Library / Income-tax Act, 2025: The Professional's Master Guide

7. Salaries (Sections 15 to 19)

7.1 What is salary

Salary includes wages, pension, annuity, gratuity, fees, commission, perquisites, profits in lieu of salary, advance salary and leave encashment. Section 16 defines salary, section 17 covers perquisites and section 18 covers profits in lieu of salary. Section 19 lists the deductions and exemptions available from salary. Salary is taxable on due or receipt basis, whichever is earlier.

7.2 Key deductions and exemptions (Section 19)

Item	Old regime	New regime (default)
Standard deduction	Rs. 50,000	Rs. 75,000
Family pension deduction	1/3 or Rs. 15,000, lower	1/3 or Rs. 25,000, lower
Professional tax	Allowed	Not allowed
HRA exemption	Allowed	Not allowed
Leave Travel Concession	Allowed	Not allowed
Gratuity, leave encashment, VRS, commuted pension	Exempt within limits	Exempt within limits

7.3 Worked example: old vs new regime

Illustration 15: Priya, Mumbai, age 32, Tax Year 2026-27

Salary: Basic Rs. 7,20,000, HRA Rs. 3,60,000, Special allowance Rs. 5,70,000. Gross salary Rs. 16,50,000.

Rent paid Rs. 25,000 per month (Rs. 3,00,000 per year). Professional tax Rs. 2,500.

Investments: EPF plus PPF plus ELSS Rs. 1,50,000, health insurance for self Rs. 25,000, own NPS contribution Rs. 50,000.

Step 1: HRA exemption (old regime only), least of the three amounts below.

(a) Actual HRA received	3,60,000
(b) 50% of basic (Mumbai is a metro city)	3,60,000
(c) Rent paid less 10% of basic (3,00,000 less 72,000)	2,28,000
HRA exempt (least of above)	2,28,000

Step 2: Total income under both regimes.

Particulars	Old regime (Rs.)	New regime (Rs.)
Gross salary	16,50,000	16,50,000
Less: HRA exemption	(2,28,000)	Not allowed
Less: Standard deduction	(50,000)	(75,000)
Less: Professional tax	(2,500)	Not allowed
Income from salary	13,69,500	15,75,000
Less: Section 123 (old 80C)	(1,50,000)	Not allowed
Less: Section 126 (old 80D)	(25,000)	Not allowed
Less: Section 124 (old 80CCD(1B)) own NPS	(50,000)	Not allowed
Total income	11,44,500	15,75,000

Step 3: Tax.

Tax computation	Old regime (Rs.)	New regime (Rs.)
Old: 5% of 2.5 lakh to 5 lakh	12,500
Old: 20% of 5 lakh to 10 lakh	1,00,000
Old: 30% of 1,44,500	43,350
New: 5% of 4 lakh to 8 lakh		20,000
New: 10% of 8 lakh to 12 lakh		40,000
New: 15% of 3,75,000 (12 lakh to 15.75 lakh)		56,250
Tax before cess	1,55,850	1,16,250
Health and education cess 4%	6,234	4,650
Total tax	1,62,084	1,20,900

Result: the new regime saves Priya Rs. 41,184, even after giving up HRA and all deductions. Always compute both before advising.

Key point

Under the new regime a salaried resident with salary up to Rs. 12,75,000 pays zero tax: Rs. 12,75,000 less Rs. 75,000 standard deduction is Rs. 12,00,000, and the rebate under section 156 covers the full tax.

Employer contribution to NPS (section 124, old 80CCD(2)) is allowed in the new regime too, up to 14% of salary.

7.4 Perquisites in brief

Rent-free accommodation, car, free meals above limits, ESOPs, interest-free loans and club facilities are valued under the Income-tax Rules, 2026. The employer reports them in Form 123 (old 12BA).
ESOP: taxable as perquisite when shares are allotted (FMV on exercise date less amount paid). Later sale gives capital gains with cost equal to that FMV.
A vehicle provided for travel between home and office is excluded from perquisites under the 2025 Act, clarifying the earlier position.
Employees declare investments and HRA details to the employer in Form 124 (old 12BB).

