Over a crore government staffers and pensioners received their salary arrears in August this year, in line with the seventh Pay Commission’s recommendations, which were implemented with effect from January 1, 2016. Cases like theirs result in a slightly complex situation when it comes to computing tax payable, as your income during the financial year and arrears get clubbed. For tax-payers who shudder at the thought of filing their ordinary annual returns, adding arrears to the mix can be a stressful experience.
Here’s help on decoding the tax effect on arrears for such tax-payers.
Implications of arrears
Arrears are subject to tax in the financial year you receive the proceeds if they haven’t been taxed earlier on an accrued basis – that is, when the income was originally due. For example, part of government employees’ arrears would have been due in financial year 2015-16, but since they were paid out in August 2016, they will be accounted for in 2016-17, with 2017-18 being the corresponding assessment year. Since the arrears pertaining to the period between January and March 2016 weren’t taxed in 2015-16, tax liability will get created in the current financial year.
Clubbing arrears and current year’s salary leads to a situation where income for the year gets inflated. You are likely to get pushed into a higher tax slab, resulting in a tax outgo much higher than what is warranted. To circumvent such unfair tax implications, tax laws allow you to claim relief under section 89 (1) in such cases.
To calculate this relief, you need to start by adding your arrears to your current financial year’s total income and calculating the tax payable, including surcharge and cess applicable, if any. Next, calculate the tax liability for the same year by leaving out the arrears. Now, ascertain the difference between these two tax payable figures (i). Next step is to calculate tax liability for the financial year/s to which the arrears pertain by adding the amount to that year’s total income. Repeat the process by excluding arrears from that year’s total income. Compute the difference between the two tax liabilities then add up this difference for all the years to which the arrears pertains to arrive at (ii). The tax relief under section 89 will be the excess, if any, of (i) over (ii).
For example, say Ms A is the beneficiary of arrears originally due in 2014-15, but received in the month of August 2016, necessitating calculation of her tax liability after factoring in the impact of arrears. Now, let’s assume she has paid an income tax of Rs 1 lakh for 2015-16 without taking into account the arrears. If it were to be included, her tax liability would go up to say Rs 1.3 lakh. The difference is Rs 30,000 (a). Likewise, suppose the tax payable sums for the year 2014-15 with and without the arrears were Rs 80,000 and Rs 60,000 respectively; the difference in this case is Rs 20,000 (b). The difference between (a) and (b), that is, Rs 10,000 will be the relief Ms A can claim under section 89.
If you have any relief to be claimed under section 89 then Form 10E (to know more about form 10E filing click here) must be filed online on the Income Tax Department website. If you file your tax return claiming relief under section 89 but did not file Form 10E you are bound to get a notice from the tax department for non-compliance. Further your return will not processed until you submit this form 10E, in case if you fail to do so your return will be treated as null and void after the expiry of the period allowed in the notice.