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Rule 2BB of the Income Tax Rules specifies the allowances paid to employees which are not taxable. One of the allowances which is exempt from tax is what is commonly called Uniform Allowance.

Rule 2BB exempts from income tax:

any allowance granted to meet the expenditure incurred on the purchase or maintenance of uniform for wear during the performance of the duties of an office or employment of profit.

Recently, a payroll manager known to us wished to introduce a head of pay called Attire Allowance in his organization. A certain sum of money was to be provided to employees under the head for the purpose of buying clothes for office wear. The entire amount paid under the head was to be tax exempt as long as the employees provided proof of expenditure by way of receipts for purchase of clothes. The organization did not enforce uniform clothing for its employees. The payroll manager was of the view that the amount paid under Attire Allowance shall be fully non-taxable. His argument was that the term uniform stated in Rule 2BB can be liberally interpreted as any clothing which is used for office wear, and hence Attire Allowance can be tax exempt.

We are not in agreement with the above view.

Rule 2BB refers to “uniform.” According to the Oxford English Dictionary, the meaning of the word uniform is as follows.

The distinctive clothing worn by members of the same organization or body or by children attending certain schools.

The term distinctive clothing in the above denotes that unless the clothing reflects similar design, colour, etc. it cannot be referred to as uniform. Employees can be said to be wearing uniform only when their outfits are identical and as per the design standard prescribed by the organization. Of course, there can be differences in uniform among certain classes of employees on the basis of, say, seniority or nature of work, within the same organization.

Unless an organization has an explicit policy related to uniform to be worn by employees, any amount paid for the purpose of buying clothes, even if for office wear, shall be fully taxable.

Why should the word uniform be interpreted strictly and not be understood as any formal attire worn at workplace?

Legislative Intent

Rule 2BB presents the allowances for the purposes of clause (14) of section 10 of the Income Tax Act. Section 10, as you may know, specifies the income which are not to be included in Total Income for taxation. Section 10(14) refers to

any such special allowance or benefit, not being in the nature of a perquisite within the meaning of clause (2) of section 17, specifically granted to meet expenses wholly, necessarily and exclusively incurred in the performance of the duties of an office or employment of profit, as may be prescribed, to the extent to which such expenses are actually incurred for that purpose.

According to Section 10(14), the allowance should be granted to meet expenses incurred wholly, necessarily and exclusively for the performance of official duties, for it to be tax exempt. While expenses on uniform can be deemed to be wholly for official purpose, expenses on other clothing, even if formal wear, cannot be said to have been incurred wholly for official purposes. Hence, it is important to interpret the word uniform in Rule 2BB in a strict manner.

Case Laws

The income tax authorities have, on more than one occasion, held that allowances for clothing shall be fully taxable unless the organization has a defined policy for employee uniform.

1. ITA No. 155, 159, 287 & 332 Ahd 2012

The Income Tax Department’s below argument was accepted by the adjudicating authority.

"Appellant's contention that the normal dress worn by its 
employees in office is "uniform" cannot be accepted. 
 
If appellant's interpretation of 'uniform' were to 
be accepted, in every office, any dress worn by the employees'
would qualify as 'uniform'.

There is no doubt that there was no 'uniform' prescribed in 
ONGC during the period under consideration and this fact was
well within the knowledge of appellant.
 
Conclusion drawn by the ACIT(TDS) that additional salary in the
garb of 'uniform allowance' was being paid is therefore, on 
sound footing. Since the payment in question was not towards
purchase or maintenance of "uniform', it cannot be covered under 
Rule 2BB(l)(f) read with section 10(14)(i)."

2. ITA Nos. 674 to 676, 856 and 857 Ahd 2011

The adjudicating authority rejected that the head of pay called Office Wear Allowance can be tax exempt in the absence of uniform clothing policy.

"At the time of hearing before us, the ld. Counsel for the assessee
could not establish how the wear-allowance paid to the employees was 
exempt u/s 10(14). During the course of argument before us, he fairly 
admitted that there was no dress code for the employees. Thus, the 
employees were free to wear any dress.

When there was no dress code and the employees were free to wear any 
dress, how the wear-allowance can be said to be granted to meet the 
expenses wholly, necessarily and exclusively in the performance of 
duties of an office."

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In the previous post, we had a look at taxability of fuel expense reimbursement to employees for motor car provided by the employer. What about employee-owned car?

Employee owns the car and the employer reimburses fuel expense to employee
The monthly perquisite value is as follows.

i) The car is used wholly and exclusively for official duties.
When the car is used only for official purpose, the monthly perquisite value for the purpose of taxation is Rs 0. This is irrespective of fuel and other car running and maintenance expense amount reimbursed to an employee. For example, if a company reimburses Rs 1 lakh per month for the purpose of fuel expenses to an employee, the entire Rs 1 lakh shall be tax free as long as the car is used solely for official purposes.

Please note that the following conditions should be met for the reimbursement to be tax free.

–	the employer should maintain complete details of journey undertaken for official purpose including date of journey, destination, mileage, and the amount of expenditure incurred.
–	the employer should issue a certificate to the effect that the expenditure was incurred wholly and exclusively for the performance of official duties.

From the above, it should be clear that the fuel expense reimbursement shall be fully non-taxable only if the car is wholly used for official purposes and the organization maintains details of journeys undertaken by the employee.

ii) The car is used partly for official purposes and partly for personal purposes of the employee.
When the car is used for both official and personal purposes, the monthly perquisite value for the purpose of taxation is as follows.

Running expenses	Car engine cubic capacity does not exceed 1.6 litres	Car engine cubic capacity exceeds 1.6 litres
The expenses for maintenance and running are fully met or reimbursed by the employer.	Actual amount incurred by the employer minus Rs 1,800 (plus Rs 900, if chauffeur is also provided to run the motor car), per month.	Actual amount incurred by the employer minus Rs 2,400 (plus Rs 900, if chauffeur is also provided to run the motor car), per month.

