Understanding Salary Arrears and Tax Relief Under Section 89(1)

Understanding Salary Arrears and Tax Relief Under Section 89(1)

Salary arrears refer to compensation earned in a prior financial year but paid in the current year. These payments may result from retroactive salary increases, delays in payment disbursement, or unresolved financial dues. Since salary arrears are taxed in the year they are received, they can potentially elevate an individual into a higher tax bracket. To alleviate this financial pressure, the Income Tax Act, 1961 provides relief under Section 89(1).

This comprehensive guide will delve into the taxation of salary arrears, explore the relief available under Section 89(1), demonstrate the claiming process using Form 10E, and outline any updates for the Assessment Year 2024–25.

What Are Salary Arrears?

Salary arrears are payments associated with prior periods that are received in a subsequent financial year. Typical scenarios include:

• Retroactive pay raises
• Delays in salary settlements
• Unpaid dues from previous employment years
• Salary amounts finalized after the fact

Taxation of Arrears: Section 15(c) of the Income Tax Act, 1961

According to Section 15(c) of the Income Tax Act, 1961, any salary arrears received must be taxed in the year they are received, rather than the year to which they pertain, provided they have not been taxed previously. Therefore, income attributable to earlier years will be incorporated into the total income of the current year, thus subjecting it to relevant taxation.

Relief Under Section 89(1)

To address the increased tax liability due to lump-sum arrears, Section 89(1) provides relief, applicable to:

• Salary received in arrears or in advance
• Arrears of family pension
• Gratuity
• Commuted pension
• Termination compensation
• Early withdrawal from provident funds

This relief mechanism ensures that taxpayers are not adversely affected by the timing of payment relative to the income earned.

How to Calculate Relief Under Section 89(1)

To compute the tax relief available under Section 89(1), follow these steps:

1. Calculate the total tax on income (including arrears) for the year of receipt.
2. Calculate the tax on total income (excluding arrears) for the same year.
3. Determine the difference between the totals from steps 1 and 2.
4. Calculate total tax (including arrears) for the financial years relevant to the arrears.
5. Calculate total tax (excluding arrears) for those earlier years.
6. Determine the difference from steps 4 and 5.
7. Calculate Relief = Step 3 – Step 6.

If the tax difference in Step 3 is less than the difference in Step 6, no relief will be available. Note that these calculations should be repeated if the arrears span multiple previous financial years.

Filing Form 10E for Claiming Relief

To secure relief under Section 89(1), it is essential to file Form 10E before submitting your Income Tax Return (ITR). This form must be completed and submitted via the Income Tax e-filing portal using the taxpayer’s credentials.

Sample Relief Calculation

Here is an illustrative example of the relief computation:

Step 1: Tax Including Arrears for AY 2023–24

• Salary: ₹10,00,000
• Arrears: ₹5,00,000
• Total Income: ₹15,00,000
• Tax: ₹2,80,000
• Cess @ 4%: ₹11,200
• Total Tax: ₹2,91,200

Step 2: Tax Excluding Arrears

• Salary: ₹10,00,000
• Tax: ₹1,50,000
• Cess @ 4%: ₹6,000
• Total Tax: ₹1,56,000

Step 3: Difference for AY 2023–24

₹2,91,200 – ₹1,56,000 = ₹1,35,200

Step 4: Tax Including Arrears for Prior Years

• AY 2018–19: ₹9,00,000 → Tax: ₹1,20,000
• AY 2019–20: ₹9,50,000 → Tax: ₹1,25,000
• AY 2020–21: ₹10,00,000 → Tax: ₹1,30,000
• Total: ₹3,75,000

Step 5: Tax Excluding Arrears for Prior Years

• AY 2018–19: ₹8,00,000 → Tax: ₹90,000
• AY 2019–20: ₹8,50,000 → Tax: ₹98,000
• AY 2020–21: ₹9,00,000 → Tax: ₹1,10,000
• Total: ₹2,98,000

Step 6: Difference for Previous Years

₹3,75,000 – ₹2,98,000 = ₹77,000

Step 7: Relief Calculation

₹1,35,200 – ₹77,000 = ₹58,200

Final Tax Payable After Relief

• Original Tax: ₹2,91,200
• Less Relief: ₹58,200
• Net Tax Payable: ₹2,33,000

Applicability Under the New Tax Regime

Relief under Section 89(1) applies to both the old and new tax regimes, effective for the Financial Year 2023–24 and onward.

Updates to Form 10E and Annexures (As of 2024)

To enhance clarity and accuracy, Form 10E has undergone the following changes:

Annexure I

• Breaks down arrears by financial year
• Requires the employer’s PAN

Annexure IIA

• Mandatory for claiming gratuity relief
• Requires submission of Form 16E for service periods exceeding 15 years

Digitized Process and Validation

The income tax portal now features:

• Pre-filled Form 10E with auto-populated arrear details
• Real-time verification of employee PAN and employer TAN during filing

These improvements aim to minimize errors and streamline the filing process.

Interest on Delayed Processing

If relief under Section 89(1) is processed more than three months after ITR submission, the Income Tax Department will credit interest at the rate of 6% per annum on the delayed relief amount.

Conclusion

Grasping the taxation of salary arrears is vital for effective tax planning. Section 89(1) offers significant relief for employees encountering delayed payments, ensuring they are not unduly penalized due to the timing of income receipt. By accurately and timely filing Form 10E, taxpayers can legally mitigate their tax liabilities while adhering to income tax regulations.

For optimal outcomes, individuals should maintain thorough documentation, ensure precise relief calculations, and stay informed about updates to the income tax portal and revisions to relevant forms.