Seventh pay commission report is out and as per recommendation it should be effective from January 1, 2016. But as happens with most government plans the actual revision of salary would take some time. And actual credit to employee’s bank account even more time. A delay of a year or so is not unheard of. Assuming that the amount is credited in later half of 2016, all the employees would receive a lump sum amount which would be arrears from the effective date.
Arrears makes everyone happy but pain of paying higher taxes makes them worried? In this post we explain the taxation of arrears with example.
Arrears Tax Calculation:
We take a simple example. Amit is a government employee and he has received his long awaited salary dues as arrears. Here are the numbers.
- Salary income for FY 2015-16: Rs 9,00,000
- Additional Arrears received: Rs 5,00,000
- Total income: 14,00,000
This arrears was due from last 3 financial years as follows:
- FY 2014-15: Rs 2,00,000
- FY 2013-14: Rs 1,75,000
- FY 2012-13: Rs 1,25,000
We use this example to illustrate tax calculation on arrears. For simplicity we would assume that Amit has not invested for any tax exemption, so his income stated above is “Net Taxable Income”.
Calculate tax for present year without considering arrears
So for FY 2015-16, the taxable income without arrears = Rs 9,00,000
Income Tax Payable = Rs 1,08,150
Calculate tax for present year after adding arrears payout
So for FY 2015-16, the taxable income without arrears = Rs 9,00,000 + Rs 4,00,000 = Rs 14,00,000
Income Tax Payable = Rs 2,52,350
Subtract income tax payable you get in step 2 from step 1
Additional tax due to arrears: Rs 2,52,350 – 1,08,150 = Rs 1,44,200
Also Read: Best Tax Saving Investments u/s 80C
Allocate the arrears components to the respective financial years. So in our case it’s as follows
FY 2014-15: Rs 2,00,000
FY 2013-14: Rs 1,75,000
FY 2012-13: Rs 1,25,000
Calculate new tax payable for each financial year where the component of arrears is present i.e. adding arrears to the old income in respective financial years.
Add the excess tax payable across the financial years due to arrears. In our case it comes out to be Rs 1,03,000. This means that had the salary payout been on time you would have paid this amount as tax.
Subtract the excess tax payable due to arrears in Step 3 from the additional tax payable in Step 5.
Tax Difference: Rs 1,44,200 – Rs 1,03,000 = Rs 41,200.
If you consider arrears payment as income for only present financial year, you would be paying Rs 41,200 extra as taxes, without any fault of yours. Government thankfully understands the situation and has provided relief for tax payers under Section 89(1).
Also Read: Tax Planning Guide for FY 2015-16
Calculate your final tax liability for FY 2015-16
So for FY 2015-16, the taxable income with arrears = Rs 9,00,000 + Rs 4,00,000 = Rs 14,00,000
Income Tax Payable = Rs 2,52,350
Tax Deduction u/s 89(1) on account of arrears = Rs 41,200
Net Tax payable = Rs 2,52,350 – 41,200 = Rs 211,150
To claim the above tax benefit u/s 89(1), you need to fill up Form 10E. From FY 2014-15 (assessment year 2015-16), the income tax department has made it mandatory to file Form 10E if you want to claim relief under section 89(1). The form can be filled online on the Income Tax Website.
The question is what would have happened if there was no excess or lower tax as in Step 6?
There would be no special treatment. You just calculate your tax after adding arrears and pay our taxes. Section 89(1) would not be applicable!
Form 10E: How to fill?
The Form 10E can be filled online from Income Tax website. Here are the steps:
- Login to Income Tax efiling website.
- After you have logged in, click on tab named ‘e-File’ and select ‘Prepare & Submit Online Form (Other than ITR)
- On the next screen, select Form 10E and the Assessment Year from the drop down.
- The Form 10E would be displayed with instructions and annexure. Fill the relevant details and submit.
In case you do not submit Form 10E to take advantage of Sec 81(1), you might receive notice from income tax department saying: The relief u/s 89 has not been allowed in your case, as the online form 10E has not been filed by you. The furnishing of Online form 10E is required as per sec.89 of the Income Tax Act
You can download the income tax calculator for past financial years here. Use them to calculate your taxes for the respective years.