Can an employee claim a benefit of more than Rs 1,800/Rs 2,400 per month specified in the above table?

If the car is used for both official and personal purposes, there is no need for the employer to maintain details of journeys made. But please note that the benefit shall only be to the extent of Rs 1,800 (plus Rs 900 with chauffeur) if the engine capacity is less than or equal to 1.6 litres and Rs 2,400 (plus Rs 900 with chauffeur) if the engine capacity is greater than 1.6 litres. If an employer spends more than Rs 1,800/Rs 2,400 per month on official journeys, the benefit can be increased to the actual amount spent as long as the employer maintains complete details of journey undertaken for official purpose and issues a certificate to the effect.

Note:

1. Please note that Rule 3 of the Income Tax Rules specifies perquisite amounts for a calendar month and hence it is important that employers record the months for which the perquisite value is applicable, in payroll. Also, employers should receive receipts towards vehicle maintenance expenses in total from employees in case employees seek a reimbursement. For example, if the fuel expense reimbursement of Rs 15,000 is for the month of April, the employer should receive fuel receipts for the entire Rs 15,000 for the month of April.
2. The employer should ascertain that an employee owns a car (by way of checking documents such as the RC book) prior to providing the reimbursement.

Illustration 1
An employee owns a car (with 1.5 litres engine capacity) and his employer reimburses Rs 20,000 per month towards fuel and other car maintenance expenses incurred for both official and personal journeys. The company does not reimburse driver salary and does not maintain records for the official journeys undertaken. What is the monthly perquisite value?

Ans: Since the car’s engine capacity is less than 1.6 litres and the car is used for both official and personal purposes, the perquisite value per month is Rs 20,000 (actual amount incurred towards car running expenses) minus Rs 1,800 = Rs 18,200 per month.

What about taxability of fuel expense reimbursement for employee-owned vehicle which is not a car?

Employee owns a vehicle (say, a motorcycle) other than car and the employer reimburses the fuel expense amount to employee
Rule 3 specifies perquisite valuation for “any other automotive conveyance” (automotive vehicles other than car) as follows. One case presume that the term “other automotive conveyance” refers to vehicles such as motorcycle and autorickshaw. The monthly perquisite value is as follows.

i) The vehicle is used wholly and exclusively for official duties.
When the vehicle is used only for official purpose, the monthly perquisite value for the purpose of taxation is Rs 0. This is irrespective of fuel and other vehicle running and maintenance expense amount reimbursed to an employee. For example, if a company reimburses Rs 1 lakh per month for the purpose of fuel expenses to an employee, the entire Rs 1 lakh shall be tax free as long as the vehicle is used solely for official purposes.

Please note that the following conditions should be met for the reimbursement to be tax free.

–	the employer should maintain complete details of journey undertaken for official purpose including date of journey, destination, mileage, and the amount of expenditure incurred.
–	the employer should issue a certificate to the effect that the expenditure was incurred wholly and exclusively for the performance of official duties.

From the above, it should be clear that the fuel expense reimbursement shall be fully non-taxable only if the vehicle is wholly used for official purposes and the organization maintains details of journeys undertaken by the employee.

ii) The vehicle is used partly for official purposes and partly for personal purposes of the employee.
When the vehicle is used for both official and personal purposes, the monthly perquisite value for the purpose of taxation is as follows.

Running expenses	Perquisite value per month (Rs)
The expenses for maintenance and running are fully met or reimbursed by the employer.	Actual amount incurred by the employer minus Rs 900

Can an employee claim a benefit of more than Rs 900 per month specified in the above table?

If the vehicle is used for both official and personal purposes, there is no need for the employer to maintain details of journeys made. But please note that the tax benefit shall only be to the extent of Rs 900 per month. If an employer spends more than Rs 900 per month on official journeys, the tax benefit can be increased to the actual amount spent as long as the employer maintains complete details of journey undertaken for official purpose and issues a certificate to the effect.

Note:

1. Please note that Rule 3 of the Income Tax Rules specifies perquisite amounts for a calendar month and hence it is important that employers record the months for which the perquisite value is applicable, in payroll. Also, employers should receive receipts towards vehicle maintenance expenses in total from employees in case employees seek a reimbursement. For example, if the fuel expense reimbursement of Rs 15,000 is for the month of April, the employer should receive fuel receipts for the entire Rs 15,000 for the month of April.
2. The employer should ascertain that an employee owns the vehicle (by way of checking documents such as the RC book) prior to providing the reimbursement.

Illustration 2
An employee owns a motorcycle and his employer reimburses Rs 5,000 in the month of April towards fuel and other maintenance expenses incurred for both official and personal journeys. The employer does not maintain records for the official journeys undertaken. What is the perquisite value for April?

Ans: Since the motorcycle is used for both official and personal purposes, the perquisite value for April is Rs 5,000 (actual amount incurred towards motorcycle running expenses) minus Rs 900 = Rs 4,100.

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Organizations use “Fuel Expense Reimbursement” as a pay component for tax saving, particularly for members of middle and senior management. The typical payroll treatment for the head of pay is as follows:

1. Pay a certain sum of money as remuneration under the head each month.
2. Seek petrol/diesel purchase receipts from employees.
3. Provide full tax exemption to the extent receipts are submitted.
4. Tax the amount for which receipts are not submitted.

We find employees getting paid significant sums of money under the head and receiving 100% tax exemption to the extent fuel receipts are submitted.

Payroll managers would do well to note that there is no blanket 100% tax benefit on fuel expense reimbursement. In fact, there is no direct reference to petrol/fuel expense reimbursement in the income tax law. Rule 3 of the Income Tax Rules, which pertains to valuation of perquisites, provides guidelines on how to tax amounts paid to employees for the purpose of meeting “running and maintenance charges” of motor car and other vehicles. The term running and maintenance charges includes expenses incurred on petrol/diesel.

Factors that determine taxability of fuel expense reimbursement for car

According to Rule 3, the following factors determine the extent to which fuel expense reimbursement should be taxed.

