Section 89(1): Claim Relief on Salary Arrears
Updated: Aug 2
Salary arrears are a double-edged sword. Though it would certainly come as a pleasant surprise if one does receive back pay, it will bump up your income to a higher tax bracket, increasing the tax liability for the year. Fortunately, the Income Tax Act has a provision under Section 89(1) that permits a taxpayer to claim relief on receipt of salary or wage arrears. The article will help you understand how salaried individuals can claim the tax relief, thus better equipping them to take good care of their finances.
Table of Content
Understanding Salary Arrears
Salary arrears are any salary payment that an employee gets for past pay periods in which they did work but were not compensated. It can take place due to various reasons and usually stands as a correction in order that the amount of compensation made to an employee is matched with his work or contract agreement or the agreed salary.
Arrears may result from:
Administrative errors: Cases where due to clerical or payroll mistakes, salary payments have been delayed or incorrectly calculated.
Incremental retrospectives: Often, salary increments that are effective from a past date will result in arrears for the period between the effective date of the increment and the date when the increment is actually paid.
Delayed negotiations: It may be the case, especially for unionized positions or contractual jobs, where the impact of wage negotiations transcends to employees' previous pay periods. Therefore, this may entail a lump sum check once the agreement is reached.
Adjustments brought about by employment legal rulings: Legal rulings or an Employment Tribunal ruling may dictate salary adjustments dating back several months or even years.
Common instances where employees receive arrears salary:
Promotions: A staff is due for promotion, and it comes with an increase in salaries, effective from the previous period; he will be paid the difference between the old and new salary as arrears.
Annual wage revision: Wage revision is announced annually in many organizations, with retrospective effect from a specific date but processed later on account of various administrative reasons.
Changes of employment terms: These are periodic reviews of employees' terms of work, like work hours, roles, and duties, which usually come with retrospective effective dates. Their salaries could be adjusted to reflect this change; hence, leading to arrears.
Error corrections: Correcting payroll mistakes where past salaries were underpaid can result in a payment, in one consolidated amount, of the difference.
Legal settlements: In case any legal settlement/award changes the terms of past salaries, the additional amounts are paid as arrears.
Overview of Section 89(1)
Section 89(1) of the Income Tax Act, 1961—is, therefore, a special provision which provides some relief to an assessee whose income consists partly of salary arrears or advance salary received in any financial year. This section provides relief on those cases in which a lump sum, if received as arrears, may raise the tax liability for that financial year because of the enhanced tax rate due to being pushed into a higher tax bracket.
Purpose of Tax Relief under Section 89(1)
The general purpose of Section 89(1) is to introduce fairness and equity in the treatment of persons who draw their income unevenly. It has following objectives:
Tax Neutrality: The preconditioning of s 89(1) ensures that a taxpayer is not put off by a higher rate of taxation because of some lump sum payments which relate to more than one tax period. This provision tries to neutralize the effect of such taxation that may adversely affect an individual because his income has come at an inappropriate time.
Prevention of Tax Bracket Creep: Unless this relief was available, individuals receiving arrears would be inappropriately pushed to a higher rate of tax simply because the arrears added to regular income bumped up the total income for that year into a higher tax bracket. Section 89(1) allows the rollover mitigation of bracket creep by recomputing tax liabilities as if the income was received equally over the years it relates to.
Equitable Treatment: It provides for the equal treatment of every taxpayer. It adjusts the tax payment for the years in which the income accrued but was not received. It is based on the principle that due to administrative delays or any other reason beyond their control, a taxpayer shall not be placed in a worse position by way of additional taxes.
Eligibility Criteria for Claiming Relief under Section 89(1)
Under Section 89(1), relief can be claimed by any taxpayer who receives income in arrears or by way of advance which relates to previous years. Hence, applicability of this section would be irrespective of whether he is a government employee or an employee in the private sector who suffers additional tax because of payment of salary in arrears or by way of advance.
Types of Income Covered Under This Provision
Section 89(1) encompasses a number of different types of income. If that sort of income is received in arrears or in advance, it will be entitled to tax relief. The major categories are as follows:
Salary Arrears: This is the most common form of income under this section. If an employee receives salary payments accruing in earlier years but paid during the current year, he may claim relief for the tax year in which the arrears are received.
Advance Salary: When an employee receives his salary in advance, say, before the event of termination of employment agreement or before the payment due date for the future months, such a provision may apply.
