Salary for NPS purposes

The word "salary" does not mean the same thing every time it appears in the NPS tax rules. For working out contribution limits and deductions, the workbook gives it a narrow, specific meaning.

"Salary" here means basic salary and dearness allowance, and dearness allowance counts only if the terms of employment treat it as part of retirement benefits. Every other allowance and every perquisite is left out.

This narrow definition applies to both the 10%/20% limit on the employee's own contribution under Section 80CCD(1), and the salary-percentage limit on the employer's contribution under Section 80CCD(2). Only basic pay plus qualifying dearness allowance goes into that calculation; bonuses, HRA and other perquisites do not.

The workbook's own worked case: an employee's basic salary is Rs 6,00,000 a year, with dearness allowance of Rs 2,40,000 a year (40% of basic), of which 50% — Rs 1,20,000 — forms part of retirement benefits under the terms of employment. Salary for computing the NPS deduction is Rs 6,00,000 + Rs 1,20,000 = Rs 7,20,000, not the full Rs 8,40,000 of basic plus total dearness allowance.

Continuing the workbook's own figures: the employee's employer, a non-government entity, contributes 15% of basic salary to NPS — Rs 90,000 (15% of Rs 6,00,000). Because employer contributions to NPS are capped at 10% of salary under the old tax regime for a non-government employee, the deduction under Section 80CCD(2) is limited to 10% of Rs 7,20,000 = Rs 72,000, even though the employer actually contributed Rs 90,000.

Using the full Rs 8,40,000 of basic-plus-DA instead of the correct Rs 7,20,000 "salary for NPS purposes" would overstate the allowable deduction by Rs 12,000 — 10% of the Rs 1,20,000 difference.

Chapter 12 (Taxation of Other Products), section 12.3.1, "Tax treatment of contribution to NPS," states this narrow salary definition separately for both employee and employer contributions, immediately before working through Example 9's full computation. Expect a question that gives a dearness allowance figure and asks the candidate to apply the "if terms of employment so provide" condition correctly.

• Dearness allowance counts only if the terms of employment treat it as part of retirement benefits — not automatically, and not the full DA amount unless all of it qualifies.
• This "salary" is narrower than the Section 17(1) definition used elsewhere in the Act — perquisites and other allowances that count as salary for other purposes are excluded here.
• The same narrow definition applies to both the employee's and the employer's NPS contribution limits. Using a different salary figure for each is a common computational error.