1. Car ownership – Provided by the employer or owned by the employee
2. Car usage:
   • For official purposes alone
   • For personal purposes alone
   • Partly for official and partly for personal purposes
3. Cubic capacity of the car engine: Lesser than/equal to or more than 1.6 litres

The monthly perquisite values (the salary amount to be added to the taxable income) for fuel expense reimbursement under different circumstances are as follows.

Employer provides the car and reimburses the fuel expense amount to employee
The car could be owned or hired by the employer and provided to the employee. The car may be used by the employee or any member of the employee’s household. The monthly perquisite value is as follows.

i) The car is used wholly and exclusively for official duties.
When the car is used only for official purpose, the perquisite value for the purpose of taxation is Rs 0. This is irrespective of fuel and other car running and maintenance expense amount reimbursed to an employee. For example, if a company reimburses Rs 1 lakh per month for the purpose of fuel expenses to an employee, the entire Rs 1 lakh shall be tax free as long as the car is used solely for official purposes.

Please note that the following conditions should be met for the reimbursement to be tax free.

–	the employer should maintain complete details of journey undertaken for official purpose including date of journey, destination, mileage, and the amount of expenditure incurred.
–	the employer should issue a certificate to the effect that the expenditure was incurred wholly and exclusively for the performance of official duties.

From the above, it should be clear that the fuel expense reimbursement shall be fully non-taxable only if the car is wholly used for official purposes and the organization maintains details of journeys undertaken by the employee.

ii) The car is used exclusively for personal purposes of the employee or any member of his household.
When the car is used only for personal purpose, the total perquisite value for the purpose of taxation is the following.

Actual amount of expenditure incurred by the employer on the running and maintenance of motor car including driver salary, if any.
plus
Normal wear and tear of the car. The annual normal wear and tear value is calculated as 10% of the actual cost of the car. If the car expense reimbursement is for a period which is less than a year, the wear and tear value should be correspondingly adjusted for the period.
minus
Any amount charged from the employee for use of the car.

In summary, if a car provided by an employer is used entirely for personal purposes of an employee, the total running and maintenance expense incurred/reimbursed by the employer is taxable in the hands of employee.

iii) The car is used partly for official purposes and partly for personal purposes of the employee.
When the car is used for both official and personal purposes, the perquisite value for the purpose of taxation is as follows.

Running expenses	Car engine cubic capacity does not exceed 1.6 litres	Car engine cubic capacity exceeds 1.6 litres
a) The expenses for maintenance and running are fully met or reimbursed by the employer.	Rs 1,800 per month (plus Rs 900, if chauffeur is also provided to run the motor car)	Rs 2,400 per month (plus Rs 900, if chauffeur is also provided to run the motor car)
b) The expenses for running and maintenance for private or personal use are met by the employee. The employer reimburses expenses pertaining to official use.	Rs 600 per month (plus Rs 900, if chauffeur is also provided to run the motor car)	Rs 900 per month (plus Rs 900, if chauffeur is also provided to run the motor car)

Note:

1. If the car is used for both official and personal purposes, there is no need for the employer to maintain details of journeys made. The perquisite value is irrespective of the actual amount reimbursed.
2. Rule 3 does not explicitly state what the perquisite value is if an employee uses an employer provided car for partly official and partly personal purposes and foots the entire bill for car running expenses.

Illustration
A company provides a car (with 1.5 litres engine capacity) to an employee and reimburses Rs 20,000 per month towards fuel and other car maintenance expenses incurred for both official and personal journeys. The company does not reimburse driver salary. What is the monthly perquisite value?

Ans: Since the car’s engine capacity is less than Rs 1.6 litres and the car is used for both official and personal purposes, the perquisite value per month is Rs 1,800.

We find many organizations providing “Vehicle Maintenance Reimbursement” for employer-provided car as a head of pay to employees, given that the maximum perquisite value is only Rs 3,300 per month if the usage is declared as partly official and partly personal. While this is a legitimate tax saving idea, employers should ensure that the underlying transaction is genuine and the documentation is valid and complete. Let us explain this.

Some organizations create car lease agreements with employees’ friends and relatives (without a car actually being provided to the employee) in order to create an impression that there is a car lease transaction. In many cases organizations do not pay any car lease rent to the car owner. The idea behind such lease agreements is just to create a picture that cars are hired by the employer for the use of employees. The employees are then provided with vehicle expense reimbursements and the corresponding perquisite values are added to the taxable income of employees. From a compliance point of view, such employers argue that since they have created lease agreements, they are in compliance with Rule 3 of the Income Tax Rules.

Please note that compliance with income tax rules requires that any documentation created is for a genuine transaction. If a company creates agreements with individuals for the purpose of creating car lease documentation, the Income Tax Department could well check the following in order to establish the genuineness of the transaction.

1. Does the organization pay car lease rentals to the owner of the car as per the agreement?
2. Does the organization comply with the service tax rules pertaining to car lease transactions for employee use. In other words, if an organization needs to pay service tax for car lease charges under the reverse charge mechanism, does it pay the required service tax?
3. If the car lease agreement is with individuals, does the agreement specify the details of the car? Does the organization maintain copies of documents such as the RC book in order to ensure that the car actually exists?

Payroll managers should ensure that car leases are genuine, and lease agreements do not exist just for the sake of seeking tax benefits.

What if an employer provides more than one car to an employee?

When an employer provides more than one motor car for the use of an employee or the members of the employee’s household, the perquisite value shall be calculated as follows.

1. With regard to the car which is wholly and exclusively used for official purposes, the perquisite value shall be zero.
2. The perquisite value for the second car shall be calculated as though the car is used partly for official and partly for personal purposes and the employee has borne the running and maintenance expenses (described earlier in this article).
3. The perquisite value for third, fourth, etc. cars shall be calculated as though the cars are used fully for personal purposes (described earlier in this article).