Family Pension Arrears: Delayed payments received in one-time payment for the family pension fall under this category of income. Beneficiaries of pension to a deceased employee, on receiving past dues, can claim relief under this section.
Gratuity: Relief may be available if gratuity for past services is received in years for which it was not paid and when received is subjected to tax in that year.
Compensation from Employer: Compensation received on termination of employment which relates to previous years can also be granted relief under Section 89(1).
Leave Encashment: If an employee encashes unused leave from previous employment years in a later year, the income from this encashment qualifies for relief.
Calculating Relief under Section 89(1)
Computing relief allowable under Section 89(1) can be a bit complex since one needs to compare tax computed for the current year without and with arrears. Here is a step by step process to understand this:
Step-by-Step Calculation Process
Identify the Total Amount of Arrears: Compute total amount received as arrears or advance salary in the current FY which belongs to previous financial year.
Compute Tax of the Current Year Inclusive of Arrears: Compute the total taxable income for the current financial year, including arrears. Then, compute tax payable by applying the current year's tax rates.
Compute Tax of the Current Year Exclusive of Arrears: Compute total taxable income for the current year, exclusive of arrears. Then, apply the current year's tax rates and again compute payable tax.
Compute Tax for the Year(s) to Which Arrears Relate: For every previous year, compute the total taxable income for this year, as if arrears had been received in the respective years. Apply the tax rates of those respective years.
Calculate Additional Tax Paid Due to Arrears: From step 2 (with arrears), deduct the tax without taking arrears into account as calculated in step 3. This becomes the sum of additional tax paid due to arrears.
Compute Relief Under Section 89(1): If the total tax paid under step 2 is more than the total of the tax computed under step 3 and the tax recalculated for the previous year(s) under step 4, the balance will represent the relief that may be claimed under Section 89(1).
Example:
Suppose Mr. Kumar received INR 200,000 as salary arrears in FY 2023-24 for the work he did in FY 2021-22. His taxable income without arrears for FY 2023-24 is INR 800,000, and his taxable income for FY 2021-22 was INR 600,000. The tax rates for both the years for simplicity are considered to be the same.
Steps to Calculate Relief under Section 89(1):
Step 1: Calculate Tax Without Arrears: Calculating tax on INR 800,000 being the normal income without arrears for FY 2023-24. Calculate the tax on INR 600,000 for FY 2021-22.
Step 2: Calculate Tax With Arrears: Calculate the tax on INR 1,000,000 being the normal income plus arrears for FY 2023-24. Note that the arrears are added only in the year in which it is received, not in the year to which it relates.
Step 3: Calculate Differential Tax for the Year of Receipt: Subtract tax calculated in Step 1 for FY 2023-24. The difference is the extra tax paid on account of including arrears.
Step 4: Tax Calculation for Previous Year Including Arrears For FY 2021-22: The tax will have to be calculated on INR 800,000. The basic income taken for the said previous year was INR 500,000. Arrears received during the previous year pertained to FY 2021-22, hence add these also.
Step 5: Calculate Differential Tax for the Previous Year: Now subtract the tax calculated for FY 2021-22 without arrears from the tax calculated for FY 2021-22 with arrears.
Step 6: Compute the Tax Relief: The relief under Section 89(1) is the difference between the differential tax for the year of receipt, as computed in Step 3, and the differential tax for the previous year, as computed in Step 5. If this amount is positive, that will be the relief that Mr. Kumar can claim.
Calculation:
Assume the tax rate is 30% for simple calculation:
Tax for FY 2023-24 on INR 800,000: INR 240,000
Tax for FY 2023-24 on INR 1,000,000: INR 300,000
Differential Tax for FY 2023-24: INR 300,000 – INR 240,000 = INR 60,000
Tax for FY 2021-22 on INR 600,000: INR 180,000
Tax for FY 2021-22 on INR 800,000: INR 240,000
Differential Tax for FY 2021-22: INR 240,000 – INR 180,000 = INR 60,000
Tax Relief under Section 89(1): INR 60,000 – INR 60,000 = INR 0
How to Claim Relief under Section 89(1) in ITR
Under Section 89(1) of the Income Tax Act, there may be some gain made by taxpayers who receive salary arrears or advances. This relief makes adjustments for the higher tax that might be applicable due to the lump sum payment received in one financial year and hence pushing an individual into a higher tax bracket. Here is how to claim it correctly:
Steps to Claim Relief under Section 89(1)
Calculation of tax on total income including arrears: Compute the tax payable on your total income, including the arrears/advance received during the year.
