budget 2018, has reintroduced the standard deduction of Rs 40,000.
The provision of standard deduction was earlier available but was abolished in the Finance
Act 2005. It is also proposed that this deduction would replace the existing transport
allowance of Rs 1600 per month and medical allowance of Rs 15,000 per annum. They are
usually deducted from the gross salary and claimed as an exemption.4

Taxpayer, who receives pension from his former employer, is also eligible to claim this
deduction. The pension received by a taxpayer from his former employer is taxable under the
head ‘Salaries’. Accordingly, any taxpayer who is in receipt of pension from his former

3
Gestetner Duplicators (P) Ltd. v. CIT [1979] 117 ITR 1 (SC)
4
Budget 2018 gives Rs 40,000 standard deduction, removes other allowances: Salaried may be left poorer, Feb
24, 2018, https://economictimes.indiatimes.com/wealth/tax/budget-2018-gives-rs-40000-standard-deduction-
removes-other-allowances-salaried-may-be-left-poorer/articleshow/62458566.cms ( Accessed on Aug 14, 2018)

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employer shall be entitled to claim a deduction of Rs. 40,000 or the amount of pension,
whichever is less, under Section 16 of the Act.5

SECTION-16(ii): ENTERTAINMENT ALLOWANCE TO GOVERNMENT

EMPLOYEES

Some employees are required to incur expenditure on the entertainment (tea etc.) of
customers, clients etc. who come to meet them in connection with their official or business
work. In case employee is given a fixed amount every month to meet this type of expenditure
then it is fully added in salary and out of Gross Total Salary, a deduction under section 16
shall be allowed only to govt. employees. This means that in case this allowance is given to
employees working in private sector, it is fully taxable.

But in case any amount is reimbursed against any expenditure incurred by employee, it shall
be fully exempted.

Deduction under section 16(ii) admissible to govt. employees shall be an amount equal to
least of following:

1. Statutory Limit of Rs. 5,000 (maximum).

2. 1/5th of Basic Salary.
3. Actual amount of entertainment allowance received during the previous year.

Where the employee is in receipt of entertainment allowance, the amount so received shall
first be included in the salary income and thereafter the following deduction shall be made .

A deduction in respect of any allowance in the nature of an entertainment allowance

specifically granted by an employer to the assessee who is in receipt of a salary from the
Government, a sum equal to onefifth of his salary (exclusive of any allowance, benefit or
other perquisite) or five thousand rupees, whichever is less. Entertainment allowance is
allowed in computing income from salary only in case of employees of the government and

5
CBDT amends Section 16 of Income Tax Act, Apr 05, 2018, http://www.freepressjournal.in/business/cbdt-
amends-section-16-of-income-tax-act/1251149 ( Accessed on Aug 14, 2018)

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will cease to be allowable for persons other than those employed in government i.e.
entertainment allowance deduction will not be allowed to other employees.6

Where an employee, not entitled to claim deduction under this clause, spends some money on
the entertainment of customers of the concern, the amount so spent cannot be deducted from
the salary income. No deduction on account of entertainment allowance is available to non-
government employees.

Case Study:

1. Mr. M is an employee of Gujarat government gets Rs. 1, 20,000/- as basic pay. He is

also getting the entertainment allowance for Rs.15, 000/-, Rs. 10,000/- as DA and Rs.
15,000/- as house rent allowance.
Gross salary would be: Rs. 1, 60,000 (1,20,000+15,000+10,000+15,000).

Basic pay is only considered for computing salary for entertainment allowance. Rs.
1,20,000/- is the basic pay which is to be considered for entertainment allowance.
On computing the entertainment allowance the least of the following three is
exempted from tax.
 The maximum limit of 5,000/- is considered for computation of entertainment
allowance.
 The 20% of salary i.e.20%*1,20,000 = 24,000 is considered for computation
of entertainment allowance.
 The actual entertainment allowance of Rs.15000 is considered for computation
of entertainment allowance.

The exempted EA u/s 16(ii) is Rs. 5000/- which is to be deducted from gross salary that
includes entertainment allowance also. Hence, taxable salary will be Rs. 1, 55,000/-. (Rs. 1,
60,000-Rs. 5,000/-).

