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Section 206AA: Higher TDS on salary

June 15, 2010 1 comment

The Income Tax Department, by introducing Section 206AA, has mandated that TDS deductors should deduct TDS at 20% or the actual TDS rate(s), whichever is higher, in the event of the assessee (deductee) not submitting a valid Permanent Account Number (PAN).

You can take a look at the text of Section 206AA by clicking here. This section is effective April 01, 2010.

The idea behind Section 206AA is to penalize assessees who do not have a valid PAN. Given that the 20% TDS rate could be higher than the TDS rate prescribed by law in many instances, assessees who do not have a valid PAN will be forced to get themselves a PAN in order to avoid the possibility of seeking refund.

The question for payroll managers is whether Section 206AA is applicable to TDS on salary payments.

We hear from some tax practitioners that the tax department intends to bring only non-salary payments under Section 206AA, and hence salary payments are excluded from this section.

While the text of Section 206AA does not make any explicit reference to TDS on salary, nowhere in the text it is mentioned that Section 206AA is not applicable to salary payments. In fact, the text states that all payments under Chapter XVII-B (Chapter 17B) are to be considered for the applicability of Section 206AA. Since chapter XVII-B includes payments under Section 192 (salary payments) of the Income Tax Act, payroll managers should assume that Section 206AA covers salary payments.

Things to do for the payroll manager with regard to conforming to Section 206AA

1. Check the validity of PAN of your employees

A payroll manager should deduct TDS on salary as per Section 206AA for employees:

  • who have not submitted PAN
  • who have submitted invalid PAN
  • who have submitted PAN which is not theirs

Please collect PAN information from employees who are yet to submit the PAN information. With regard to employees who have provided the PAN information, please check the validity of PAN of both existing and new employees in your organization ahead of monthly payroll.

You could do an online check on the PAN of employees in your organization by using the NSDL site. For information in this regard, please take a look at the following link.

http://tin.nsdl.com/onlinepanintro.asp

In case any of your employees do not have PAN, please inform them you may deduct TDS at a higher rate in case they do not submit a valid PAN. Ideally, PAN should be included in the employee master data which is collected at the time of an employee joining your organization.

2. Include PAN in all salary related communication to employees.

According to Section 206AA,

The deductee shall furnish his Permanent Account Number to the deductor and both shall indicate the same in all the correspondence, bills, vouchers and other documents which are sent to each other.

Hence, in payslips and other documents pertaining to compensation, please state the employee PAN.

3. Deduct TDS as per Section 206AA, where applicable

Please note that Section 206AA is applicable only if the deductee has an incidence of income tax. In case of salary payments, if an employee has a taxable income which is below the minimum taxable income i.e. less than Rs. 160,000 per annum for male and less than Rs. 190,000 for female employees, then Section 206AA will not be applicable even if the employee does not furnish PAN. Please take care to exclude such employees from the purview of Section 206AA.

We will discuss the methodology for deduction of higher TDS under Section 206AA in the next post.

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Categories: Income Tax, Payroll

Changes to Form 16 format

June 12, 2010 2 comments

The Income Tax Department has announced modifications to the format of Form 16 in its notification dated May 31, 2010. You can take a look at the notification and the new Form 16 format by clicking here. The highlights pertaining to the new Form 16 format are as follows.

1. The new format should used for tax on salary, deducted on or after April 01, 2010.
2. Employers should issue Form 16 to employees by May 31 of the financial year, immediately following the financial year in which the salary was paid and tax was deducted.
3. There are two parts in the new Form 16 format:

Part A: Presents information such as PAN of the employer, employee etc., and a summary of the tax deducted at source with information such as Form 24Q receipt numbers, amounts of tax deducted and remitted.

Part B: Presents salary, exemption, and deduction information for the employee along with the signature of the person responsible for deducting tax in the organization.

4. Unlike the earlier Form 16 format the new one does not include details of tax remittance. Information pertaining to tax remittance including information such as challan identification number and bank BSR code should be presented in what is called Annexure B for non-government deductors and Annexure A for government deductors. Non-government employers should enclose Annexure B along with Form 16.

According to the notification,

If an assessee is employed under more than one employer during the year, each of the employers shall issue Part A of the certificate in Form No. 16 pertaining to the period for which such assessee was employed with each of the employers. Part B may be issued by each of the employers or the last employer at the option of the assessee.