Illustration 16: ESOP

Arjun exercises 1,000 options at Rs. 100 each on 1 August 2026 when the FMV is Rs. 600. Perquisite = 1,000 x (600 less 100) = Rs. 5,00,000, taxed as salary with TDS under section 392.

He sells the shares in September 2027 at Rs. 900. Capital gain = 1,000 x (900 less 600) = Rs. 3,00,000. Holding period counts from allotment.

7.5 Relief for arrears (section 157, old 89)

When salary arrears are received in a later year, tax can go up because of higher slabs. Relief is available by recomputing tax as if the arrears were taxed in the years they relate to. The employee files the relief form (old Form 10E, now Form 39) before filing the return.

7.6 Is it salary at all? Employer and employee relationship

Income is taxed as salary only if there is an employer and employee relationship. Payments to consultants, retainers and independent professionals are business or professional income, taxed under a different head and subject to TDS under section 393 rather than 392. The courts look at the degree of control over how the work is done, integration into the organisation, the right to terminate, and whether the person works for others as well.

Illustration 17: Director remuneration

A whole time director of a company receives a monthly salary under an employment contract. This is salary. An independent director receives sitting fees and commission for attending board meetings; he is not an employee, so this is income from other sources or profession, with TDS at 10% under section 393 (old 194J).

Judicial view: Director as employee

Ram Prashad v. CIT (Supreme Court, 1972): whether a managing director is an employee depends on the terms of his appointment. Where he works under the control and supervision of the board, the relationship is one of employment and the remuneration is salary; where he acts as an agent with independent powers, it may not be.

7.7 Allowances under the Income-tax Rules, 2026

Allowances are fixed cash amounts paid by the employer. They are fully taxable unless a specific exemption applies. The Rules, 2026 have substantially increased several limits that had not changed for decades. Most of these exemptions are available only in the old regime; the transport allowance for specially abled employees and certain official allowances are available in both.

Allowance	Exempt limit (Rules, 2026)	Earlier limit
House rent allowance	Least of actual HRA; 50% of salary in Mumbai, Delhi, Kolkata, Chennai, Ahmedabad, Bengaluru, Hyderabad, Pune (40% elsewhere); rent paid less 10% of salary	50% only for 4 metros
Children education allowance	Rs. 3,000 a month per child, up to 2 children	Rs. 100
Children hostel allowance	Rs. 9,000 a month per child, up to 2 children	Rs. 300
Transport allowance for specially abled employees	Rs. 15,000 a month in metros, Rs. 8,000 elsewhere (plus DA as specified)	Rs. 3,200
Transport allowance for employees in transport business	70% of allowance, up to Rs. 25,000 a month	Rs. 10,000
Underground allowance (mines)	Up to 15% of basic pay	Rs. 800
Travel, daily, conveyance, helper allowances for official duty	To the extent actually spent for official work	Same
Uniform allowance	To the extent spent on uniform for work	Same

"Salary" for HRA means basic pay plus dearness allowance (if part of retirement benefits) plus commission as a fixed percentage of turnover, for the period during which rented accommodation was occupied.

Illustration 18: HRA in Ahmedabad

Hardik works in Ahmedabad. Basic salary Rs. 60,000 a month, DA forming part of retirement benefits Rs. 10,000 a month, HRA Rs. 30,000 a month. Rent paid Rs. 32,000 a month. He is in the old regime.

Salary for HRA = Rs. 70,000 a month = Rs. 8,40,000 a year. Under the Rules, 2026, Ahmedabad qualifies for 50%.

