Hi Shankar,
Below, please find the basis of computation of income from salary as defined by the Income Tax Act. Please go through the Gratuity section; your query will be answered in full. In a nutshell, in light of your example, out of Rs. 14 Lakhs, Rs. 10.5 lakh would be taxable income.
Rgds., Balkrishna
Computation of Income
This section contains only salient features for the computation of income. The sections in this topic are as follows:
Salary income
House Property income
Capital Gains
Other Sources Income
Deductions
Rebates
Salary Income
Salary normally includes wages, annuity, pension, gratuity, commission, perquisites, etc., and any other payment received by an employee from the employer during the year.
Allowances
Most allowances are taxable, like City Compensatory allowance, tiffin allowance, fixed medical allowance, and servant allowances; encashment of any concession is also taxable.
A) House Rent Allowance
Out of the house rent allowance received during the year, the least of the following three amounts will not be included in income:
The amount equal to 50% of annual salary, for persons staying in Mumbai, Chennai, Calcutta or Delhi, but 40% for others
The actual amount of house rent allowance received
The amount of rent actually paid in excess of 10% of annual salary
Here, salary includes basic salary, dearness allowance, and commission on a fixed percentage but not other allowances.
B) Transport allowance
Transport allowance for traveling from residence to office is exempt up to Rs 800 per month.
C) Any allowance granted for encouraging academic, research, and other professional pursuits
To the extent the allowance is utilized for the purpose specified.
D) Children Education Allowance
Rs. 100 per month per child up to a maximum of two children
E) Any allowance granted to an employee to meet the hostel expenditure on his child
Rs. 300 per month per child up to a maximum of two children
Perquisites
The following perquisites are not taxable either under the executive instructions of the Central Board of Direct Taxes or by virtue of specific provisions in the Act/Rules:
Rent-Free House
Rent-free official residence provided to a judge of a High Court or of the Supreme Court.
Rent-free furnished residence (including maintenance thereof) provided to an official of Parliament, a Union Minister, or a Leader of Opposition in Parliament
Accommodation provided in a 'remote area' to an employee working at a mining site or an onshore oil exploration site, or a project execution site or an accommodation provided in an offshore site of similar nature.
Accommodation provided on the transfer of an employee in a hotel for not exceeding 15 days in aggregate.
Car
Reimbursement of expenses in respect of a car (which is owned by an employee and used for personal and official purposes) (amount not taxable is up to Rs. 1,200 per month for a car having an engine capacity of not more than 1600cc, Rs. 1,600 per month for a car of above 1600cc, and Rs. 600 per month for a driver).
Conveyance facility provided to High Court Judges and Supreme Court Judges.
Conveyance facility provided to an employee to cover the journey between the office and residence.
Interest-Free Loan
Interest-free / concessional loan of an amount not exceeding Rs.20,000
Others
Gift-in-kind up to Rs.5,000 in a year.
Employer's contribution to staff group insurance scheme.
Leave Encashment
Leave encashment while in service is taxable. Encashment of sick leave is taxable.
Leave encashment received at the time of retirement is fully exempt in the case of Government Servants. In the case of non-Govt. Employees, leave encashment is exempt to the extent of the least of the following four amounts:
Rs. 3,00,000/-
Ten months' average salary;
Cash equivalent of the leave due at the time of retirement;
Leave encashment actually received at the time of retirement.
Here the average salary means the average of the salary drawn during the last ten months before retirement.
Gratuity
Any death cum retirement gratuity received by Government or Local Authority employees is exempt from tax. For Non-Government Employees, the taxability depends on whether Gratuity is covered under the Gratuity Act
A) Gratuity covered under the Gratuity Act
For Gratuity covered under the Gratuity Act, the total of gratuity received by an employee, covered by the Gratuity Act, from various employers in the whole of service is exempt from tax to the extent of the least of the following three amounts:
15 days' salary, based on the last drawn salary, for each completed year of service
Rs. 3,50,000/-; or
The gratuity actually received.
