In today’s fast-paced work environment, receiving arrears in salary is a common occurrence for many employees in India. If you’re wondering about the details of arrears in salary, how they’re calculated, and how they affect your tax liability, this blog will help you understand everything you need to know.
Arrears in salary refer to the backdated payment made to an employee for previous months or years, typically when there’s a delay in salary revision or adjustment. These are generally paid when a company decides on a pay hike or the government announces new pay scales, such as during the implementation of pay commissions for government employees. For example, if your salary was increased retroactively from the start of the financial year, but you’re receiving the difference now, that extra payment is called an “arrear.”
Arrears can impact both employees’ income and their income tax, so understanding how they work is essential for effective financial planning. Let’s explore the various aspects of arrears in salary in detail.
Why Are Arrears in Salary Paid?
Arrears usually arise due to:
- Delayed salary hikes : Companies or governments often decide on pay increases that apply retroactively. The delay in implementation leads to a one-time lump-sum payment.
- Salary corrections : Errors in earlier payroll cycles might require companies to pay employees arrears to correct discrepancies.
- Adjustments after negotiations : In cases where collective bargaining agreements are finalized after a delay, employees might receive arrears to make up for missed payments.
Calculation of Arrears in Salary
The amount of arrears in salary is calculated based on the difference between the old and revised salary for the months affected. Here’s a quick breakdown of how this calculation works:
Step 1: Identify the period for which arrears are applicable (e.g., April to September).
Step 2 : Calculate the difference in salary per month before and after the hike.
Step 3 : Multiply the difference by the number of months in the arrears period.
Step 4: Sum up the arrear amounts for each month to arrive at the total arrears in salary.
For example, if your salary was revised from ₹50,000 to ₹55,000, and the revision applies to the past six months, the arrear calculation would be ₹5,000 (difference) x 6 months = ₹30,000.
Taxation of Arrears in Salary
The taxation of arrears in salary is an important consideration, as receiving a lump-sum amount can push your income into a higher tax bracket. In India, arrears are considered a part of your income and are thus taxable according to your income tax slab. Here’s how taxation on arrears works:
Tax Calculation for the Financial Year : Arrears are added to your annual income for the year in which they are received, potentially increasing your total taxable income.
Relief Under Section 89(1) : To reduce the tax burden, the Income Tax Act provides Section 89(1), which allows tax relief on arrears. This section helps avoid higher taxation by calculating the tax difference had the arrears been received in the original financial year.
For example, if your total taxable income with arrears in salary puts you in a higher tax bracket, Section 89(1) can help lower your tax liability.
Claiming Tax Relief on Arrears Under Section 89(1)
To avoid paying additional taxes on arrears, you can claim relief under Section 89(1). Here’s how it works:
1. Calculate Tax for the Years Concerned : Determine your tax liability for each year by adding arrears to the corresponding year’s income.
2. Calculate Tax for the Current Year with Arrears : Add the entire arrear amount to your current year’s income and calculate the tax.
3. Compare Tax Amounts : The difference in tax between the two methods will help you claim relief, which essentially spreads out the tax burden.
Steps to Claim Section 89(1) Relief:
- Fill Form 10E : Form 10E must be filed online through the [Income Tax e-filing portal](https://www.incometax.gov.in/iec/foportal/) to claim relief under Section 89(1).
- Provide Details of Arrears : Mention the arrears amount and respective financial years accurately in Form 10E.
- Submit the Form : Once Form 10E is submitted, the relief will be automatically considered in your tax filing.
Claiming this relief is highly recommended for employees with large arrears to avoid paying excess taxes in the year of receipt.
Arrears in Salary for Government Employees
Arrears are common for government employees in India, especially during the implementation of new pay commissions (like the 7th Pay Commission). Typically, these arrears accumulate over time and are paid out in one or two installments. For example, when the 7th Pay Commission recommendations were implemented, government employees received arrears in line with the revised pay structure dating back to the effective date.
Advantages and Disadvantages of Arrears in Salary
Advantages:
- Higher Total Income : Arrears provide a lump-sum addition to your salary, which can be helpful for significant expenses or investments.
- Retroactive Pay : Receiving arrears is a way for employers to ensure that employees are compensated fairly based on revised pay scales.
- Tax Relief Possibilities : Section 89(1) allows employees to reduce their tax burden on arrears.
Disadvantages:
- Higher Tax Liability : Without proper relief, the additional income can push you into a higher tax bracket.
- Complex Calculation Process : Employees need to understand how to calculate their arrears and claim tax relief, which can sometimes be challenging.
FAQs
1. What exactly are arrears in salary?
Arrears are payments made to employees for past salary revisions, adjustments, or corrections. They are typically paid when salary increments or adjustments are delayed.
2. How are arrears in salary calculated?
Arrears are calculated based on the difference between the old and revised salary over the arrears period. Multiply the difference by the number of months for which the arrears are applicable.
3. Is tax relief available on arrears in salary?
Yes, under Section 89(1) of the Income Tax Act, employees can claim tax relief on arrears to avoid higher taxation due to receiving a lump-sum amount.
4. How do I claim Section 89(1) relief on arrears?
To claim Section 89(1) relief, you must file Form 10E on the Income Tax Department’s e-filing portal. This form helps spread the tax burden by calculating the tax difference had the arrears been paid in their original years.
5. Does receiving arrears impact my tax bracket?
Yes, receiving arrears can increase your taxable income for the year, potentially pushing you into a higher tax bracket. Relief under Section 89(1) can mitigate this impact.
6. Are government employees eligible for arrears in salary?
Yes, government employees frequently receive arrears, particularly when new pay commissions, such as the 7th Pay Commission, are implemented.
Conclusion
Arrears in salary play an essential role in fair employee compensation, especially when salary increments are delayed. They ensure that employees receive the full benefits of salary hikes or adjustments. However, receiving arrears can also result in a sudden increase in taxable income. Thankfully, tax relief under Section 89(1) provides a way to manage this tax burden.
By understanding the process, calculating your arrears accurately, and using tools like Form 10E on the Income Tax e-filing portal, you can efficiently handle your arrears without unnecessary tax stress. Make sure to consult reliable sources or tax advisors if you have significant arrears, as this can help you make the most of your finances while minimizing tax liabilities.