(a) Actual HRA (30,000 x 12)	3,60,000
(b) 50% of salary (8,40,000 x 50%)	4,20,000
(c) Rent paid less 10% of salary (3,84,000 less 84,000)	3,00,000
HRA exempt	3,00,000
Taxable HRA (3,60,000 less 3,00,000)	60,000

Under the old rules Ahmedabad was a 40% city, so (b) would have been Rs. 3,36,000; the exemption would still be Rs. 3,00,000 here, but for employees paying higher rent the change adds real value.

7.8 Valuation of perquisites

Perquisites are benefits in kind. They are valued under the Rules and added to salary. The table summarises the main ones, reflecting the Rules, 2026.

Perquisite	Valuation (broad)
Rent-free accommodation (private employer, owned or leased)	Owned: percentage of salary based on city population (10%, 7.5% or 5%). Leased: lower of actual lease rent and 10% of salary. Less any rent recovered from the employee
Motor car used for official and personal purposes, engine up to 1.6 litres or electric, expenses met by employer	Rs. 5,000 a month, plus Rs. 3,000 if a driver is provided
Same, engine above 1.6 litres	Rs. 7,000 a month, plus Rs. 3,000 for driver
Car owned or hired by employer, running expenses met by the employee (mixed use, up to 1.6 litres)	Rs. 2,000 a month, plus Rs. 3,000 if a driver is provided
Car owned by the employee, running expenses reimbursed by the employer (mixed use)	Actual expenses less the amount prescribed in the Rules for official use
Car used only for official purposes, with records	Nil
Car used only for personal purposes	Actual cost to employer plus 10% of cost of car as hire charges
Interest-free or concessional loans	Interest at SBI lending rate on 1 April less interest recovered; exempt if aggregate loans do not exceed Rs. 2,00,000, and for medical loans for specified diseases
Free meals	Exempt up to Rs. 200 per meal during office hours, or through non-transferable vouchers
Gifts and vouchers	Exempt up to Rs. 15,000 in the year; the entire amount is taxable if it exceeds this
Club membership, credit card for personal use	Actual amount paid by employer
ESOP or sweat equity	FMV on date of exercise less amount paid by employee
Employer contribution to PF, NPS and superannuation	Taxable to the extent aggregate exceeds Rs. 7.5 lakh in a year, along with accretions on the excess
Medical treatment in employer's hospital or approved hospital	Exempt within conditions

Judicial view: Valuation of perquisites

Arun Kumar v. Union of India (Supreme Court, 2006): upheld the Rules for valuing rent-free accommodation. A perquisite is a benefit or advantage given by the employer in connection with employment, and the Rules supply the machinery to value it; the valuation in the Rules is binding.

Illustration 19: Company car and loan

Kavya, a manager, is provided a 2.0 litre car with driver for official and personal use; all expenses are paid by the employer. She also has a housing loan from the employer of Rs. 10,00,000 at 4% when the SBI rate is 9%.

Car perquisite = (7,000 plus 3,000) x 12 = Rs. 1,20,000.

Loan perquisite = 10,00,000 x (9% less 4%) = Rs. 50,000 (the Rs. 2 lakh exemption does not apply since the loan exceeds it).

Total perquisites added to salary = Rs. 1,70,000. These values are taxable in both regimes.

Illustration 20: Employer retirement contributions above Rs. 7.5 lakh

A senior executive's employer contributes Rs. 4,50,000 to PF, Rs. 3,00,000 to NPS and Rs. 1,50,000 to a superannuation fund, total Rs. 9,00,000. The excess of Rs. 1,50,000 over Rs. 7,50,000 is a taxable perquisite, and the annual accretion (interest or returns) on that excess is also taxable each year, computed as per the Rules.

7.9 Retirement benefits in detail

Gratuity

Employee	Exempt amount
Government employee	Fully exempt
Covered by the Payment of Gratuity Act	Least of: actual gratuity; 15/26 x last drawn salary (basic plus DA) x completed years of service (part of a year above 6 months counts as a full year); Rs. 20,00,000
Not covered by that Act	Least of: actual gratuity; half month's average salary (last 10 months) x completed years (ignore part of a year); Rs. 20,00,000

Illustration 21: Gratuity

Ramesh retires from a private company covered by the Payment of Gratuity Act after 24 years and 8 months of service. Last drawn basic plus DA = Rs. 1,04,000 a month. Gratuity received = Rs. 16,00,000.