The period of perquisite value

Please note that Rule 3 of the Income Tax Rules specifies perquisite amounts for a calendar month and hence it is important that employers record the months for which fuel reimbursements are made and the corresponding perquisite value is applicable, in payroll. Also, employers should receive receipts towards vehicle maintenance expenses in total from employees. For example, if the fuel expense reimbursement of Rs 15,000 is for the month of April, the employer should receive fuel receipts for the entire Rs 15,000 for the month of April.

In the next post, we will take a look at the basis of perquisite value calculation for fuel expense reimbursement for car owned by the employee.

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A new tax year is about to begin and it is time to get ready to implement the budget proposals related to tax on salary. As you are aware, the Union Budget for FY 2016-17 was tabled in the Parliament by the Finance Minister of India on 29-Feb-2016. Here are the key proposals related to computation of tax on salary which payroll managers need to consider for FY 2016-17.

1. The tax slabs remain the same.

The tax rates for salaried employees below 60 years of age for FY 2016-17 shall be the same as those for FY 2015-16.

Total Income for the Year in Rs	Tax Rate in %
Up to 2,50,000	Nil
2,50,001 to 5,00,000	10
5,00,001 to 10,00,000	20
Above 10,00,000	30

The tax rates for salaried employees aged 60 years and above but below 80 years for FY 2016-17 are as follows.

Total Income for the Year in Rs	Tax Rate in %
Up to 3,00,000	Nil
3,00,001 to 5,00,000	10
5,00,001 to 10,00,000	20
Above 10,00,000	30

Note:
1. The Education cess including Higher Education cess stays at 3%.

2. Tax relief under Section 87A

The tax credit under Section 87A has been increased to Rs 5,000 for FY 2016-17 (from Rs 2,000 for FY 2015-16) if the total income does not exceed Rs 5 lakh for the year. This means that there will be no tax payable up to a taxable salary of Rs 3 lakh per annum.

3. Increase in surcharge

In case the total taxable income goes beyond Rs 1 crore in the year, a surcharge of 15% (subject to marginal relief) is to be deducted – the surcharge was 12% in FY 2015-16.

4. Employer contribution to superannuation fund

Any employer contribution made to a superannuation fund in excess of Rs 1.5 lakh shall be taxable – the limit was Rs 1 lakh in FY 2015-16.

5. Construction period in respect of housing loan interest benefit

As per Section 24, the acquisition or construction of house property should now be completed within five years (it was  3 years in FY 2015-16) from the end of the financial year in which capital was borrowed – for an employee to get the interest benefit of Rs 2 lakh (for a self-occupied house). Given the delays in construction of apartments/house properties these days, the increase in time limit from 3 to 5 years will help a number of employees who wish to avail benefit under Section 24.

6. Benefit to first home buyers

Section 80EE – The budget provides for a benefit of Rs 50,000 on interest payment towards housing loan taken by first home buyers subject to the following conditions.

a. The benefit shall be available from FY 2016-17 and continued with in subsequent years until the limit of Rs 50,000 is attained. Please note that this benefit is in addition to the interest benefit provided by Section 24 of the Income Tax Act.

b. The housing loan should be sanctioned by a financial institution during the period beginning on the 1st day of April, 2016 and ending on the 31st day of March, 2017.

c. The amount of loan sanctioned for acquisition of the residential house property should not exceed Rs 35 lakh.

d. The value of residential house property should not exceed Rs 50 lakh.

e. The employee should not own any residential house property on the date of sanction of loan.

f. The employee should have taken the housing loan from a financial institution (a banking company to which the Banking Regulation Act, 1949 applies, or any bank or banking institution referred to in section 51 of that Income Tax Act or a housing finance company).

The Finance Bill states that the assessee should not own any residential house property on the date of sanction of loan. Does this mean that an assessee could have owned and sold a house property prior to the date of sanction of loan and still be eligible for this benefit? The Finance Bill does not explicitly state that the employee should be first time home buyer to be eligible for this benefit. However, the Finance Minister, in his budget speech, clearly mentions that this benefit is available to “first – home buyers.” Hence, we presume that an employee should not be owning or have owned any house property at the time of or prior to the date of sanction of the loan in order to be eligible for Section 80EE benefit.

7. Taxability of employer’s contribution to Provident Fund (PF)

Currently, any employer PF contribution in excess of 12% of salary (Basic and Dearness Allowance) is taxable as per The Fourth Schedule of the Income Tax Act. The Finance Bill has introduced a limit of Rs 1.5 lakh in addition to the 12% limit. Consequently, as per the revised Rule 6(a) of the Fourth Schedule of the Income Tax Act, the exemption on PF contribution made by the employer shall now be restricted to 12% of the salary of the employee or Rs 1.5 lakh, whichever is lower.

The limit of Rs 1.50 lakh has been dropped in the amendment to the Finance Bill 2016, as passed by the Parliament. Consequently, any Employer PF contribution which is more than 12% of salary shall be taxable in the hands of an employee without the Rs 1.5 lakh limit.

8. Deduction in respect of rent paid – Section 80GG

Employees, who do not receive House Rent Allowance from their employer, but pay house rent, are eligible to seek deduction in respect of rent paid, under Section 80GG. The maximum deduction which was Rs 2,000 per month in FY 2015-16 has been increased to Rs 5,000 per month for FY 2016-17. Please note that the conditions pertaining to Section 80GG should be met by an employee for availing the benefit.

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If you thought that regulatory authorities are all about coercing us into submission by instilling the fear of punishment, you may have to think again. The Employee Provident Fund Organization, commonly referred to as the Provident Fund Department, has announced an incentive scheme in order to motivate employers to complete Universal Account Number (UAN) related formalities.

The PF Department introduced the UAN as the unique identifier for each PF member over a year ago. According to the PF Department:

The UAN will act as an umbrella for the multiple Member Ids allotted to an individual by different establishments. The idea is to link multiple Member Identification Numbers (Member Id) allotted to a single member under single Universal Account Number. This will help the member to view details of all the Member Identification Numbers (Member Id) linked to it. If a member is already allotted Universal Account Number (UAN) then he / she is required to provide the same on joining new establishment to enable the employer to in-turn mark the new allotted Member Identification Number (Member Id) to the already allotted Universal Identification Number (UAN).