B) Gratuity not covered under the Gratuity Act
For Gratuity not covered under the Gratuity Act any gratuity not covered by the Gratuity Act is exempt from tax to the extent of the least of the following three amounts
The half month's salary for each completed year of service; or
Rs.3,50,000/-; or
The gratuity actually received.
VRS Compensation
Compensation received at the time of voluntary retirement is exempt up to Rs 5 lakhs under certain conditions.
Deductions from Salary income
Certain deductions are available while determining the taxable salary income.
A) Standard Deduction
Standard deduction from the Assessment year 2004-05
Income from salary before giving Standard Deduction
Amount of standard Deduction from the assessment year 2004-05
Income from salary is less than Rs. 1.5 lakhs
40% of gross salary or Rs.30,000 whichever is lower
Income from salary exceeds Rs. 1.5 lakhs but does not exceed Rs. 5 lakhs
Rs. 30,000
Income from Salary exceeds Rs. 5 lakhs
Rs. 20,000/-
B) Professional Tax
Professional tax, which is paid, is allowed as a deduction.
C) Arrears salary
If salary is received in arrears or in advance, it can be spread over the years to which it relates and be taxed accordingly as per section 89(1) of the Income tax Act.
House Property Income
Tax is on the annual value of the house property after allowing certain deductions. House Property consists of any building, flat, shop, etc., and the land attached to the building.
Computation of income from Self Occupied property
Income is computed after giving certain deductions from the annual value of the property.
A) Computation of annual value of self-occupied property
The annual value of Self-occupied property is taken as NIL if the property is fully utilized for own residential stay during the year or if the property is not actually occupied as owner and is also not let out. If a property is let out for only a part of the year, proportionate annual value will be calculated.
B) Entitled deductions for self-occupied property
The only entitled deduction is interest, if any payable, on a loan taken for the purchase or construction of the house property. The maximum deduction on this account is Rs.30,000/-; However, for properties acquired or constructed between the 1st April 1999 and the 1st April 2003 out of borrowed funds, the maximum limit is Rs. 1,50,000/-
Computation of income from let out property
Income is computed after giving certain deductions from the net annual value of the let-out property.
A) Computation of net value of let-out property
For let-out properties, the gross annual value will be the greater of the following three amounts:
Municipal value of the property;
Actual rent received during the year;
Fair rent i.e. rent of similar properties in the same or similar locality.
Out of the gross annual value, municipal taxes actually paid during the year have to be deducted to arrive at the net annual value.
B) Entitled deductions for let-out property
The deductions available for computing House Property Income are:
30% of the net annual value for repair and maintenance and rent collection expenses for the property
Interest on money borrowed to build, buy or repair the property;
Ownership of property
Besides owning property in own name, a person is deemed as owner in the following three cases:
As transferor of the property to spouse or minor child for inadequate or no consideration;
As the holder of an impartible estate or a property in part performance of a contract under the Transfer of Property Act;
As a shareholder of a cooperative society or a company, which entitles to hold any property.
Capital Gains
If any Capital Asset is sold or transferred, the profits arising out of such sale are taxable as capital gains in the year in which the transfer takes place.
Definition of capital asset
Capital Asset means all movable or immovable property except trading goods, personal effects, agricultural land other than within municipal areas or within 8 kilometers from it wherever notified and gold bonds. Jewelry and ornament are not personal effects and their sale will attract capital gains.
Distinction between short term and long-term asset
Capital Assets are of two types i.e., long term and short term. Long-term capital assets are assets held for more than 36 months before they are sold or transferred. In the case of shares, debentures, and mutual fund units, the period of holding required is only 12 months. Different rates of tax apply for gains on transfer of the long-term and short-term capital assets. Gains on short-term capital assets are taxed as regular income.
Computation of Capital Gains
Capital gains are to be computed by deducting the following three amounts from the consideration money received on transfer of the asset.
i) The actual cost of the asset or its estimated market value as