The purport of the above text in the notification is not very clear. We wonder why any employee would not want to have Part B of the Form 16 from any of their employers if they change jobs during a year. If anything, employees should insist on receiving the Form 16 in full from all their employers in a year in order to have adequate information for filling in their tax return. Also, in case of tax refund, only when employees have complete information in their Form 16 will they be able to claim their refund correctly.

From the point of view of employers, it would be cumbersome to check with their employees whether they want Part B of the Form 16 before issuing Form 16.

Categories: Income Tax, Payroll

Form 16 – Salary and TDS pertaining to previous employment

June 5, 2010 7 comments

When employees change their job, they have the option of declaring their salary and tax on salary — pertaining to their previous employment — to their current employer for the sake of tax deduction.

When the current employer issues Form 16 for an employee, can information on salary and TDS pertaining to previous employment of the employee be shown in the Form 16?

Some tax practitioners opine that salary and TDS pertaining to the previous employment should be added to salary and TDS pertaining to the current employment, and the total amounts of salary and TDS should be shown in the Form 16 issued by the current employer.

We disagree with the above view.

We believe that salary and TDS pertaining to previous employer should not be presented in the later employer’s Form 16 for the following reasons.

1. There is no place in the current Form 16 format (as prescribed by the tax authorities) to present salary and TDS amounts pertaining to previous employment of an employee.
2. A company, while it can consider salary and TDS pertaining to another employer for the purpose of tax calculation on salary, cannot certify salary and TDS pertaining to the other company in its TDS certificate (Form 16).
3. If the previous employer salary and TDS are presented in Form 16, there will be a mismatch between data in the annexure of the fourth quarter Form 24Q and Form 16. This is because a company cannot present salary and TDS data pertaining to previous employer in its Form 24Q. The Annexure 2 of the fourth quarter Form 24Q contains nothing but details of an employee’s Form 16.
4. If TDS pertaining to the previous employment is added to the tax deducted by the current employer, the Form 16 will show a shortfall in tax remittance by the employer.

For example, let us consider the following:
Tax deducted in the previous employment: Rs. 10,000
Tax deducted in the current employment: Rs. 5,000

If in Form 16 the above two are added, the total tax deducted will be shown as Rs. 15,000 for the year, while the total tax amount remitted (by way of TDS challan payments across months) will only be Rs. 5,000 since the current company can only present the tax amount remitted by it.

This gives an incorrect picture that the employer has not remitted fully the tax amount deducted.

In short, our view is: “Consider previous employer salary and TDS for tax calculation, but not for display in Form 16.”

Categories: Income Tax, Payroll

Calculation of loss of pay – Part II

May 25, 2010 2 comments

In the previous post, we talked about how some organizations make the mistake of presenting loss of pay as a deduction in payroll instead of reduction in pay. Let us examine some more issues pertaining to loss of pay in this post.

Loss of pay when pay calculation is on the basis of the calendar day logic

If your organization follows the calendar day logic, ensure that you record dates pertaining to the days for which loss of pay should be applied for an employee. For example, let us assume that the payroll manager wishes to apply 1 day loss of pay for an employee in July payroll. It is important for the payroll manager to know to which month the loss of pay pertains. Depending on the month, the loss of pay value would change. If the employee has a monthly salary of Rs. 31,000 on which loss of pay has to be applied, the value of one-day salary in July is Rs. 1,000 (Rs. 31,000/31 days) while the value of one-day salary in June is Rs. 1033 (Rs. 31,000/30).

In case the loss of pay pertains to a day in June, and if the payroll manager applies a 1 day loss of pay in July and reduces pay by Rs 1,033 instead of Rs. 1,000, he would be committing a mistake.

Hence, in the above example, the payroll software should have the capability to take the loss of pay input by way of dates, calculate the correct loss of pay amount and reduce pay accordingly. It may be noted that many of the payroll software applications in India simply take the loss of pay input by way of days without taking cognizance of the month in which the loss of pay days fall.

Taking cognizance of dates is important not only for calculation but also for reversal of loss of pay. There are occasions when loss of pay, applied in the previous month’s payroll, may be reversed in a subsequent month on account of loss of pay having been applied by mistake earlier. Again, if the dates pertaining to the loss of pay are not considered, the reversal of loss of pay may be done incorrectly and the employee may be credited with a loss of pay reversal amount which may be different from the actual loss of pay amount deducted earlier.

Impact of loss of pay on pay arrears

Whenever pay structure changes happen with retrospective effect, payroll managers should remember to make adjustments for loss of pay, if applicable, while calculating arrear pay. Here again, unless dates pertaining to loss of pay days are recorded, the payroll manager may be calculating arrear pay incorrectly.

