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Link between Payroll, Income Tax, and TDS

For salaried employees, the employee's Income Tax (IT) deduction is the responsibility of the employer (Company). Employer has to calculate the IT on the employees salary, deduct the amount while paying the salary, and then pay it to the Income Tax Department in the employee's name. The Tax that is deducted is called as TDS (Tax Deducted at Source).

eTDS returns

eTDS stands for electronic Tax Deducted at Source Returns. From July 2004 onward, employers need to file the various Income Tax returns in an electronic format. The paper formats of the returns are no longer accepted.

Digital Signature for Form 16

To address the challenge of physically generating, signing, and distributing large number of Form 16s, the Income Tax department has now allowed organizations to generate Form 16s and sign them digitally. These documents are called as Digitally Ssigned Form 16s. After the introduction of this facility, it is not needed to print and sign Form 16s

Form 24Q

Form 24Q is a statement/report that you need to generate quarterly in a financial year. This statement contains information on all employees who have a taxable income, the tax that has been deducted every month, and whether the deducted tax has been paid. This statement needs to be generated and filed with the Income Tax department. The statement needs to be generated in an e-format i.e. as a file in a format specified by the IT department. This is also commonly referred to as eTDS Returns

Changes in eTDS

The format of the eTDS file has changed. The following are the changes in the eTDS file format:

  1. It contains the name of the software that is generating these returns.
  2. It contains information on the category of the deductor i.e. organization doing the tax deduction.
  3. There are some additional fields that have been incorporated that are not applicable for non-Government (private sector) organizations.

The eTDS file now needs to be generated as per the revised format. The eTDS file should be validated using the file validation utility FVU 2.128.

Income Tax Computation

Indian Income Tax laws are one of the most complicated in the entire world. We will make an attempt here to give a broad overview on how Income Tax is computed.

The IT for an employee is calculated on an annual (yearly) basis. This is called as Financial Year. The year begins on April 1st and ends on March 31st of the subsequent year. For. example, April 1, 2009 to March 31, 2010. The IT for an employee is calculated on an annual basis. Annual here means for a year, which is the year beginning April and ending March of the subsequent year. For.example, April 1999 to March 2000. This is also referred to as Financial Year.

Income Tax is broadly calculated as follows:

  1. The Income for a year is calculated (this is the actual income paid to an employee).
  2. To this income, the Perquisites are added (this is the notional value of the Perquisites or benefits given to an employee).
  3. Next, the government-allowed Exemptions are calculated and deducted from the income.
  4. Further, the Profession Tax is deducted from the income.
  5. The balance income at his stage is termed Income chargeable under head Salaries.
  6. To this, any other income declared by the employee is added. Any loss is also deducted.
  7. Next, deductions in terms of Medical Claim Premiums, Savings in LIC, Bonds, and others (referred to as Chapter 6A Deductions) are deducted from the income.
  8. The balance income is called as Taxable Income.
  9. On this income, tax is calculated based on the slabs prescribed.

Detailed explanations are provided as follows:

Income for the Year

  • Year or Financial Year is the period from April to March of next year. For example, if you are in July 2009 then the tax (financial) year is the period from April 2009 to March 2010.

  • Income for the year consists of 2 kinds, Monthly or Regular Earnings and one-time or Other Earnings.
  • Monthly Earnings consists of all amounts paid to the employee every month. This generally consists of Basic, DA, HRA, Conveyance, Special Allowance, Personal Pay, etc.
  • Other Earnings consists of all components that are not paid on a regular basis but are more of a one-time payment. This includes components such as Performance Incentive, Bonus, Sales Incentive, Taxable Reimbursements, etc.
  • Income for Income Tax calculations are calculated on an annual basis (yearly). The amounts that are actually paid and mentioned in the payroll are considered as income. To this, we add the income that is expected to be paid to the employee. This is called as Projected Income. For example, if you are in the month of June then the actual payout for April, May, and June are considered. To this, we add the projected income (projection) from July to March.

    Please note that the amount is calculated on an annual basis. The deductions are done monthly.

