Under Section 192 of the Income Tax Act, every employer who is paying a salary income to his employee is required to deduct TDS from the salary income if it exceeds the basic exemption limit. This deduction is based on the estimate of the income that will be earned in the particular financial year and the applicable tax rates. As most employees make investments to save tax, organizations ask their employees to declare their investments at the start of the financial year.
Based on this declaration of tax-saving investments, the organization calculates the taxable income and the projected tax, which the employee is liable to pay for the financial year. This tax is then deducted on a monthly basis as tax deducted at source (TDS). If this information is not furnished, it results in higher TDS, as it will be calculated on the entire income without taking into account tax-saving deductions.
In such cases, though the extra tax deducted can be claimed at the time of filing IT returns, it will result in a lesser take-home salary for the employees for the entire financial year.
Recommended read: Payroll processing in India- A complete step by step guideline
What is Financial Year?
In India, a Financial Year (FY) is the period between 1 April and 31 March – the year in which you earn an income. There are 4 quarters in a financial year; April-June, July-September, October-December, January-March. The income tax returns are filed and taxes for a company are usually paid in the next year after the end of the Financial Year. This next year in which the income is assessed to tax is called as the Assessment Year.
How is Income Tax Calculated?
Income from salary is the sum of Basic salary + HRA + Special Allowance + Transport Allowance + any other allowance. Some components of an employee’s salary are exempt from tax, such as telephone bills reimbursement and; leave travel allowance. If an employee receives HRA and lives on rent, you can claim an exemption on HRA.
What is TDS?
Tax Deducted at Source (TDS) is exactly what the name suggests. It is the amount of money deducted as tax by the payer before making a payment for any kind of service or job done. TDS has to be paid by individuals as well as businesses.
For example, when an employer gives a salary to his employee, he has to cut a certain percentage of the amount as TDS before making the payment. The employer must then deposit the money with the government.
TDS applies to other types of payments as well – such as rent, commission, interest payment by banks, professional fees, consultation fees, etc. It is mandatory for companies and institutions to deduct this tax and deposit it with the Income Tax Department within the stipulated time.
As salaries are paid after TDS, one of the steps in pre-payroll is collecting tax information of the employees. In fact, gathering data on tax-saving investments of employees completes the list of data prerequisites for processing payroll. Let us briefly understand the important exemptions and tax-saving investments that are available to employees and should be considered for calculating TDS.
How to calculate TDS on salary?
When an employee receives compensation from an employer, as a payment for professional services there is a certain percentage of the total sum that has been deducted as TDS. This is tax deducted at source. According to Indian tax laws, employers are expected to deduct a percentage of the total payment as tax and deposit it with the government.
The Finance Minister introduced a new tax regime in Union Budget, 2020 wherein there is an option for individuals and HUF (Hindu Undivided Family) to pay taxes at lower rates without claiming deductions under various sections. The following Income Tax slab rates are notified in new tax regime vs old tax regime:
|Income Tax slab||Tax Rates as Per New Regime||Tax Rates as Per old Regime|
|INR 0 – ₹2,50,000||Nil||Nil|
|INR 2,50,001 – ₹ 5,00,000||5%||5%|
|INR 5,00,001 – ₹ 7,50,000||INR 12500 + 10% of total income exceeding ₹5,00,000||INR 12500 + 20% of total income exceeding ₹5,00,000|
|INR 7,50,001 – ₹ 10,00,000||INR 37500 + 15% of total income exceeding ₹7,50,000||INR 62500 + 20% of total income exceeding ₹7,50,000|
|INR 10,00,001 – ₹12,50,000||INR 75000 + 20% of total income exceeding ₹10,00,000||INR 112500 + 30% of total income exceeding ₹10,00,000|
|INR 12,50,001 – ₹15,00,000||INR 125000 + 25% of total income exceeding ₹12,50,000||INR 187500 + 30% of total income exceeding ₹12,50,000|
|Above INR 15,00,000||INR 187500 + 30% of total income exceeding ₹15,00,000||INR 262500 + 30% of total income exceeding ₹15,00,000|
Investment Declaration Guide in Brief
How to reduce Income Tax?
As per Clear Tax, an Investment declaration has to be done at the beginning of a financial year. The employer asks employees to declare tax-saving investments for the year to be able to deduct tax accordingly from your monthly salary. Investment declaration is important for employees because it can lead to higher in-hand salary.
Investment declaration has to be made for the following tax-saving investments and expenses:
House Rent Allowance
Least of the following is exempt from tax – Actual HRA received; Rent paid in excess of 10% of salary; or 50% of salary for metros and 40% for non-metro cities.
Leave Travel Allowance
An exemption can be claimed on travel with family for a vacation in India. This exemption can be claimed twice in a block of 4 years, subject to certain conditions.
The entire professional tax paid by the employee is allowed as a deduction from taxable income.
Investments under Section 80C, 80CCC and 80CCD
Deductions under Section 80C, 80CCC, and 80CCD are subject to the overall limit of Rs.1,50,000. The following are some of the popular investments and exemptions under these three sections.
- Life insurance premiums paid by the employee for self, spouse, or children.
- Contribution to PPF
- Investment in Unit Linked Insurance Plans (ULIPs)
- Investment in Equity-linked saving schemes (ELSS)
- Investing in term deposits of 5 years or more in banks and post offices
- Investment in National Saving Certificates (NSC)
- Investment in Sukanya Samriddhi Scheme.
- Investment in notified deposit schemes of Public Sector Housing Finance Company, Housing Development Authorities.
- Home loan repayment
- Children’s tuition fees paid to schools, colleges or other educational institutions in India, applicable for 2 children.
- Payment made to the pension plans of LIC or another approved insurer
- Deduction for a contribution towards National Pension Scheme of Central Government.
Under this Section, a deduction can be availed on the premium paid on a medical insurance policy for employee, spouse, children or parents. The amount of deduction depends on certain conditions such as – whether the policy is for the employee, family or parents or if the parents are senior citizens etc.
Interest paid on the education loan of an employee, spouse or children for higher education in India or abroad is eligible for deduction. There is no limit for the amount of deduction, however, there is a limit on the time period. It can be claimed only for 8 assessment years from the time interest is paid or when interest is paid fully, whichever is earlier.
This deduction is available for donations made to specified funds and charitable institutions. Some of these donations are 100% exempt while others have a limit.
Deduction is available on income from interest earned on deposits of savings accounts in banks, post offices or cooperative societies. Deduction is lower of Rs10,000 or actual interest earned.
All these deductions are added up and removed from the gross total income of the employee to obtain the taxable income. Employees also have the option of declaring their income from other sources to the employer. This includes – rental income, interest received on bank fixed deposits or savings bank accounts, income from debt investments, mutual funds and shares; capital gains, earnings from part-time jobs or business etc. The employer can then club this income along with the salary and deduct TDS accordingly.
The Form 12BB is a statement of claims by an employee for deduction of tax. With effect from 1st June 2016, a salaried employee is required to submit the Form 12BB to his or her employee to claim tax benefits or rebate on investments and expenses. Form 12BB has to be submitted at the end of the financial year.
Form 12BB applies to all salaried taxpayers. Using Form 12BB, an employee has to declare the investments that they have made during the year. Documentary evidence of these investments and expenses have to be provided at the end of the financial year as well.
Sample Form 12 BB
Form 16 is the certificate issued under section 203 of the Income-tax Act for tax deducted at source (TDS) from income under the head ‘salary’. It is issued on deduction of tax by the employer from an employee’s salary and deposit of the same with the government.