The UAN is critical for the efficiency of processes (access to updated PF account information, triggering of transfer request when an employee moves from one employer to another, etc.) related to PF management. As part of UAN formalities, there are tasks that need to be completed by both the employer and the employee. These include completion of “Know Your Customer” (KYC) and UAN activation. According to information released by the PF Department, while over 6 crore UANs have been allotted, the basic formalities (seeding of UANs with PAN/Aadhaar and mapping of employee’s bank account to the UAN) are yet (as of Feb 2016) to be completed for over 1.5 crore UANs. Also, given that UANs are not required to be stated in the monthly PF-ECR at the time of PF remittance, many employers do not complete UAN formalities as part of onboarding of new joinees.

In order to motivate employers to complete UAN formalities, the PF Department, in a recent circular, has announced a couple of incentive schemes by which employers can receive a refund of a portion of the administrative charges paid to the PF Department.

Incentive Refund Scheme A

An establishment can claim refund of 10% of the administrative charges by meeting the following conditions each month:-

(i) Providing member’s details as required under Form No. 11 (New) (80% or above)

(ii) Seeding of all the three i.e AADHAAR (at least 80% of (i) above, bank account (100% of (i) above) and PAN (wherever applicable).

(iii) UAN activation (100% of (i) above)

Incentive Refund Scheme B

An establishment can claim refund of 5% of the administrative charges by meeting the following conditions each month:-

(a) Providing member’s details as required under Form No. 11 (New) (60% or above).

(b) Seeding of all the three i.e AADHAAR (70% of (a) above, bank account (80% of (a) above) and PAN (wherever applicable).

(c) UAN activation (60% of (a) above).

Note:

1. The incentive, by way of refund, shall be payable at the end of every quarter starting from quarter ending March, 2016, as per the procedure prescribed by the Central Provident Fund Commissioner. The circular does not detail the method for claiming the refund. We presume the PF Department will be notifying the method by way of another communication.
2. The establishments, in order to be eligible for Incentive Refund Scheme A or B, should have fulfilled the criteria in each month of a quarter.
3. The incentive schemes shall be in operation for one year with effect from 1-Jan-2016 to 31-Dec-2016 (i.e. for the quarters beginning Jan-2016, Apr-2016, Jul-2016, and Oct-2016).

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According to Section 15 of the Income Tax Act, the following income shall be chargeable to income tax under the head “Salaries”—

(a)  any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not;

(b)  any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him;

(c)  any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.

Section 15 states that salary should be taxed whenever it is due or paid, whichever is earlier. For example, let us assume that an organization pays salary to its employees on the first day of each month for the month which ended the previous day. One could then state that the salary for a month falls due on the last day of the month while the date of payment is the first day of the next month. As per Section 15, the salary should be taxed on the basis of the tax rates prevailing on the last day of the month, which is the date of salary accrual.

Now let us take a look at Section 192 which states the rules for tax deducted at source (TDS).

192. (1) Any person responsible for paying any income chargeable under the head “Salaries” shall, at the time of payment, deduct income-tax on the amount payable at the average rate of income-tax computed on the basis of the rates in force for the financial year in which the payment is made, on the estimated income of the assessee under this head for that financial year.

Section 192 states that TDS on salary shall be deductible at the time of salary payment and the TDS amount shall be “computed on the basis of the rates in force for the financial year in which the payment is made.”

There is no lack of clarity on the letter of Section 192 when read on a standalone basis. However, given that organizations deduct the entire tax on salary by way of TDS unlike deduction of a fixed rate of say, 10% as tax on payments pertaining to professional services, Section 192 should be in absolute consonance with Section 15.

Where is the conflict?

Many organizations pay salary in the first week of each month for the month ended the previous 30th or 31st. In such organizations, as per the letter of Section 192, the March salary paid in April will have to be taxed (for the purpose of TDS) as per the rates for the next financial year (starting April). This is because Section 192 states that the tax calculation should be as per the rates in force for the year in which the payment is made.

When the salary which accrues on 31-Mar is paid on 01-Apr, shouldn’t the TDS on salary not be as per the rates prevailing on 31-Mar? If yes, then how can TDS calculation be as per Section 192 which states that TDS should be calculated as per the rates prevailing on 01-Apr?

The way Section 192 is worded puts it in conflict with Section 15 of the Income Tax Act which states that taxability on salary arises whenever salary is due/accrued or paid, whichever is earlier.

Organizations typically tax salaries that accrue in March as per tax rates for that financial year ending March in accordance with Section 15, whether the salary is paid in April or later. If one goes by Section 192, as it is currently worded, such organizations can be viewed as deducting tax in contravention to Section 192.

Issues with Form 24Q filing for the last quarter

Let us assume that an organization pays March salary on 01-Apr and remits the TDS to the Income Tax Department on 07-May. How can the organization submit the salary and TDS details to the tax authorities?

In Form 24Q of the fourth quarter, the organization cannot state 01-Apr as the “Date of Payment/Credit” in Annexure I since 01-Apr lies outside the period of the last quarter. The organization can state the accrual date of 31-Mar as the “Date of Payment/Credit” and 07-May as the “Date of TDS Deposit”  in Annexure I. However, what if the Income Tax Department raises a demand for delayed TDS remittance with the argument that since the “Date of Payment/Credit” is 31-Mar, the TDS amount should have been remitted on or before 30-Apr instead of 07-May?

Also, the organization for obvious reasons, cannot show March salary in the first quarter Form 24Q of the next year.

Let us take another example, where salary accruing on 31-Mar is paid to employees on 01-May and consequently, TDS is remitted on 07-June. Given that 31-May is the last date for issue of Form 16, should the organization leave out March salary in the Form 16 or wait until 07-June, remit TDS and file Form 24Q for the fourth quarter and then make a delayed issue of Form 16?