Years of service = 25 (8 months exceeds 6 months). Formula amount = 15/26 x 1,04,000 x 25 = Rs. 15,00,000.

Exempt = least of 16,00,000, 15,00,000 and 20,00,000 = Rs. 15,00,000. Taxable = Rs. 1,00,000.

Leave encashment on retirement

For non-government employees, the exemption is the least of: actual amount; 10 months' average salary; cash equivalent of unavailed leave calculated at 30 days for every year of service; and Rs. 25,00,000 (lifetime limit). Leave encashment while in service is fully taxable.

Illustration 22: Leave encashment

Ramesh also receives Rs. 12,00,000 for 300 days of accumulated leave. His entitlement was 30 days a year and he availed 450 days in 25 years. Average salary for the last 10 months = Rs. 1,00,000.

Leave to credit on the 30 days basis = (25 x 30) less 450 = 300 days = 10 months. Cash equivalent = 10 x 1,00,000 = Rs. 10,00,000. Ten months' average salary = Rs. 10,00,000.

Exempt = least of 12,00,000; 10,00,000; 10,00,000; 25,00,000 = Rs. 10,00,000. Taxable = Rs. 2,00,000.

Pension

Uncommuted (monthly) pension is fully taxable as salary. Commuted pension (lump sum) is fully exempt for government employees. For others, one third of the full commuted value is exempt if the employee also receives gratuity, and one half if he does not.

Illustration 23: Commuted pension

Ramesh commutes 40% of his pension and receives Rs. 8,00,000. The full commuted value (100%) is therefore Rs. 20,00,000. Since he also received gratuity, exempt amount = one third of 20,00,000 = Rs. 6,66,667. Taxable = Rs. 1,33,333.

VRS and retrenchment compensation

Compensation on voluntary retirement under a scheme that meets the prescribed conditions is exempt up to Rs. 5,00,000, once in a lifetime. Retrenchment compensation is exempt up to the least of the amount under the Industrial Disputes Act formula, Rs. 5,00,000 and the actual amount.

7.10 Provident funds

Fund	Employer contribution	Interest	Withdrawal
Statutory PF (government)	Exempt	Exempt	Exempt
Recognised PF (EPF)	Exempt up to 12% of salary (within the overall Rs. 7.5 lakh cap)	Exempt up to 9.5%; interest on employee contribution above Rs. 2.5 lakh a year taxable	Exempt after 5 years of continuous service; otherwise recomputed as unrecognised
Unrecognised PF	Not taxed yearly	Not taxed yearly	Employer share and interest taxed as salary on withdrawal; interest on own share as other sources
Public Provident Fund	Not applicable	Exempt	Exempt

Practice note

When an employee withdraws EPF before completing 5 years, TDS applies at 10% above Rs. 50,000 if PAN is given. Check whether the service with earlier employers was transferred; transferred service counts towards the 5 years.

7.11 Relief for arrears of salary (section 157) with a worked example

When salary relating to earlier years is received in a later year, the whole amount is taxed in the year of receipt, possibly at a higher slab. Relief is computed as follows:

(1) Tax on total income of the current year including arrears, less tax on total income of the current year excluding arrears.
(2) Tax on total income of the earlier year including the arrears relating to it, less tax on total income of that year excluding them.
Relief = (1) less (2), if positive. The employee must file Form 39 (old 10E) before filing the return.

Illustration 24: Arrears relief

Leela receives arrears of Rs. 3,00,000 in Tax Year 2026-27 relating to FY 2024-25 due to a pay revision. Her taxable income for Tax Year 2026-27 without arrears is Rs. 11,00,000 (new regime), and for FY 2024-25 it was Rs. 7,00,000 (new regime as then applicable).

