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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.

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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 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.

Section 192 of the Income Tax Act should be worded better

March 30, 2010 Leave a comment

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.

Property under construction: Tax benefit from principal repayment

March 23, 2010 Leave a comment

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.