An optimum salary structure can be defined as the salary structure from which an employee derives the maximum Tax Benefits. We all face the common situation as to how to plan for the salary every year and how to reduce tax on it and increase our home take salary. The best salary structure should be designed in such a way that it includes all such allowances from which an salaried employee derives maximum exemptions and claims all the applicable deductions to him as per the provisions of Income Tax Act, 1961. Here are some of the safe components of your salary structure which can minimize your tax burden and help you plan your Salary Structure. Optimum Salary Structure for maximum Tax Benefits:
- Basic Pay :
The basic pay is the biggest chunk in the allover salary. It is usually 35-50% of CTC. Senior employees get much less basic pay as a proportion of CTC than mid- and junior-level staff. This is because basic pay is fully taxable and so for people in higher tax brackets it makes sense to keep that to the minimum and get paid through allowances that attract nil or lower tax.
- Dearness Allowance :
Dearness allowance (given mostly to government employees) is a percentage of basic pay and is paid to lower the impact of inflation. Dearness allowances and dearness pay should form a part of basic salary. This will help in minimizing tax incidence on house rent allowances, gratuity and commuted pension .
- House Rent Allowance :
HRA is one of the allowances included in the salary structure for the accommodation expenses incurred by the employees. This exemption is available only if the employee is living in rented accommodations. In case the employee lives in his/her own house and does not pay any rent, he/she cannot claim HRA. The actual HRA offered will be the lowest of the following three provisions:
- Actual amount received as HRA from the Employer ;
- Excess of rent paid over 10% of basic salary ;
- 50% of basic salary (for metro cities) and 40% of basic salary (non-metro cities).
For the purpose of calculating the HRA, the salary is defined as the sum of the basic salary, dearness allowances and any other commissions. If the employee is not receiving a dearness allowance or commissions then the HRA will be 50%/40% of the basic salary.
- Conveyance Allowance :
Conveyance allowance is the allowances provided from the employer to the employees and exempted from taxes for commuting between home and office. It is exempt upto Rs.800 p.m .
- Children Education Allowance :
Children Education Allowance is a kind of allowance for the education of children of employees by the employer.. It is exempt up to Rs 100 per month per child up to a maximum of two children. Also, Rs. 300 per month per child up to two children is allowed if they are in hostel.
- Leave Travel Allowance :
LTA is granted by the employers to the employees as part of the remuneration to provide for travel expenses incurred during the year .It also covers such expenses of the spouse, children as well as dependent parents and siblings. However, exemption is not available for more than two children of an individual born after October 01, 1998. This restriction does not apply in respect of children born before this date, and also in cases where an individual, after having one child, begets multiple children (twins or triplets or quadruplets, etc.) on the second occasion. The term “Child” includes a step-child and an adopted child of the individual. It can be claimed for the journeys made within India only .The actual cost incurred towards the fare of the journey is only exempt from taxes.
- Journey performed by Air – Economy Air fare of National carrier by the shortest route or the amount spent whichever is less will be exempt
- Journey performed by Rail – A.C. first class rail fare by shortest route. or amount spent whichever is less will be exempt.
- Place of origin and destination place of journey connected by rail but journey performed by other mode of transport – A.C. first class rail fare by shortest route or amount spent whichever is less.
- Place of origin & destination not connected by rail (partly/fully) but connected by other recognized Public transport system – First class or deluxe class fare by shortest route or amount spent whichever is less.
- Place of origin & destination not connected by rail (partly/fully) and not connected by other recognized Public transport system also – AC first class rail fare by shortest route (as the journey had been performed by rail) or the amount actually spent, whichever is less.
The Taxpayer can claim exemption in respect of 2 journeys in a block of 4 years as provided by the Income Tax Act, 1961. In case a taxpayer is not able to claim both the exemptions or has claimed only 1 exemption in a particular block, he can carry forward the exemption of only 1 journey to the next year and not to the next block. Please note that exemption for only one journey can be claimed in a particular calendar year and also incase the LTA is encashed without performing the journey, no LTA exemption would be allowed and the entire amount received would be taxable.
- Medical Allowance :
Medical Reimbursements are the actual amount that the employer’s gives to an employee when they submit bills for medical treatment availed. Medical Reimbursements or allowances are exempt from taxes upto Rs.15000 as defined by the Income Tax Act, 1961 .