  • Projection means that the income of the current month is assumed to be the monthly income till the end of the financial year, i.e. current month's income is projected till the end of the financial year. For example, if the employee's Basic is 3000 in June then the Basic in July, August, etc…. up to March is assumed to be 3000 per month. The same logic applies to other monthly components. The summation of all these components for the financial year is the regular Earnings.
    • The amount that is projected may not always be the amount paid in that month. Take the example of Basic, which is 3000. If in a month, a person has a one day LOP then his Basic paid will be Rs. 2900. In this case, we need to project 3000 and not 2900.

Perquisites

  • Perquisites or Perks are the benefits given to an employee instead of actual cash. Here no cash salary is paid, but a notional value is added to the taxable income of the employee. Some common Perquisites and their explanations are given as follows:
  • House Perquisite or House Perquisites
    • If a company provides housing to the employee or rent for a house instead of paying an HRA (House Rent Allowance) then a House Perquisite needs to be calculated and added to the Taxable Income.
    • A very common way of calculating the House Perquisite is to take 10% of the total taxable income of the employee.
    • The actual method involves a calculation based on the actual rent paid for the house or FRV (Fair Rental Value) and whether the employee stays in a metro or non-metro city.
    • HRA and House Perquisite are mutually exclusive components, i.e. if an employee is getting HRA then House Perquisite is not calculated and vice verse.
  • Vehicle Perquisite
    • Vehicle Perquisite is calculated when the company either provides a vehicle to the employee or pays a rent for the vehicle used by the employee for company purposes.
    • Vehicle Perquisite is based on the type of vehicle (above or below 1200cc) and whether the employee employs a driver whose salary is also claimed from the company.
    • The calculated amount is added to the taxable income of the employee as Vehicle Perquisite.
  • Assets at Residence
    • If a company provides assets to an employee then a Perquisite for the Assets at Residence needs to be calculated. These assets generally include White Goods (TV, Fridge, Washing Machine, Furniture, A/C, etc).
    • A general method of calculating the assets at Residence is to take 10% of the value of the assets as the Perquisite Value.
    • The calculated amount is added to the taxable income of the employee as Perquisite on Assets at Residence.
  • Lunch Perquisite
    • If a company provides Lunch to its employees then a Perquisite for the Lunch so provided needs to be calculated.

Exemptions

  • On the income that is paid to an employee, there are certain exemptions that can be claimed. Claiming an exemption will result in the taxable income of the employee being reduced. The common exemptions are given as follows:
  • House Rent Exemption (HRA Exemption)
    • An employee can claim an exemption towards house rent if he is living in a rented accommodation. This is called as House Rent Exemption. The exemption is calculated as follows:
      • 40% of total Basic. (This will be 50% in case the employee is living in a metro).
      • Total HRA.
      • Annual Rent paid in excess of 10% of Basic. ( Rent Paid - 10% of Basic).
      • The least of the above 3 will be taken as the exemption.
    • If an employee has to avail HRA Exemption, then he has to provide proof of Rent paid. This will be in the form of rent receipts.
    • In case an employee has stayed in a rented accommodation only for part of an year, then the exemption will be given only for the HRA received in that period. Exemptions will only be calculated for the month the rents have been paid.
  • Conveyance Exemption
    • An employee can claim an exemption on the amounts paid to him under Conveyance. This is called as Conveyance Exemption.
    • Conveyance Exemption is calculated on a monthly basis. Every month the employee can claim Rs. 800 or actual Conveyance paid, whichever is lower, as Conveyance Exemption.
  • Medical Exemption
    • An employee can claim an exemption on the amounts spent on Medical expenses for self and dependent family members. This is called as Medical Exemption.
    • Medical Exemption is calculated as Rs. 15000 or the actual Medical amounts paid for a financial year, whichever is lower.
    • The employee will need to produce medical bills to claim this exemption.
  • LTA Exemption or Leave Travel Allowance Exemption
    • An employee can claim an exemption based on the money spent during a tour with family. This is called as LTA Exemption.
    • LTA Exemption can be claimed twice in a block of 4 years.
    • There is no upper limit on the exemption that can be claimed.
    • All the amount received by the employee under LTA can be claimed as an exemption provided the same as been spent.
    • There are various rules on how to calculate the exemption amounts.
  • Education Exemption
    • An employee can claim an exemption on the expenses incurred toward providing education for up to two dependent children. This is called as Education exemption.

