Can Employees Claim Short Notice Deductions on Their Tax Returns? Seeking Advice

If an employee resigns from the company and the Full and Final is prepared as follows:

Payments
• Salary: Rs. 30,000
• Leave Encashment: Rs. 20,000

Deductions
• Short Notice: Rs. 40,000
• Balance to pay: Rs. 10,000

We consider Rs. 50,000 as income in the Income Tax Return, but what about the Short Notice Deduction of Rs. 40,000? Can we claim a deduction in the Individual Income Tax Return as it is a loss to the employee if the new employer does not pay the Short Notice amount?

Your replies to the above query will be appreciated.

Thanks
Regards

According to me, you should consider his net earnings as taxable income, i.e., ₹10,000/-. Net earnings in this case are the earnings before statutory deductions, if any.

Your taxable income will be $10,000, which is the amount you will finally get after deductions.

I am part of a company that delivers payroll-related services/software, and we have taken the view that the notice period deduction amount cannot be considered for tax exemption for an employee for the following reasons.

1. The Income Tax Act does not explicitly or implicitly allow such an exemption.
2. The notice period deduction is a penalty levied on an employee for not adhering to the terms of employment, i.e., serving a certain period after resignation before leaving the organization. This is somewhat similar to an employee paying a fine for losing a company property, such as a laptop or mobile phone. The penalty an employee pays cannot be used for the purpose of claiming a tax exemption.

Will your company treat Rs. 40K recovered from an employee on account of Short Period Notice as income of the company or a reduction in expenditure on their balance sheet? Please make a decision accordingly.

As per my understanding, income that is received or receivable is taxable. Since this amount is neither received nor receivable by the employee, it cannot be considered as the income of the employee or an expenditure of the company.

Thanks,

V K Gupta

Thank you for your prompt response. As per Tegautham, income tax has to be paid on the amount deducted as short notice, as it is like a penalty imposed on the employee for not serving the notice period. While other members are of the opinion that we will have to pay only on Rs. 10,000/-, which is the actual received amount.

However, in the same scenario, if employees have taken a loan from HDFC, then the amount paid as interest is exempted from their taxable income.

So, my query is: how can the employee pay income tax on the short notice that is already deducted from them? Can they claim for exemption? If yes, under what section can the employee show the exemption in the income tax return?

Regards,
Arun

Just to clarify, I didn't say or mean the above. There is no income tax payable on the short notice deduction. The law does not provide for it. All I said was that the total taxable income of the employee cannot be reduced to the extent of short notice deduction (thereby giving a tax benefit to the employee on account of the short notice deduction).

Arun said: "While other Members are of the opinion that we will have to pay only on Rs.10,000/- which is the actual received amount."

The net pay cannot be considered for the purpose of tax calculation. If anything, the net pay is arrived at after tax deduction and hence the same cannot be used for tax calculation. Tax calculation is always done on the gross pay after considering the tax rules governing individual heads of pay (Basic, HRA, Conveyance, etc.). Some deductions such as Profession Tax can be used to reduce the total taxable income. However, without gross pay, income tax cannot be calculated.

Rs. 40,000/- will be part of taxable income since, under the IT Act, expenses/penalties are not allowed for deductions. Here, the taxable income will be a salary of Rs. 30,000/- since leave encashment can be non-taxable to a certain extent or in whole, as per rules at the time of leaving the services.

Regards,
Rakesh

Any amount that is not paid to an employee for whatever reason is not taxable in the hands of the employee. So, what needs to be considered for tax is only the net amount of Rs. 10,000 that he has received. The deduction of notice period salary is not considered in income tax as a penalty. It is income not earned.

Else, all salary deducted for absence from work would also not be considered as allowable in the computation of tax. The same logic would be used—leave without pay is a penalty for the failure to adhere to terms of employment, that is, he was supposed to come to work but has not come.

I tend to agree with Saswat. Just because someone's salary software lacks certain provisions does not mean that any theoretical amount should be considered as the Gross Salary of the person. For example, in the hiring CTC statements, lots of things are added as salary components but never given.

For example, if incentives are given as Rs. 500,000 p.a. on fulfillment of more than 100% targets, and the company as well as the individual achieves only 50%, thereby receiving only Rs. 200,000, which means being penalized by Rs. 300,000. Does it mean that the full amount of Rs. 500,000 should be shown as his income?

If this is the case, then Income Tax at source should also be deducted on such fictitious incentive income in full too.

This is the reason why employees who separate during the year have their Form 16 containing their Gross Salaries as that of the whole year, as if they had continued service till the end of the year.

In the software, the full salary data is fed once, and the same data is used without any change or rectification/modification until the end of the financial year, resulting in displaying the total gross salary in the Income Tax Statements.

Please refer to this thread: https://www.citehr.com/467783-false-...ml#post2082808

The problem lies with such software and not the Income Tax rules; this has to be rectified. If an employee is not paid any amount for whatever reasons by the employer, then how can he be asked to pay Income Tax on it?

I am certain that this is a bug or a matter that escaped the attention of software developers. There must be codes/systems to reconcile and rectify this type of errors.

It appears as if the software has been designed keeping only the employees on roll/service in its scope, and there are no sufficient provisions built-in for eventualities such as correct/rectified Form 16 for employees who left service mid-year.

Warm regards.

I am not an expert in IT, but I will share my experience. Recently, Rs. 2 Lac was deducted from my Full and Final settlement for the shortfall in notice pay. However, the deducted amount is not considered for tax exemption, but the full calculation of Full and Final settlement. The new employer, who refunds the shortfall in notice pay, treats such reimbursement as taxable income, and IT gets deducted. In summary, for the same amount, the employee is losing heavily on IT. This is the practice being followed across reputed companies as far as I know.

Regards,
Pon

In this case, you happen to be in a peculiar situation where the circumstances are against you. Neither the law is designed to take this exception into account nor does it change the requirement of law. Let me try to explain.

From Your New Employer's Viewpoint

It's simple. Every amount he pays you, he has to account for in salary TDS working. So since he is paying you (and you are paying the previous employer), he has to deduct TDS on the payment. Here he does not have a choice. Even if he were to pay directly, actually he is still paying on your behalf, and it's equivalent to payment being made to you.

For Your Previous Employer

The law requires him to deduct TDS equally every month. So he has to get workings from you in April as to what the earnings and tax-exempted investments you are doing, so he can compute the total earning and tax you are liable for. If he does not cover TDS equally every month, he can be asked to explain (e.g., if you promised to but didn't make PPF payments).

By the time you resigned and then paid back notice pay (effectively reducing your taxable income in that company substantially), it was too late for them to modify the TDS working or refund the amount of excess TDS. Once paid, TDS cannot be refunded by the company (the only option is a refund after assessment).

Of course, in some cases, it may be deliberate to punish you for leaving, but in most cases, the scenario pans out like this. The higher the salary, the higher the impact in such a scenario. The income tax department made the TDS rules stronger as people were not paying taxes honestly, etc.

Of course, for all of this, it is not a complete loss. You need to file a return showing the total taxable income and the amount of tax paid (TDS) and claim a refund. They will take some time to pay it back. But you are entitled to interest from the date of filing returns till the date of the refund.