TIBS Blog

The opening sentence of Section 192 of the Indian Income Tax Act is presented as follows. Please click here to see the source.

192. (1) Any person responsible for paying any income chargeable under the head “Salaries” shall, at the time of payment, deduct income-tax on the amount payable at the average rate of income-tax computed on the basis of the [rates in force] for the financial year in which the payment is made, on the estimated income of the assessee under this head for that financial year.

The section states that tax on salary shall be deductible at the time of salary payment. No problem about that.

It gets a bit confusing when one reads the phrase “….income-tax computed on the basis of the [rates in force] for the financial year in which the payment is made,…” in the above excerpt.

When salary payment is made within the same financial year, the tax rates in force for the financial year should be used for tax computation, according to Section 192. So far, so good.

But what if salary, which accrues on March 31 of a year, is paid out in the first week of April (the beginning of the next financial year)?

There are many organizations that pay salary — that accrues on the last day of a calendar month — in the first week of next month. If one were to go by the letter of Section 192, in such organizations, until February salary, employees’ salary should be taxed as per tax rates prevailing in that financial year. But the March salary paid in April will have to be taxed as per the rates for the next financial year (starting April).

Even if salary is paid on the last day of March, final settlements for employees who leave an organization in March may be processed only in April or later. In such cases too, the words that describe Section 192 give rise to confusion.

What is the confusion about?

The way Section 192 is worded puts it in conflict with Section 15 of the Income Tax Act which states that taxability on salary arises whenever salary is due/accrued or paid, whichever is earlier. In case of fixed heads of pay such as Basic pay, salary accrues on March 31, and taxability arises on March 31 according to Section 15. While the tax may be deducted in April or later, whenever the salary is paid, the amount of tax calculated should be as per the tax rates that prevailed in March.

Organizations tax salaries that accrue in March as per tax rates for that financial year ending March, in accordance with Section 15, whether the salary is paid in April or later. If one goes by the (poorly worded) section 192, such organizations can be viewed as deducting tax in contravention to Section 192.

Software developers, at the time of testing software, use what are called test cases to check if a software application works as per the functional specification the software is expected to meet. A test case is a set of rules/conditions which a developer applies to check if the software is functioning as expected. It is important for law makers to apply test cases while drafting a law in order to check if the words fully and accurately convey the intention of the law.

Section 192, the way it is currently worded, fails the test case of March salary paid in April.

A well worded law goes a long way in ensuring compliance with the spirit of the law. On the other hand, a poorly written law increases the cost of and lowers the likelihood of compliance.

The Indian Income Tax Act clearly specifies the conditions under which a salaried employee can claim tax rebate on interest payment for housing loan. Section 24 of the Income Tax Act states that no deduction is permissible on interest payment during the years in which construction of the property is still to be completed. Interest for pre-construction period is eligible for deduction in 5 equal installments (across 5 years) from the year construction is completed.

What about tax rebate on account of principal repayment? When the property for which a loan has been taken is under construction, can an employee claim rebate under Section 80C for principal repayment?

Some payroll managers opine that Section 80C doesn’t explicitly bar the rebate on account of principal repayment when the property is under construction. However, a look at the law suggests that tax rebate on principal repayment may not be allowed when the property is under construction.

The relevant clause under Section 80C is presented as follows. Click here to see the source.

80C. (1) In computing the total income of an assessee, being an individual or a Hindu undivided family, there shall be deducted, in accordance with and subject to the provisions of this section, the whole of the amount paid or deposited in the previous year, being the aggregate of the sums referred to in sub-section (2), as does not exceed one lakh rupees.

(2) The sums referred to in sub-section (1) shall be any sums paid or deposited in the previous year by the assessee—

(xviii) for the purposes of purchase or construction of a residential house property the income from which is chargeable to tax under the head Income from house property (or which would, if it had not been used for the assessees own residence, have been chargeable to tax under that head), where such payments are made towards or by way of

(a) any instalment or part payment of the amount due under any self-financing or other scheme of any development authority, housing board or other authority engaged in the construction and sale of house property on ownership basis; or

(b) any instalment or part payment of the amount due to any company or co-operative society of which the assessee is a shareholder or member towards the cost of the house property allotted to him; or

(c) repayment of the amount borrowed by the assessee from

(1) the Central Government or any State Government, or

(2) any bank, including a co-operative bank, or

(3) the Life Insurance Corporation, or

(4) the National Housing Bank, or

(5) ……………

A close look at clause (xviii) stated above suggests that for the principal repayment to be considered for tax rebate under Section 80C, there should be an income (or notional income) from the house property. When a property is under construction, there is no likelihood of income, and hence under Section 80C there is no provision for tax rebate on account of principal repayment. Only in the year in which the construction is completed can the principal repayment be considered for tax rebate. The same rule is applicable not only for principal repayment but also for stamp duty and registration charges.