For example, let us assume that an employee has 1 day loss of pay in June. If the organization hikes pay by revising the pay structure of the employee in August with effect from June 1, the payroll manager should ensure that the arrear pay is calculated after taking into the impact of the one-day loss of pay in June.

Clarity in loss of pay rules for non-statutory deductions in payroll

We find that in many organizations there is no clear-cut policy pertaining to application of loss of pay on deductions, particularly with reference to fixed deductions such as loan recovery and those on account of benefits such as accommodation, recreation club facility, and transport provided by the organization.

The organization’s policy should specify if there is a hierarchy among deductions with regard to applying loss of pay. For example, a loan recovery may come first and a deduction for recreation club may come later.

In case an employee has loss of pay for the whole month, the policy should specify if fixed deductions should be carried out, given the possibility of a negative net salary on account of 100% loss of pay. If deductions such as loan recoveries are deferred to subsequent months on account of 100% loss pay, the payroll manager should re-work perquisite valuation, if applicable, on loan deductions and re-calculate the income tax liability for the year.

Categories: Payroll

Calculation of loss of pay – Part I

May 21, 2010 7 comments

The basis of calculation of loss of pay for employees is fairly well established, yet, we come across many instances of incorrect calculation of loss of pay in organizations. The mistakes we are talking about here are not calculation errors but those on account of organizations adopting an incorrect basis for calculation of loss of pay.

Let us look at a common mistake committed by payroll managers while calculating loss of pay on employee salary.

Loss of pay amount as a deduction in payroll

Some payroll managers view loss of pay as a deduction in payroll instead of a reduction in pay. For example, an employee receives a monthly Basic salary of Rs. 10,000 in April and is entitled to no other head of pay. The Provident Fund (PF) contribution is Rs.  1,200 per month (12% of Rs. 10,000). The company in which the employee works follows the calendar day basis for pay calculation. If the employee has no loss of pay in April, his salary statement will read as follows.

Earning
Basic Salary : Rs. 10,000
Deduction
Provident Fund : Rs. 1,200
Net Pay : Rs. 8,800

If the employee has 15 days loss of pay for April, the company calculates the loss of pay to be Rs. 5,000 for April, shows this as a deduction, and calculates the net pay as follows.

Earning
Basic Salary : Rs. 10,000
Deduction
Provident Fund : Rs. 1,200
Loss of Pay Deduction : Rs. 5,000
Net Pay : Rs. 3,800

The above method is wrong since PF is calculated on “fixed” Basic instead of “earned” Basic for the month. Instead of presenting the loss of pay amount as a deduction, the company should reduce the pay to arrive at the net pay. For the above example, the net pay should be calculated as follows.

Earning
Basic Salary : Rs. 5,000
Deduction
Provident Fund : Rs. 600
Net Pay : Rs. 4,400

In the above example, the company ends up paying a lower net salary — Rs. 3,800 instead of Rs. 4,400 for the month — on account of incorrect loss of pay calculation.

Specifying loss of pay as a deduction in payroll leads to incorrect income tax, PF, and Employee State Insurance (ESI) deduction calculation.

When loss of pay is stated as a deduction, the income tax, if the employee has taxable income,  is calculated on full pay and hence the employee ends up paying income tax on salary he doesn’t receive. While for PF and ESI, both employer contribution and employee deduction are overstated.

Presenting loss of pay as a deduction (instead of reduction in pay) may look like a silly mistake. But you would be surprised to know that there are many companies that commit this silly mistake while processing payroll each month.

We will examine some more issues pertaining to loss of pay calculation in the next post.

Considering TDS on Other Income while calculating tax on salary – Part II

April 11, 2010 2 comments

In the previous post, we said TDS on Other Income poses a problem to the employer from the point of view of issuing Form 16 and filing Form 24Q.

What is the problem?

In both Form 16 and the annexure in Form 24Q for the last quarter, the details of Other Income can be displayed, but there is no provision to display details of TDS on Other Income. As a result, in both Form 16 and Form 24Q, it would look as though there is a shortfall in tax deducted by the employer while in reality it is not the case. Let us take a look at an example to examine this.

A male employee receives an annual taxable salary of Rs 900,000 after all deductions. The employee has Other Income of Rs 100,000 and the TDS deducted on Other Income is Rs 10,000 (10% on Rs 100,000).

The total income including salary and Other Income is Rs 10,00,000 (Rs 900,000 plus Rs 100,000) for the year and the total tax on Rs 10,00,000 is Rs 158,620 for the year.