Tax Year 2026-27: tax on Rs. 14,00,000 = Rs. 90,000 before cess (no rebate, as income exceeds Rs. 12 lakh). Tax on Rs. 11,00,000 = nil (rebate). Difference = Rs. 90,000 plus cess.

FY 2024-25: compute tax on Rs. 10,00,000 and Rs. 7,00,000 using that year's slabs and rebate (rebate then available up to Rs. 7 lakh). Under those slabs, tax on Rs. 10,00,000 was Rs. 50,000 and on Rs. 7,00,000 nil after rebate. Difference = Rs. 50,000 plus cess.

Relief = Rs. 90,000 less Rs. 50,000 = Rs. 40,000 plus the related cess. Filing Form 39 is essential; without it the CPC will not allow the relief.

7.12 Structuring salary: practical guidance

Component	Tax point to consider
Employer NPS contribution	Deductible in both regimes up to 14% of salary (new) or 10% (old); watch the Rs. 7.5 lakh aggregate cap
Meal vouchers	Up to Rs. 200 per meal exempt; useful in the old regime
Company leased car	Fixed perquisite value may be lower than the cost of a car allowance fully taxed
Reimbursement of official expenses	Not income if supported by bills and used for official work
Children education and hostel allowance	Substantially higher limits under Rules, 2026 in the old regime
Gifts and vouchers	Keep total within Rs. 15,000 a year per employee
Telephone and internet	Employer provided telephone and internet are not taxable perquisites

Key point

Choosing between regimes should be done each year after listing all exemptions and deductions actually available. With the Rules, 2026 increasing allowance limits, some employees paying high-rent in the eight metros may again find the old regime better. Run both computations.

7.13 ESOPs and RSUs of a foreign parent

Many employees of Indian subsidiaries of multinationals receive stock options or restricted stock units (RSUs) of the foreign parent. The taxation follows a three-stage pattern:

Stage	Tax effect in India
Grant	No tax
Vesting and allotment (RSU) or exercise and allotment (option)	Perquisite = FMV on the date of exercise or allotment less amount paid. For shares listed abroad, FMV is based on the price on the foreign exchange. TDS under section 392 by the Indian employer
Sale	Capital gain: sale value less FMV taken as perquisite. Foreign shares are long-term after 24 months; LTCG at 12.5%; STCG at slab rates
Dividends	Taxable at slab rates; foreign tax withheld (for example, US tax of 25% withheld on dividends to Indian residents under the treaty) is claimed as foreign tax credit
Reporting	Shares and dividends must be reported in Schedule FA (calendar year basis) and Schedule FSI; missing this can attract the Black Money Act penalty

Illustration 25: RSUs of a US parent

Arun receives 200 RSUs of a US listed parent that vest on 15 June 2026 when the share price is USD 150 and the rupee rate is 84. Perquisite = 200 x 150 x 84 = Rs. 25,20,000, added to salary and subject to TDS. The US broker may sell some shares to cover US withholding only if required; generally no US tax applies on vesting for an Indian resident.

He sells the 200 shares on 20 August 2028 at USD 180 (rate 86). Sale value = Rs. 30,96,000. Cost = Rs. 25,20,000. Holding is more than 24 months, so LTCG = Rs. 5,76,000, taxed at 12.5%.

Chapter summary

• Salary requires an employer and employee relationship; consultants are taxed under business or profession.

• Standard deduction: Rs. 75,000 (new) and Rs. 50,000 (old).

• Rules, 2026 raised allowance limits and added Ahmedabad, Bengaluru, Hyderabad and Pune to the 50% HRA cities.

• Perquisites are valued under the Rules; car, loan, meal and gift values were revised.

• Retirement benefits have specific exemption formulas; employer contributions above Rs. 7.5 lakh are taxable.

• Arrears relief under section 157 requires Form 39 before filing the return.