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No tax on notice period pay cut
April, 21st 2017

The Income-tax Appellate Tribunal (ITAT) which adjudicates Income-tax (I-T) disputes, has held that an amount deducted by an employer for not serving out a notice period cannot be brought to tax.
In this case, two companies while settling dues had deducted salary for the notice period which the person had not served, but this deduction was not taken into account during tax assessment. However, ITAT (Ahmedabad bench) in its order dated April 18, said only salary received would be taxable, and not portions which were deducted by a company for not serving out a notice period.

Under the I-T Act, salary income is taxable on a due basis, regardless of whether it has been actually paid to an employee or not. And typically, when an employee resigns but does not serve out the notice period (provided for in the employment agreement), the employer deducts salary attributed to this period. However, I-T authorities do not consider such deductions and seek to tax entire salary due (that is, salary before allowing for such deduction). Hence, the latest order acquires significance.

"The ITAT has recognized the concept of real income, which is well accepted under I-T laws. It held that the salary against which notice pay was adjusted had not become due, as the net amount was paid by the employer. The employee had no right to receive the portion of the salary that had been deducted, under the terms of employment. Thus, the deducted amount could not be held as taxable salary income," said Gautam Nayak, tax partner, CNK & Associates.

In this case, which pertains to financial year 2009-10, N. Rebello, had resigned from two companies, viz: Reliance Communication and Sistema Shyam Teleservices. Both companies had deducted a notice pay of Rs. 1.10 lakh and Rs. 1.66 lakh respectively and handed balance salary dues to Rebello.

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Accordingly in his I-T return, Rebello claimed as a deduction Rs. 2.76 lakh from gross salary income, as this amount was not received by him. I-T authorities, in the course of assessment, denied such deduction. Commissioner (Appeals), which is the first level of appeal for a taxpayer, also upheld the action of the I-T authorities.

The Commissioner (Appeals) pointed out that under section 15 of the I-T Act, tax is triggered when the salary becomes due, irrespective of whether it is paid or not. Secondly, section 16 of the Act does not provide for any deduction made by the employer for the notice period. Thus, the deduction of Rs. 2.76 lakh claimed by Rebello was not upheld. This led to Rebello filing an appeal before the ITAT, which decided in his favour.

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