If the employer considers TDS on Other Income and deducts tax on salary accurately, the Form 16 issued by the employer will have the following amounts.

11. Total Income (8 – 10) Rs. 10,00,000
12. Tax on Total Income Rs. 154,000
13. Add Surcharge Rs. 0
14. Add Education Cess Rs. 4,620
15. Tax Payable (12+13+14) Rs. 158,620
16. Relief under section 89 (attach details) Rs. 0
17. Tax payable (15-16) Rs. 158,620
18. Less
(a) Tax deducted at source u/s 192(1) Rs. 148,620
(b) Tax paid by the employer on behalf of the
perquisites u/s 17(2)
19. Tax Payable/(Refundable) (17 – 18) Rs. 10,000

In the Form 16 excerpt presented above, the total income (No. 11) comprises both salary and Other Income while tax deducted (No. 18) contains only the amount deducted by the employer. There is no provision in Form 16 and Form 24Q to present TDS on Other income. As a result, No 19. above shows a Tax Payable amount of Rs 10,000. This, of course, is the TDS on Other Income and not the tax payable.

By taking a look at just Form 24Q — in its current format — the income tax department will not be able to figure out whether the Tax Payable figure is as a result of a genuine under deduction of tax by the employer, or due to TDS on Other Income.

If the tax department raises a query on the Tax Payable figure, the employer can always explain the same by submitting information on TDS on Other Income submitted by the employee. Instead of the tax department and the employer wasting time on raising and answering the query, why can’t the tax department simply modify the format of Form 16 and Form 24Q to include TDS on Other Income?

That way, the Tax Payable amount in Form 16 and Form 24Q will become zero and there will be no room for any doubt.

Considering TDS on Other Income while calculating tax on salary – Part I

April 8, 2010 2 comments

Section 192 of the Income Tax Act allows employers to consider employees’ Other Income and TDS on Other Income while calculating tax on employee salary. The relevant excerpt from Section 192 is presented as follows. Click here to see the source.

[(2B) Where an assessee who receives any income chargeable under the head “Salaries” has, in addition, any income chargeable under any other head of income (not being a loss under any such head other than the loss under the head “Income from house property”) for the same financial year, he may send to the person responsible for making the payment referred to in sub-section (1) the particulars of—(a)   such other income and of any tax deducted thereon under any other provision of this Chapter;

(b)   the loss, if any, under the head “Income from house property”,

in such form and verified in such manner as may be prescribed69, and thereupon the person responsible as aforesaid shall take—

(i)   such other income and tax, if any, deducted thereon; and

(ii)   the loss, if any, under the head “Income from house property”,

also into account for the purposes of making the deduction under sub- section (1) :

Provided that this sub-section shall not in any case have the effect of reducing the tax deductible except where the loss under the head “Income from house property” has been taken into account, from income under the head “Salaries” below the amount that would be so deductible if the other income and the tax deducted thereon had not been taken into account.]

Payroll managers have to keep in mind the following conditions imposed by Section 192 while considering Other Income and TDS on Other Income.

1. The employee should submit a declaration under Rule 26B with details of Other Income and TDS on Other Income, to the employer.
2. The employee cannot declare a loss under any “Other Income” other than “Income from House Property.”
3. The addition of TDS on Other Income should not reduce the tax deductible on salary.

The first two conditions are easy to understand. Let us take a look at the third condition by way of an example.

A male employee receives an annual taxable salary of Rs 200,000 after all deductions. As per the income tax rates prevailing for the financial year 2010-11, the total annual tax on salary, including Education Cess, is Rs 4,120. The employee has Other Income of Rs 200,000 and the TDS deducted on Other Income is Rs 40,000 (20% on Rs 200,000).

The total income including salary and Other Income is Rs 400,000 (Rs 200,000 plus Rs 200,000) for the year and the total tax on Rs 400,000 is Rs 24,720 for the year. Please note that the total tax including Education Cess (Rs 24,720) for the year is less than the TDS of Rs 40,000 deducted on Other Income. Just because the TDS on Other Income is higher than the total annual tax, the employer cannot ignore deducting the tax on salary.

According to Section 192, the TDS on Other Income should not have the effect of reducing the tax deductible under the head “Salaries” except where the loss under the head “Income from house property” has been taken into account, and hence the employer will have to deduct Rs 4,120 as TDS on salary.

Payroll managers can consider TDS on Other Income for the sake of calculating tax on salary. However, from the point of view of issuing Form 16 and filing Form 24Q, TDS on Other Income poses a problem to the employer. We will discuss that in the next post.