The Ahmedabad Bench of the Income Tax Appellate Tribunal (hereinafter referred to as the ‘ITAT’) recently ruled that an amount deducted by an employer from the salary of an employee for not serving notice period cannot be taxed.
Section 15 of the Income Tax Act, 1961 (hereinafter referred to as the ‘Act’) specifies the following kinds of income on which income tax is to be charged:
- any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not
- any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him
- any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year
Such income is chargeable to income tax under the head ‘Salaries’.
As per Section 16 of the Act, the income chargeable under the head “Salaries” shall be computed after making the following deductions:
- a deduction in respect of any allowance in the nature of an entertainment allowance specifically granted by an employer to the assessee who is in receipt of a salary from the Government, a sum equal to one fifth of his salary (exclusive of any allowance, benefit or other perquisite) or five thousand rupees, whichever is less
- a deduction of any sum paid by the assessee on account of a tax on employment within the meaning of Article 276(2) of the Constitution , leviable by or under any law.
Hence, salary received by an employee from his employer is subject to income tax as per the provisions of the Act. However, there are cases when an employer deducts certain amount from his employee’s salary if the employee leaves his employment without serving the notice period mentioned in the employment agreement.
In such cases, the issue arises whether deductions made from the salary of employee who has not served notice period can be treated as income and subjected to tax. This issue has been resolved by the ITAT in the case of Nandinho Rebello v. Deputy Commissioner of Income Tax dated April 17, 2013.
Nandinho Rebello v. Deputy Commissioner of Income Tax
The assessee had resigned from two companies without serving notice period and therefore, both the companies deducted a notice pay of INR 1.10 lakh (USD 1716 approx.) and INR 1.66 lakh (USD 2589 approx.) respectively and handed the balance salary to the assesse. Since there was a deduction of INR 2.76 lakhs (USD 4305 apporx.) from his gross salary income, the assesse only showed his net receipt as income while filing his return. However, the income tax authorities denied such deduction on the ground that the Income Tax Act imposes charge when salary becomes due whether paid or not. Therefore, the income tax authorities sought to tax the entire salary due, that is, the salary without deductions.
Order of ITAT
The ITAT held that the actual salary received by the assesse is only taxable. Therefore, an amount deducted by an employer for not serving out a notice period is not taxable.
The judgment is in favour of tax payers as they do not need to pay tax on income not received by them. The ITAT has recognized the concept of real income and therefore, tax payers do not have to pay tax on actual salary not received. Deductions made by an employer for not serving notice period cannot be treated as income.
 Article 276(2): The total amount payable in respect of any one person to the State or to any one municipality, district board, local board or other local authority in the State by way of taxes on professions, trades, callings and employments shall not exceed two thousand and five hundred rupees per annum