Section 16 of the Income Tax Act (ITA), 1961 deals with deductions allowed from income under the head “Salaries”. These deductions help reduce salaried individuals’ taxable income, thereby lowering their tax liability.
Key Takeaways
- Section 16 aims to balance the need for government revenue with fairness and administrative efficiency.
- Standard Deduction [Section 16(i)/(ia)] is fixed at ₹50,000 or the salary amount, whichever is lower.
- Professional tax deduction under Section 16(iii)] is limited to ₹2,500 per year, if paid by the employer, included in salary.
- Pensioners can also claim ₹50,000 or their pension amount, whichever is less, as the standard deduction.
Section 16 balances the need for government revenue with fairness and administrative efficiency. It recognizes work-related expenses, promotes economic activity, and simplifies the tax system for both taxpayers and the government.
It provides a deduction for professional taxes, entertainment expenses, and the standard deduction. A salaried worker who pays taxes could use this deduction to reduce the amount of taxable salary income that is subject to tax.
Deductions Under Section 16 of the Income Tax Act (ITA), 1961
Under Section 16, the following deductions are permitted:
- Standard deductions
- Entertainment allowance
- Professional Tax (Tax on employment)
You must deduct these amounts from your total salary to arrive at the sum taxable under the head ‘Salaries.’
Standard deduction [Section 16(i)/(ia)]
As a salaried taxpayer, every financial year, you can claim the lower amount between the following as the standard deduction from your total salary:
- ₹50,000 (from AY 2020 – 21 onwards)
- Your salary amount
You can claim this deduction as an exemption regardless of your actual spending. The government introduced this benefit in place of:
- Transport allowance
- Medical allowance
Deduction for entertainment allowance under Income Tax Section 16(ii)
In the case of entertainment allowance, the assessee is entitled to a deduction under Section 16, although he is ineligible for any exemptions (ii). Due to the inclusion of the entire entertainment allowance in the gross income calculation, the government employee is qualified to receive a deduction from gross salary.
The standard deduction is also available for the pensioners, according to the new guidelines of CBDT clarifying the applicability of the standard deduction of the pensioners. The pension received by the employer will be headed under the head of ‘salaries’.
Deduction for professional tax paid on salary income under Section 16 (iii)
The deduction for employment tax is allowed by Section 16(iii) of the Income Tax Act. A taxpayer may deduct the sum paid on account of an employment tax or professional tax under section 16. The employment tax is described in this case by Article 276(2) of the Constitution.
The state cannot charge more than ₹2500 per year as professional tax. The laws allow this taxation as a deduction from salary, as per.
If your employer paid the professional tax on your behalf, the amount is included in your salary.
What are the Benefits of Standard Deduction on Tax for Salaried Individuals?
The government introduced the standard deduction in the 2018 Union Budget to provide tax relief to salaried individuals. Later, in 2019, the finance ministry raised the limit to ₹50,000.
Before 2018, you could claim reimbursements for the transportation expenses incurred on work-related travels and medical bills. However, those deductions were limited to:
- ₹15,000 per annum as medical allowance
- ₹1,600 per month (₹1,600 X 12 = ₹19,200 per year) as transport allowance
Thus, the total amount you could reduce from your gross salary through such benefits was ₹(15,000 + 19,200) = ₹34,200.
Therefore, with the new standard deduction, the extra tax benefit has become (₹50,000 – ₹34,200) = ₹15,800.
For example, suppose your salary details are as follows:
- Basic pay: ₹5,00,000
- Dearness Allowance: ₹2,00,000
- Contributions towards EPF: ₹24,000
- Deposits in PPF: ₹50,000
- Transport allowance: ₹19,200
- Medical allowance: ₹15,000
Total income = ₹(5,00,000 + 2,00,000) = ₹7,00,000
Gross total income = ₹7,00,000 – ₹(24,000 + 50,000) = ₹6,26,000
Before standard deduction
- Deductions available on your gross income: ₹(19,200 + 15,000) = ₹34,200
- Thus, your taxable income: ₹(6,26,000 – 34,200) =₹ 5,91,800
Your total tax outgo as per current income tax slab rates (old tax regime):
- Tax on income up to ₹2,50,000 = Nil
- Tax on the amount between ₹2,50,000 and ₹5,00,000 at 5% tax rate = ₹12,500
- Tax on the remaining amount at 20% tax rate = 20% of ₹(5,91,800 – 5,00,000) = ₹18,360
After standard deduction
- Your taxable salary income: ₹(6,26,000 – 50,000) = ₹5,76,000
- Your tax liability = ₹12,500 + 20% of ₹(5,76,000 – ₹5,00,000) = ₹15,200
Therefore, the standard deduction helps you save on taxes. However, for AY 2022-23, you can avail of this deduction only if you opt for the old tax regime.
Moreover, your employer need not process any bills before you can avail of this tax break.
Thus, this facility eliminates elaborate paperwork, making tax calculations straightforward.
How does Standard Deduction Impact Pensioners?