It would help if the Income Tax Department illustrates these atypical situations and provides guidance for handling such situations.

The letter of Section 192, as it currently exits, fails the case of March salary paid in April.

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While the deadline for Provident Fund (PF) remittance by employers is the 15th of the following month, the PF department allowed an additional 5 days as grace period until now. Given that the PF remittance was done primarily by way of cheque payment at designated branches of the State Bank of India in the past, the manual system of cheque clearance and payment realization took time. Hence, the grace period of 5 days helped employers make timely PF remittances particularly when they made the remittance towards the 15th or so. As you are aware, the PF department now requires employers to make online remittances by way of internet banking. Online  remittances ensure instant payment and consequently, the PF department no longer sees the need for the grace period for PF remittance.

Effective February 2016 (PF contributions for January 2016 to be remitted in February 2016), there shall be no grace period for PF remittance. Employers need to ensure that the PF remittances are completed by the 15th of the following month in order to avoid penal charges.

You can take a look at the circular notifying the removal of grace period here.

 

 

 

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The Government of India has notified the Payment of Bonus (Amendment) Act, 2015, by way of a notification dated 01-Jan-2016. The notification impacts the Payment of Bonus Act, 1965, and mandates the following changes with regard to statutory bonus calculation.

1. Bonus eligibility:

Until now, employees who are employed on a salary exceeding Rs 10,000 per month were ineligible to receive statutory bonus as per Section 2 (13) of the Payment of Bonus Act. The salary limit has now been increased to Rs 21,000 per month. Hence, from now on, all employees whose monthly salary is Rs 21,000 or less will have to be considered for bonus payment. Given that salary refers only to Basic pay (plus DA and CCA) for all practical purposes, there will be a significant increase in the number of employees getting covered by the Payment of Bonus Act.

2. Bonus ceiling:

Until now, the Payment of Bonus Act limited the maximum salary, on which bonus needed to be calculated, to Rs 3,500 per month, as per Section 12 of the Payment of Bonus Act. In other words, if the monthly salary was greater than Rs 3,500, bonus needed to be calculated assuming a salary of Rs 3,500 per month. From now on, bonus should be calculated at actuals up to a monthly salary of Rs 7,000 per month. For salaries beyond Rs 7,000 up to Rs 21,000 per  month, the bonus calculation should be done on Rs 7,000 per month.

In case the minimum wage is higher than Rs 7,000 per month (for any employee/industrial category), the salary ceiling for the purpose of bonus calculation shall be the minimum wage and not Rs 7,000.

3. Changes are effective retrospectively:

The changes are effective 01-Apr-2014. This means that organizations will have to rework their bonus calculations – as per the changes notified – for the financial year 2014-15.

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Section 10 (13A) of the Income Tax Act along with Rule 2A of the Income Tax Rules provides for income tax exemption on House Rent Allowance (HRA) paid to employees. While HRA is one of the most widely used head of pay in Indian organizations, we find many payroll managers not calculating the exemption on HRA as per what the statutes specify. According to Section 10 (13A), any allowance paid for the purpose of an employee meeting house rent expenses is exempted, specified as follows:

any special allowance specifically granted to an assessee by his employer to meet expenditure actually incurred on payment of rent (by whatever name called) in respect of residential accommodation occupied by the assessee, to such extent as may be prescribed having regard to the area or place in which such accommodation is situate and other relevant considerations.

Explanation.—For the removal of doubts, it is hereby declared that nothing contained in this clause shall apply in a case where—

(a) the residential accommodation occupied by the assessee is owned by him ; or

(b) the assessee has not actually incurred expenditure on payment of rent (by whatever name called) in respect of the residential accommodation occupied by him ;

An employee should have lived in a house property which was not owned by him/her and the employee should have made payments towards rent in order to avail tax exemption on the HRA received.

Rule 2A of the Income Tax Rules specifies how HRA exemption should be calculated –

2A. The amount which is not to be included in the total income of an assessee in respect of the special allowance referred to in clause (13A) of section 10 shall be—

(a) the actual amount of such allowance received by the assessee in respect of the relevant       period; or

(b) the amount by which the expenditure actually incurred by the assessee in payment of rent in respect of residential accommodation occupied by him exceeds one-tenth of the amount of salary due to the assessee in respect of the relevant period; or

(c) an amount equal to –

(i) where such accommodation is situate at Bombay, Calcutta, Delhi or Madras, one-half of       the amount of salary due to the assessee in respect of the relevant period; and

(ii) where such accommodation is situate at any other place, two-fifth of the amount of               salary due to the assessee in respect of the relevant period,]

whichever is the least.

Explanation : In this rule –

(i) “salary” shall have the meaning assigned to it in clause (h) of rule 2 of Part A of the Fourth Schedule;

(ii) “relevant period” means the period during which the said accommodation was occupied by the assessee during the previous year.]

In other words, the exemption on HRA, as per Rule 2A, should be the least of the following. Let us call it the Least of Three rule.

Least of Three rule for HRA exemption calculation

The least among the below shall be the exemption on HRA.

1. The actual HRA pay amount received by the employee.

2. The house rent paid by the employee which is in excess of 10% of the salary, i.e. rent minus 10% of salary.

3. 50% of salary if the rented house is located in a metro city (Delhi, Mumbai, Kolkata or Chennai) or 40% of salary if the rented house is located in any place other than Delhi, Mumbai, Kolkata or Chennai.

Note: According to the Income Tax Act, “salary” for the purpose of HRA exemption calculation “includes basic salary as well as dearness allowance if the terms of employment so provide. It also includes commission based on a fixed percentage of turnover achieved by an employee as per terms of contract of employment but excludes all other allowances and perquisites.”

For all illustrations in this blog post, we will assume that “salary” includes only Basic and employees in the illustrations are not paid Dearness Allowance or Commission.

