Salary (Section 17(1))
The Income Tax Act's own definition of what counts as salary — wages, pension, gratuity, commission, advance salary, perquisites, leave encashment and more — under Section 17(1).
In plain language
What exactly counts as "salary" for tax purposes is not left to common sense. Section 17(1) of the Income Tax Act, 1961 spells it out.
The definition is wide. It goes well beyond the monthly pay cheque, and it decides what an employer must add up before working out how much tax to deduct.
How it works
Section 17(1) includes, among other items: wages, annuity, pension, gratuity, any fees or commission, advance of salary, perquisite or profits in lieu of salary, leave encashment, the employer's contribution to a provident fund in excess of 12% of salary, contribution to a pension scheme, and contribution to the Agniveer Corpus Scheme.
Two consequences follow directly. First, an employer's NPS contribution above the salary percentage limit, and a provident fund contribution above 12% of salary, are added to the employee's taxable salary rather than staying outside it. Second, the Government's own contribution to the Agniveer Corpus is deductible under Section 80CCH, even under the new tax regime.
Salary income needs an employer-employee relationship to exist at all. Without one, the same payment is taxed as business income or income from other sources instead. It is taxed on a due or receipt basis, whichever is earlier, except for ESOPs, which follow their own separate timing rules.
A worked example
Illustrative figures. Ms Rane's monthly pay slip shows basic pay and a special allowance. In March, her employer also pays her an advance of Rs 50,000 against next month's salary, because of a family emergency.
Even though this Rs 50,000 has not technically been "earned" for the month it is paid in, Section 17(1) expressly includes advance of salary in the definition of salary. It is added to her taxable salary for the year it is received, on a receipt basis, rather than waiting for the month it would otherwise have been due.
Why NISM asks about it
Chapter 7 (Concepts of Taxation), section 7.6.1, "Income from Salary," opens with the Section 17(1) definition before moving to the applicable deductions and exemptions. Expect a question testing which items the definition includes, particularly advance salary, leave encashment and the Agniveer Corpus contribution, which candidates often leave out.
Common exam traps
- The Section 17(1) list is inclusive, not exhaustive. "To include" language means other, similar receipts can also count as salary even if not named.
- An employer-employee relationship must exist first. The same fee paid to an independent consultant is not salary at all.
- Advance salary and leave encashment are both named inclusions, frequently missed in a quick recall of what counts as salary.
- ESOPs are a stated exception to the due-or-receipt-basis rule. They follow the separate timing rules taught in Chapter 12, not the general salary rule.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- National Pension SystemA PFRDA-regulated, defined-contribution retirement scheme in which the subscriber builds a market-linked corpus and must convert part of it into an annuity at exit; there is no guaranteed return.
- Standard deductionA flat deduction allowed without proof of expenses — Rs 50,000 (old regime) or Rs 75,000 (new regime) from salary, and 30% of net annual value from let-out house property.
- Salary for NPS purposesFor NPS contribution and deduction limits, "salary" means only basic pay plus dearness allowance where the terms of employment count it towards retirement benefits — every other allowance and perquisite is excluded.
- House Rent Allowance exemptionHouse Rent Allowance is exempt up to the least of the HRA actually received, rent paid minus 10% of salary, and 50% of salary in a metro or 40% elsewhere — and is not available under the new tax regime.