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High Risk Investment Declarations

Organizations typically accept investment declarations (for tax saving) from employees at the beginning of a tax year and expect employees to submit proof of investments only towards the end of the year or at the time of final settlement calculation in case of employees leaving the organization before the end of the year. It is our job, as a payroll service provider, to ensure that there are no instances of under-deduction of tax on salary in our customer organizations. Consequently, we are concerned about what we call “high risk” investment declarations made by employees in our customer organizations.

High risk declarations

Currently, the Income Tax Act restricts the extent of deduction available under sections such as 80C and 80D. For example, the total deduction available under section 80C cannot exceed Rs. 1.5 lakh per annum. However, the law does not provide for any limit on deductions available under the following sections.

1. Section 24 – Deduction in respect of housing loan interest on let-out property
2. Section 80E – Deduction in respect of interest on loan taken for higher education
3. Section 80G – Deduction in respect of donations to certain funds, etc.

We refer to declarations under the above sections as high risk declarations since such declarations can potentially reduce the taxable income of an employee to as low as zero. For example, if the taxable salary of an employee is Rs. 10 lakh per annum, and if the employee submits Rs. 10 lakh as investment declaration under Section 80E, his or her taxable income will drop to zero. In case this (80E declaration) turns out to be an incorrect declaration and the employee is unable to produce documentary proof to substantiate the declaration, there may be a significant increase in the employee’s income tax at the end of the year or during settlement. This can also lead to short deduction of income tax.

Incorrect investment declarations under sections such as 80C too can lead to under deduction of tax. However, frivolous declarations under sections 24, 80E, and 80G can be particularly challenging to payroll managers given the greater extent of under deduction of tax which is theoretically possible. Payroll managers will do well to keep themselves informed on high risk declarations made by employees.

Reporting on high risk declarations

As a payroll service provider, we submit periodic reports which carry details of high risk declarations to our customers. The reports contain the names of employees and the amounts they have submitted under sections 24, 80E, and 80G. Of course, there may be genuine declarations made by employees under sections 24, 80E and 80G, and it would be incorrect to assume that any declaration under these sections is a high risk declaration. We therefore apply a threshold limit while identifying declarations as high risk under each of the sections.

1. Section 24 – Housing loan interest on let-out property

We report amounts which exceed 35% of the gross salary of the employee. From our experience, we believe that any housing loan interest amount (let-out property) which is more than 35% of the gross salary could be an incorrect declaration.

For let-out property, employees need to declare the annual rental value for their property. We also include annual rent amounts (declared as income by employees) which are less than Rs. 36,000 per annum in the report. We find many employees making incorrect declarations (such as Rs. 1) for annual rental value amounts. If the declared annual rental value is less than Rs. 36,000 per annum, we request payroll managers in our customer organizations to check with the employees on the correctness of the annual rental value submitted.

2. Section 80E – Deduction in respect of interest on loan taken for higher education

We present interest (on higher education loan) amounts which exceed 5% of the gross salary of the employee. Again, there is nothing sacrosanct about the 5% cut-off. It could as well be 4% or 6%.

3. Section 80G – Deduction in respect of donations to certain funds, etc.

We report all declarations made under Section 80G to customers. As per a circular from the Income Tax Department, only declarations on contributions made to notified government funds such as the Prime Minister’s Relief Fund can be routed through the employer. We find many employees submitting details of contributions made to private charities to employers and such declarations getting rejected at the time of proof verification.

Employees should submit information on contributions made to private charities in their tax return and seek refund, if applicable, from the Income Tax Department.

Keep a constant eye on high risk declarations

If you are responsible for tax compliance in your organization, please consider generating periodic reports on high risk declarations made by your employees from your payroll software. If you have outsourced your payroll, please seek reports from your payroll vendor in this regard. You can consider checking with the employees presented in the report on whether the declarations are correct or not. In case of any mistake, please request employees to modify their investment declarations. Also, please advise your employees that incorrect declarations could lead to a significant increase in tax deduction towards the end of the year or at the time of final settlement. Needless to say, incorrect TDS deduction is both time consuming and expensive to deal with.