On the face of it, the Least of Three rule looks easy to understand. However, as we will soon see, the rule is not so easy to implement. The tax exemption is determined by Basic pay, HRA, location (metro or non-metro) of the house, and the rent paid and when any of the input factor changes, the HRA exemption amount can change. We find organizations following different methods to arrive at HRA exemption and many calculate the exemption incorrectly.

Methods of HRA exemption calculation

a. Annualized HRA exemption calculation

Some organizations use the annual amounts of Basic, HRA, and rent paid, and calculate the HRA exemption by applying the Least of Three rule.

b. Monthly HRA exemption calculation

Some organizations use the monthly amounts of Basic, HRA, and rent paid, and calculate the monthly HRA exemption by applying the Least of Three rule. The total HRA exemption for the year is the sum of all monthly HRA exemption figures.

c. Period method

In this method, the HRA exemption is calculated (by applying the Least of Three rule) for a period in which the input factors (Basic, HRA, rent paid and location) remain the same. If any of the input factors changes, the HRA exemption should be calculated for the new period with the new input figures. The annual HRA exemption is the sum of the HRA exemptions for the different periods.

For example, an employee pays the same monthly rent (metro city) of Rs 10,000 per month from April to September in a year and from October to March he lives in a different house (metro city) and pays Rs 12,000 per month. The employee’s monthly Basic salary and monthly HRA remain constant throughout the year.

As per the Period method, the HRA exemption shall be calculated for 2 periods during which the input factors remain the same.

HRA exemption for the year (Apr to Mar) = HRA exemption for Period 1 (from Apr to Sep) + HRA exemption for Period 2 (from Oct to Mar).

Does the method of calculation matter?

Yes, it does. The HRA exemption amount from the three methods will be the same only when all input factors remain constant throughout the year. If any of the input factors changes during the year, the HRA exemption as calculated by one method will be different from that calculated by other methods. Let us illustrate this with an example.

An employee, who lives in Chennai (metro city), receives Basic pay (monthly) of Rs 50,000, HRA (monthly) of Rs 25,000, and pays a monthly rent of Rs 25,000. The employee has loss of pay from October 1 to November 15, but pays full house rent in the months of October and November. Let us calculate the HRA exemption using the different methods.

Annualized HRA exemption calculation

This method calculates HRA exemption by using the annual figures.

1. Basic pay for the year = Rs 50,000 x 10.5 months (due to loss of pay for 1.5 months) = Rs 525,000.
2. HRA for the year = Rs 25,000 x 10.5 months (due to loss of pay for 1.5 months) = Rs 262,500.
3. Rent paid by the employee for the year = Rs 25,000 x 12 = Rs 300,000.

HRA exemption calculation

1. HRA received by the employee = Rs 262,500.
2. Rent paid in excess of 10% of salary = Rs 300,000 – Rs 52,500 = Rs 247,500.
3. 50% of Basic salary (since the location of the residence is in a metro city) = Rs 262,500.

The HRA exemption for the year is the least of the above, which is Rs 247,500.

Monthly HRA exemption calculation

As per this method, HRA exemption is calculated each month, and the monthly HRA exemption values are added to arrive at the exemption for the year.

1. Monthly HRA exemption amount, after applying the Least of Three rule for each month – from April to September and from December to March = Rs 20,000 per month.
2. HRA exemption amount for October, after applying the Least of Three rule = Rs 0.
3. HRA exemption amount for November, after applying the Least of Three rule = Rs 12,500.

The total of HRA exemption amounts across all months = Rs 212,500 for the year.

HRA exemption calculation for each period of input change (Period method)

As per this method, whenever any of the input factors (Basic pay, Rent paid, HRA, and Metro or Non-metro) changes for an employee during the year, the HRA exemption is re-calculated. In other words, the year is divided into as many periods as dictated by changes in the input factors, and HRA exemption is calculated for each of the periods. Finally, the HRA exemption amounts for the different periods are added to arrive at the HRA exemption amount for the year.

With regard to the illustration presented earlier, the year is divided into 3 periods, as follows.

• Period 1 (from April 1 to September 30)  – when there is no change in any of the input factors.
• Period 2 (from October 1 to November 15) – when Basic pay and HRA change (became zero) on account of loss of pay.
• Period 3 (from November 16 to March 31) – when there is no change to any of the input factors.

HRA exemption calculation

• HRA exemption for Period 1 (from April 1 to September 30) = Rs 120,000
• HRA exemption for Period 2 (from October 1 to November 15) = Rs 0
• HRA exemption for Period 3 (from November 16 to March 31) = Rs 90,000

The total of HRA exemption amounts across all periods = Rs 210,000 for the year.

The 3 methods yield different annual HRA exemption amounts:

Annual exemption method: Rs 247,500

Monthly exemption method: Rs 212,500, and

Period method: Rs 210,000.

Which is the correct method?

Depending on the method used, the tax liability for the employee would be higher or lower, and in turn the government’s receipt from tax on salary income would be higher or lower.

The above illustration presents HRA exemption calculation in the event of changes in Basic salary and/or HRA. In the event of Basic salary or HRA not changing, but the rent amount changing or the location of the residence changing (say, from metro to non-metro), there will still be differences in HRA exemption calculation across the 3 methods.

While there is no explicit instruction from the Income Tax Department on which method should be used, we are of the view that the “Period” method described above complies with the letter and the spirit of Section 10 (13A) of the Income Tax Act, 1961. The other methods such as the Annualized Exemption method and the Monthly Exemption method are not in line with the law. Let us see why.

The problem with the Annualized HRA Exemption method

Organizations using this method ask employees to submit the total rent amount paid during the year and use the annual rent amount for calculation. If an employee has a full month loss of pay in a month, say, September, the rent for September is also included in the annual rent figure. If in September, the employee received zero HRA on account of loss of pay, how can the September rent be included for HRA exemption calculation? In other words, how can rent be considered for a period in which there is no HRA and consequently no HRA exemption?