2. Mr. N is an employee of X ltd., gets Rs. 1, 80,000/- as basic pay. He is getting the
entertainment allowance for Rs. 25,000/-, Rs. 20,000/- as DA and Rs. 5000/- as High
cost of living allowance.
Gross salary would be: Rs. 2, 30,000 (1, 80,000+25,000+20,000+5,000).

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Entertainment Allowance to Government Employees, April 2017,
http://incometaxmanagement.com/Pages/Tax-Ready-Reckoner/GTI/Salary/52-Entertainment-Allowance-to-
Government-Employees-U-s-16(ii).html ( Accessed on Aug 15, 2018)

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As X is a private employee, the entire entertainment allowance Rs. 20,000/- is

taxable. Nothing is exempted from tax. Hence, taxable salary will be Rs. 2, 30,000/-.

SECTION 16 (C) TAX ON EMPLOYMENT OR PROFESSIONAL TAX:

Profession Tax is a tax which is levied by the state on the income earned by way of
profession, trade calling or employment. This tax is levied based on slab rates depending on
the income of the individual. This slab rate is decided by the state government; hence, it
varies from state to state. Any amount paid as Profession Tax to the state government is
allowed as a deduction under Section 16 of the Income Tax Act.

From the assessment year 1990-91, deduction is allowed in respect of any sum paid by the
assessee on account of a tax on employment within the meaning of clause (2) of article 276 of
the constitution, leviable by a State under any law passed by its legislature.

Where professional or employment tax is paid by the employer on behalf of the employee, it
will first be included in his gross salary as a perquisite, being a monetary obligation of the
employee discharged by the employer. Thereafter, a deduction on account of such
professional tax shall be allowed to the employee from his gross salary.

There is no monetary ceiling under Income Tax Act but as per Article 276 of the
Constitution, a state government cannot impose more than Rs. 2500 per annum as
professional tax. Under the Income Tax Act, whatever professional tax is paid during the
previous year is deductible. Suppose X, posted in Hyderabad, is required to pay Rs. 2000
every year as professional tax. On May 31 2017, he pays Rs. 4000 on account of professional
tax i.e. Rs. 2000 for the year 2016-17 and Rs. 2000 for the year 2017-18. In this case, Rs.
4000 is deductible for the previous year 2017-18. It is incorrect to state that in such a case
only Rs. 2500 is deductible.

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CHAPTER - 3

CASE LAWS IN INDIA

In Major LHG conville of convillepur vs. CIT Punjab, NWF and Delhi province,
Lahore7

“Salary signifies a recompense given to any man for his pains bestowed upon another man’s
business “. Where a father and son are joint owners of agricultural property and son gets
certain allowances for managing the property besides his share of the income from the
property. Only the surplus allowance can be taxed as his salary, his share of the income is to
be treated as agricultural.

In Amar Dye Chemicals Ltd and another vs. Union of India and others 8

In this case it was tested, whether a managing director of company is servant or agent. In
present case assessee was appointed as managing director to manage business of company in
terms of and within powers prescribed in articles of association and under terms of agreement
and he could be removed for not discharging work diligently or not acting in interest of
company . Assessee held as servant and not agent of company. Remuneration payable to
assessee would be salary.

In CIT, UP, CP and Berar, Lucknow vs. ID Varshani 9

In this case the assessee was called a Managing Agent but the powers conferred upon him
under the Articles were more in the nature of powers given to a servant and those powers
could be terminated, he was admitted to the benefits of the Company’s Provident Fund as
being an employee of the company and value of rent-free quarters occupied by him was
added as income under the head ‘salary’. It was held that the assessee was in fact the Chief
Manager of the Company and his remuneration was properly assessed as salary.

In T.K. Ginarajan vs. Commissioner of Income Tax10

In this case it was held that there is no dispute that the incentive bonus paid to the employee
by the employer is nothing but salary and there cannot be any dispute either since such

7
AIR 1935 Lah 978
8
AIR 1974 SC 636
9
AIR 1974 SC 636
10
(2013) 9 SCC 270

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payment are covered by the exhaustive definition of ‘salary’ under section 17(1) of the
Income Tax Act, 1961.

In ITC Limited, Gurgaon vs. CIT11

In this case court held that tips received from customers by employees being waiters, etc. in a
hotel/restaurant cannot be considered as ‘salary paid or allowed’ to them under section 15(b).