- Employees Provident Fund :
EPF is a fund composed of contributions made by the Employee during his/her tenure of employment along with an equal contribution of Employer. It is calculated as 12% of basic salary and an equivalent amount is also contributed by the employer. However, employee has an option to deposit more than 12%. Out of this 12 %, 3.67% is deposited to provident fund and 8.33% is deposited in pension scheme. Employees drawing basic salary upto Rs.15000 have to compulsorily contribute to the provident fund whereas employees drawing above Rs.15000 basic salary have an option to become member of the provident fund. The amount invested in an Employees Provident Fund is exempt from tax under Section 80C of the Income Tax Act. Withdrawal from an EPF is subject to tax if it is carried out within 5 years of employment with the same employer.
- Other Allowances :
As per the provision of Section 10(14) of Income Tax Act,1961, there are certain allowances given to employees from the employer which are exempt from taxes upto the amount actually incurred by the employees. These allowances include Helper/Assistance allowance, Research allowance, Uniform allowance, News Paper and Periodical allowance, etc.
- Deductions under Chapter VI A:
The Chapter VI A of Income Tax Act, 1961 allows certain deductions u/s 80C (upto a limit of Rs.150000) , 80 D, 80 CCC, 80G, 80 TTA for making some specified investments .These includes :
- LIC Premium subject to maximum of 10% of sum assured
- Deposit in NSC i.e. National Savings Certificate
- Tax Savings Mutual Fund
- Equity Linked Savings Scheme
- Depositing in Tax Saving Post Office Scheme
- Tuition Fees maximum of 2 children
- Stamp Duty, Registration Fees paid for purchase for of new house
- Payment of Principal of Home Loan
- ULIP of UTI/LIC
- 5 year fixed deposit in scheduled bank
- Contribution to pension fund (80CCC)
- Medical Insurance premium paid by the employee for self and dependents upto Rs.15000 and upto Rs.20000 in case of dependent parents (senior citizen).
- Exemption for Handicapped Dependencies – maximum of Rs.75000 in case of more than 80% handicap, Rs.50000 lesser than 80% (80DD)
- Self Severe Disability- maximum of Rs.100000 in case of more than 80% handicap, Rs.50000 lesser than 80% (80 U)
- Donations given to specified institutions, Relief Fund provides 100 % tax exemption whereas others provide 50 % tax exemption (80 G).
- Exemption from Savings Bank Interest and Post Office interest upto Rs.10000.
Let us take an example and compute the taxable income under the different cases i.e. with and without claiming the allowances and deductions.
Computation of Total Income
Income from Salary
House Rent Allowance
Children Education Allowance
Leave Travel Allowance
Newspaper & Periodicals
Professional Taxes u/s 16(iii)
Total Taxable Salary(A)
Income from House Property
Self Occupied House Property
Annual Let able Value
Deduction u/s 24
Current Financial Year Interest
Total Of House Property(B) Gross Total Income (A-B)
Deductions under Chapter VI A
Repayment of Housing Loan
Investments in 5 years FD
Investments in Mutual Funds
Stamp Duty for Purchase of house
Total of 80C
Medical Insurance Premium for self and senior citizen parents
Donations made to Prime Minister’s Relief Fund
Total Taxable Income
Case-I reflects the situation in which the assessee is not entitled for any of the allowances enlisted above and has not claimed any of the deductions under Chapter VI A whereas Case-II reflects the situation where assessee in entitled for the said allowances and has claimed almost all possible deductions. Therefore, we can see the difference in Total Taxable Income in both the situations. It clearly shows the benefits derived from an optimum salary structure which enables the assessee to save a major part of taxes by planning his/her investments and salary structure. Here in Case-II, the Taxable Income is almost reduced to half that of in Case-I. As per the above example, in case-I the assessee would be liable to pay Rs. (25,000+1,00,000+1,34,280) =Rs.2,59,280 as taxes on Income and in Case-II, the assessee would be liable to pay Rs.(25,000+1,00,000+23,280) =Rs.1,48,280 as taxes on Income. So, here we can clearly see the benefits which could be derived by having an optimum salary structure.