The problem with the Monthly HRA Exemption method

In this method, employees are asked to submit the total rent amount paid for each month and specify if the location of the residence is in a metro city or a non-metro city/town. If within the same calendar month, an employee lives in rented accommodation in 2 cities, one metro and the other non-metro, this method would fail since both locations cannot be considered for exemption calculation for that month.

The Income Tax Act does not mandate calculation of monthly HRA exemption amounts and hence we wonder on what basis payroll managers look at the month as the period for HRA exemption calculation.

Let us illustrate the problem with the Monthly exemption method with an example.

An employee receives a monthly Basic salary of Rs 50,000 and a monthly HRA of Rs 25,000. In the month of September, the employee lives in his own house (and hence pays no rent) from September 1 to September 15 and moves into a rented accommodation (in a metro city) from September 16 for a monthly rent of Rs 25,000. Further, the employee has loss of pay from September 16 to September 30, and hence receives no Basic salary and HRA for that period.

According to the Monthly exemption method, the HRA exemption for the month of September is Rs 10,000, by applying the Least of Three rule. However, for the period from September 1 to September 15, the employee does not live in a rented house and hence is not eligible for HRA exemption, while for the period from September 16 to September 30, the employee has no Basic pay or HRA on account of loss of pay and hence is not eligible to claim HRA exemption. If one were to use the Period method, the HRA exemption for both the periods in the month (from September 1 to September 15 and from September 16 to September 30) will be zero.

The Period method is the only method which is compliant with the Income Tax Act under all possibilities.

Please note that, as per the Income Tax Act, the salary, for the purpose of HRA exemption calculation, is to be determined on “due” basis and hence the Period method should be used for HRA exemption calculation including for situations such as salary arrear payments and loss of pay.

Why is the Period method not followed widely?

1. Lack of awareness: Many payroll managers are unaware of the limitations of annualized exemption and monthly exemption calculations. Given that the  Monthly Exemption method is widely used in India, one can safely say that the manner in which HRA exemption is calculated in many organizations in India is not in line with the Income Tax Act.

2. Payroll software limitations: The Period method is difficult to implement. Whenever Basic pay, HRA, residence location, or the rent paid change, the HRA exemption has to be re-computed. There aren’t too many payroll software (other than Hinote’s HRWorks) in India which can automatically re-compute HRA exemption whenever the input factors change. Manual computation of HRA exemption for each period is cumbersome and prone to errors.

We request the Income Tax Department to provide instructions (with numerical examples illustrating complex situations such as salary arrears, loss of pay etc.) on how HRA exemption should be calculated.

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As a payroll service provider, we verify the supporting documents submitted by employees when they seek tax benefit. If an employee seeks deduction under Section 24 of the Income Tax Act, for the housing loan interest, we typically seek a certificate from the bank/financial institution which presents the loan principal and interest schedule for the year, property construction completion certificate from the builder or employee declaration to that effect, proof of property ownership, etc. What we do not seek from the employee is proof of loan interest payment by way of, say, bank passbook copy.

Is proof of loan interest payment not important?

An employee need not have paid the interest to the bank/financial institution in order to claim tax benefit under Section 24. We find that many payroll managers are under the mistaken notion that an employee should have made the interest payment and the employer should be verifying the same by checking the bank passbook etc. as proof of interest payment.

The employer needs to verify only the total interest payable (not paid), by checking the loan statement from the bank/financial institution. As long as an employee has a valid housing loan, he can claim tax benefit on the interest for the year, whether or not he makes the interest payment to the bank/financial institution.

Why? Because Section 24 says so.

As per Section 24 of the Income Tax Act:

(b) where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital, the amount of any interest payable on such capital:

Provided further that where the property referred to in the first proviso is acquired or constructed with capital borrowed on or after the 1st day of April, 1999 and such acquisition or construction is completed within three years from the end of the financial year in which capital was borrowed, the amount of deduction under this clause shall not exceed ⁹[two lakh rupees].

As you can see from the above, Section 24 refers to interest “payable” and not the interest actually paid by an employee. The amount of annual interest payable can be considered for deduction every year. It does not matter whether the interest has been actually paid or not paid during the year.

Circular No. 363, dated 24.06.1983

The Income Tax Department issued a circular (No. 363) in 1983 which deals with an issue pertaining to housing loans provided to central government employees. As per the House Building Advance Rules of the Central Government of India, the recovery of the principal (on housing loan provided to government employees) is made first in not more than 180 monthly installments and then interest is subsequently recovered in not more than 60 installments. This means that while interest on housing loan accrues in the first 180 installments, the deduction/payment of the accrued interest starts only after 180 months.

The circular clarifies that in the period (say, the 1st year of the loan) when interest accrues but is not paid, the benefit under Section 24 is available. According to the circular:

Since the word used is ‘payable’, deduction under section 24(1) (vi ) would be on the basis of accrual of interest which would start running from the date of the drawal of the advance.

House property loan interest, accrued but not deducted/paid, is somewhat unique to loan provided by the government. Employees, when they take a housing loan for property acquisition/construction from banks/financial institutions, will need to pay interest as soon as it falls due. However, even when employees do not pay interest on time, they can claim tax benefit if the interest payment falls due in the year.

Applicability of the circular to non-government employees

While the circular answers a specific question on loans offered by the Central Government, its pronouncement on the matter of interest payable versus paid should be construed as being applicable to all assessees and not just the Central Government employees. Section 24 of the Income Tax Act applies equally to all assessees and there is nothing in law which states that a different text for Section 24 should be used for private sector employees.

This issue has also been settled by the court. In the case of CIT v. Devendra Brothers & Co. 200 ITR 146, the Allahabad High Court has stated that as long as the interest in respect of the housing loan has fallen due, the amount of interest whether it is paid or not would be a permissible deduction. According to the judgement, “if the amount of interest sought to be deducted had fallen due or a liability in that regard had been incurred in the previous years relevant to the assessment year in question, whether factually the amount of interest is paid or not, it is a permissible deduction” under the Income Tax Act in computing the income chargeable to tax under the head “Income from house property”.

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