As per section 15(b), any salary that is paid or allowed to an employee by or on behalf of an
employer or former employer though not due, or before it becomes due, alone becomes
taxable. There should be vested right in an employee to claim any salary from an employer or
former employer. In the present case, there was no vested right in the employee to claim any
amount of tip from his employer and since tips are purely voluntary.

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2016 6 SCC 652

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CHAPTER - 4

COMPARATIVE STUDY

Both the terms ‘tax deduction’ and ‘tax exemption’ refer to a lowering of taxable income;
they are forms of tax relief or tax breaks provided by the government. However, tax
exemptions may also include complete relief from taxes, reduced rates and tax on only a
portion of income. Tax exemption means you don’t have to pay tax for a particular income.
E.g. a person may get a tax exemption for donating to charitable institutions and various
relief funds.

In order to encourage investments, the government generally offers tax exempt entities to
invest in. Such entities are exempted from a single or multiple taxation laws. For example,
investments in the Sukanya Samriddhi Scheme are fully tax exempt. Money deposited under
this scheme will be exempted from tax at the time of investment, accumulation of interest and
payout of returns.

In case of tax deduction, income tax liabilities decrease by a specified amount for spending
money in particular avenues. Investment in various schemes helps to reduce taxable income.
For example, a person can get tax deduction by paying life insurance premiums and home
loan EMI. Tax deductions are offered by government to tempt taxpayers to participate in
programs carrying societal benefits.

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CHAPTER - 4

CONCLUSION

India is a developing country. To make it a developed government require funds and in order
to generate funds government levy taxes. Government also levy taxes so as to spread equality
of income in the country. More the person earns more he has to pay tax.

In India two type of tax system prevails: Direct Taxation and Indirect Taxation.

Under the system of Indirect taxation one person collects from many people and pays it to
government, excise duty, service tax, sales tax are very common examples of indirect
taxation. Under the system of Direct Taxation tax is levied directly on the person who has to
pay it more commonly said as Income Tax.

We have seen that there are various deductions available to an individual under the Income
Tax Act, 1961. Deduction is mainly used by the government to promote savings to increase
investments in certain areas, for which the income of the assessee is reduced to that extent.
Likewise, exemptions are used to help the weaker sections of the society to grow and prosper.
By providing exemptions, the government is trying to give an equal opportunity to boost that
segment. These should not exceed the gross total income and for claiming each a set of
conditions need to be fulfilled. The law is pretty clear on deductions and there is not much
scope for interpretation. Usually the widest possible scope is given to the sections concerned
with disability as these are related with social welfare.

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BIBLIOGRAPHY

BOOKS

 Vinod K Singhania Kapil Singhania, Direct Taxes Law & Practice, (60th ed. June
2018)
 T.N. Nanoharan & G.R. Hari, Direct tax laws & international taxation, Snow white
(June 2018).
 Behram A Palkhivala, The law and practice of Income Tax , LexisNexis (10th ed.)

WEBLINKS

 https://indiantaxguide.wordpress.com/page/3/
 https://www.incometaxindia.gov.in/Charts%20%20Tables/Deductions.htm
 https://economictimes.indiatimes.com/wealth/tax/budget-2018-gives-rs-40000-
standard-deduction-removes-other-allowances-salaried-may-be-left-
poorer/articleshow/62458566.cms
 http://www.freepressjournal.in/business/cbdt-amends-section-16-of-income-tax-
act/1251149
 http://incometaxmanagement.com/Pages/Tax-Ready-Reckoner/GTI/Salary/52-
Entertainment-Allowance-to-Government-Employees-U-s-16(ii).html
 www.investopedia.com

LAW DATABASE

 LexisNexis
 Manupatra
 SCC Online

CASE LIST

 Gestetner Duplicators (P) Ltd. v. CIT

 Major LHG conville of convillepur vs. CIT Punjab, NWF and Delhi province, Lahore
 Amar Dye Chemicals Ltd and another vs. Union of India and others
 CIT, UP, CP and Berar, Lucknow vs. ID Varshani
 T.K. Ginarajan vs. Commissioner of Income Tax
 ITC Limited, Gurgaon Vs. CIT

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