Profession Tax

  • The government allows the entire Profession Tax paid by the employee to be deducted from the taxable income of the employee.

Income Chargeable under the head Salaries

  • The income that remains after removal of the exemptions and Profession Tax is called as Income chargeable under the head Salaries.
  • Income under head Salaries = Actual Income + Projected Income + Perquisites - Exemptions - Profession Tax.

Other Income

  • To the salary income, you will then need to add any other income that is declared by the employee. This could be interest income or any other income.
  • An important element that is commonly used here is the Loss on House Property. If an employee is repaying an housing loan then the interest paid on that loan can be reduced from the Salary income of the employee. This is put as negative income and adding this to the Salaries reduces the Salary income.

Gross Total Income

  • The amount that is computed when the Other Income is added to the Salaries is called as Gross Total Income.

Chapter 6 Deduction

  • From the Gross Total Income, the investments made by the employee under various approved funds and payments done for Mediclaim, etc can be deducted.
  • These deductions are called as Chapter 6 Deductions.
  • There are various sections under which an employee can claim a deduction. The most common are 80C, 80D, 80G, and 80CCC. A brief information on the sections and various items under each are listed here. This is not an exhaustive list.
    • 80C pertains to investments made under PF, PPF, NSS, Post Office Savings schemes, LIC Premiums, etc.
    • 80D pertains to premiums paid for Medical Insurance.
    • 80DD pertains to amounts spent on Medical Treatments.
    • 80E pertains to interest paid on Education loans.
  • Aggregate amount deductible under section 80C shall not exceed one lakh and fifty thousand rupees.
  • Aggregate amount deductible under the three sections, i.e. 80C, 80CCC, and 80CCD shall not exceed one lakh and fifty thousand rupees.
  • The total of all amounts deductible under Chapter 6 is added up and removed from the Gross Total Income.
  • This amount is called as Taxable Income. This amount is always rounded off to the nearest 10 rupees.
Income Tax payable
  • On the Taxable Income, income tax is calculated.
  • Income Tax is computed on a slab basis.
  • On the income tax, depending on various rules and policies in effect, Surcharge and cess will be calculated.
  • The sum of the Income Tax, Cess, and Surcharge is called as the Total Tax payable.
Tax Deduction at Source (TDS)
  • The income tax payable is an annual amount i.e. it is the amount to be paid for an entire year.
  • Deduction of this income tax from the income paid to the employee is the responsibility of the employer. The employer needs to do this deduction.
  • This deduction is called as Tax Deducted at Source or TDS.
  • Usually, the employer will compute the total tax. From this tax, the amount of tax already paid will be deducted. The balance amount is divided by the number of remaining months in the financial year and the tax is deducted in equal installments.
  • This is shown as a the Income Tax deduction in the payslip of the employee.

Various reports to be generated as an employer

As an employer you need to generate and file the following reports:

  1. Monthly Income Tax Report: This is the total amounts that you have deducted from each employee. This amount needs to be paid under a Tax Challan to the Income Tax Department.
  2. In June 2009, the Income Tax Department notified that the monthly statement of Income Tax deducted and paid should be filed as a separate report called Form 17. This was later withdrawn and is expected to come into effect from April 2010 onward.
  3. Form 24Q: This is a report that needs to be generated every quarter. This gives information on all the amounts paid to your employee, tax that you have deducted, and the tax that you have paid. Quarter is a 3 month period starting from April of every year.
  4. In June 2009, the Income Tax Department notified that the quarterly return Form 24Q was not needed and instead a quarterly compliance statement called Form 24C was to be generated and filed. This was later withdrawn and is expected to come into effect from April 2010 onward.
  5. Form 24: This report needs to be generated once a year. This is a consolidated information of all amounts paid to an employee, tax deducted. and tax paid.
  6. Form 16 and Form 12BA: This report needs to be generated and given to an employee once a year. This contains complete information on all the salaries paid to the employee along with information on Perquisites, Exemptions, Deductions, and Tax calculations. This is given either when an employee leaves the company or at the end of the Financial year.

 

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