Calculation of tax on total income excluding arrears: Thereafter, work out the tax payable on your income, excluding the arrears/advance.
Compute tax for previous year(s): The tax that would have been payable in the previous year(s) had the arrears been received in those years.
Claim Relief: If you have paid more tax after adding arrears to it than the amount of tax without including arrears, then you are eligible for relief. Now, you can claim relief to the extent of the difference between these two amounts.
Submissions of Form 10E: On or before the date of filing returns, submit Form 10E online through the web-based facility of Income Tax e-Filing. Your claim for relief can be rejected if you fail to submit Form 10E.
Reporting in ITR: The relief under Section 89 at the time of filing of ITR has to be reported in the respective section.
Potential Mistakes and How to Avoid Them
Following are the potential mistakes and suggestions to avoid them:
Not Filing Form 10E: This is one of the most common errors. The Form 10E should always be filed online prior to filing ITR.
Incorrect Calculations: The tax calculations have to be correct. Using incorrect figures may result in a shortfall in tax paid or a lower relief claimed. Professional tax software or a tax expert would definitely help in this regard.
Not Reporting Arrears in ITR: Non-reporting of this relief in the ITR may lead to compliance problems. Ensure that it is filled properly in the return form at the proper place.
Ignoring Data of Previous Years: While recalculating tax for previous years, ensure that relevant data and tax rates of those years are correctly taken to ensure correct calculation of relief.
Documentation: Keep all the related documents of arrears and relief claims, like salary statements and Form 10E, safely for any future queries from the Income Tax Department.
FAQ
Q1. What is Section 89(1)?
Section 89(1) of the Income Tax Act provides relief to the assessee if he is receiving any part of his salary in arrears or in advance or family pension in arrears. This relief helps in diminishing additional tax liability that may otherwise be payable in the year in which the arrears are received.
Q2. Who is eligible for relief under Section 89(1)?
Any taxpayer who receives his salary or family pension in arrears or in advance, which is taxable in a single financial year, is eligible to claim this relief. The relief is applicable if the arrears increase the total income to a higher tax bracket.
Q3. How do I calculate the relief under Section 89(1)?
You have to do the following while calculating the relief:
Calculate tax on the aggregate income including arrears for the year in which it is received.
Calculate tax on the aggregate income excluding arrears for the year in which it is received.
Calculate tax for arrears added to each of the relevant preceding years separately and find the difference in tax for each year.
The relief under section 89(1) is the excess amount of total tax calculated in the first step over the sum of tax calculated in the subsequent steps.
Q4. Which documents do I need to claim relief under Section 89(1)?
You need to fill and submit Form 10E before filing your ITR. Your claim for relief under Section 89(1) may be denied if Form 10E is not submitted.
Q5. Can I claim relief under Section 89 if I file the ITR on my own?
Yes, you can claim relief under Section 89 while filing your ITR on your own. Ensure that Form 10E has been submitted prior to filing your return and also ensure that the calculation of relief is properly done by following the guidelines given by the Income Tax Department.
Q6. What are the common mistakes made while claiming relief under Section 89(1)?
Following are the common mistakes made while claiming relief under Section 89(1):
Filing Form 10E after filing the return.
Wrong computation of the tax rebate amount.
Omitting any relevant assessment year at the time of recalculating tax on receipt.
Q7. How do I make a claim for relief under Section 89(1) without any error?
By following the below steps the relief under Section 89(1) can be claimed without any error:
File Form 10E before filing your ITR.
Calculate your tax or consult your tax expert accordingly.
Period-wise analyze the tax computation in respect of each year affected by the arrears.
Q8. What is the consequence if I do not avail of relief under section 89(1)?
You will be actually paying more tax than you are supposed to for the relevant year in which you received your arrears of income besides interest, since the same can bring your income into a higher slab.
Q9. Can I claim this relief in a later year if I missed it in the year of filing?
No, you must claim this relief in the same year when you file your return for the year in which you received the arrears. Claims for relief cannot be carried forward or claimed retrospectively.
Q10. Where can I find more Information or Assistance for claiming relief under section 89(1)?
For detailed information and personalized assistance, please visit the official website of the Income Tax Department or consult with a tax professional.
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