The income tax laws consider pensions received from former employers as income under the head ‘Salaries’. Thus, if you are a pensioner, you can claim ₹50,000 or your pension amount, whichever is less, as the standard deduction.
As a pensioner, you might not enjoy transport or medical expenses allowances. Thus, with a standard deduction, you can get significant tax relief.
What are the Limits to Standard Deduction?
The standard deduction amount cannot exceed ₹50,000. Even if your salary exceeds this amount, you can only deduct this sum under Section 16. Also, if your net salary is less than ₹50,000, you can deduct a sum equal to your salary and not more.
For example,
- Suppose you earn a gross salary of ₹3,00,000.
- The House Rent Allowance (HRA, exempt from taxes) you get as a part of this salary amount = ₹60,000
- Your Leave Travel Allowance (LTA, tax-exempt salary component) = ₹50,000
- Other exemptions (such as contributions towards EPF and PPF) = ₹1,44,000
- Thus, your net salary = ₹46,000, which is lower than ₹50,000.
Hence, you can claim a standard deduction of ₹46,000 only.
How to Calculate a Standard Deduction if You Worked under Multiple Employers in the Same Financial Year?
The standard deduction is a fixed sum applicable to your overall income for the entire financial year.
For example, suppose you earned ₹50,000 net salary under one employer from April to September. Then, you changed jobs and earned ₹50,000 under your second employer up to the month of March. Thus, your total salary income for the financial year from April to March is ₹(50,000 + 50,000) = ₹1,00,000.
Therefore, you are entitled to a standard deduction of ₹50,000. Your net salary this fiscal = ₹(1,00,000 – 50,00,000) = ₹50,000.
The standard deduction under Section 16 vs income tax deductions under Chapter VI-A, including Section 80:
| Standard Deduction
|
Chapter VI-A Deductions
|
| It is a flat deduction regardless of actual expenditure.
|
These deductions are based on actual expenses or investments.
|
| This deduction is available only to individuals earning salary income or pension. Self-employed taxpayers, professionals, or business owners cannot claim this benefit.
|
These deductions are available on the gross income, which is the sum of the earnings from all income sources.
|
| This deduction is applied to the salary income before computing the gross income.
|
These deductions are applied after arriving at the gross income.
|
| The limit is fixed at ₹50,000.
|
The limits vary from section to section. For example, Section 80C allows deductions up to ₹1,50,000.
|
How Can You Claim a Standard Deduction?
Claiming a standard deduction under Section 16 of the Income Tax Act of 1961 is a straightforward process, but the specific steps might vary depending on your chosen filing method.
Usually, your employer includes this deduction when calculating the tax deducted at source (TDS) applicable on your annual salary. Form 16 that your employer issues should reflect this amount. However, if it is not included, you can claim the standard deduction while filing your tax return.
Remember that you must be a salaried individual or pensioner filing an income tax return under the old tax regime (not the new tax regime under section 115 BAC).
Claiming the deduction:
For Online Filing
- When filing your income tax return electronically, the standard deduction is automatically applied by your platform.
- You do not need to mention it or submit any documents explicitly.
For Offline Filing
- Fill out the relevant form (ITR-1, ITR-2, etc.) based on your income category. In the designated section for deductions under Section 16, mention the standard deduction amount (₹50,000 or your salary, whichever is lower).
- You do not need to submit any documents specifically for the standard deduction, but ensure you keep your Form 16 and other income documents for record-keeping purposes.
What are the Documents or Bills Necessary to Claim the Standard Deduction?
The standard deduction requires no documents. You need not submit any proof of expenses to your employer or the tax department to get this tax break.
Entertainment Allowance [Section 16(ii)]
a) If you are a Central Government or State Government employee, you can claim deductions towards entertainment allowance from your salary. The available deduction is the least among
- ₹5,000
- 20% of your basic pay, excluding perquisites, benefits, or other allowances
- The actual amount your employer provides as entertainment allowance
- The deduction does not depend on the amount you actually spent on entertainment.
b) For non-government employees, entertainment allowance is not applicable.
Professional Tax or Tax on Employment [Section 16(iii)]
Some Indian states levy a professional tax or direct tax on employment under Article 276(2) of the Indian Constitution. Any individual earning an income needs to pay this tax. The state cannot charge more than ₹2,500 per year as professional tax.
The tax laws allow this taxation as a deduction from salary, as per the following rules:
- If your employer paid the professional tax on your behalf, the sum is included in your salary as a ‘perquisite.’ You can deduct the amount from your gross salary.
For example, suppose your base pay is ₹2,50,000.
You have to pay ₹400 as professional tax per month, and your employer pays the amount.
Then, the gross salary you received is ₹2,50,000 + ₹(400 X 12) = ₹2,54,800.
The amount you can deduct from it on account of professional tax = is ₹4,800.
Thus, your net salary income = ₹2,50,000.
If your employer deducted the tax from your salary, you did not receive the money from your employer. Therefore, you need not add the amount to your income under the heading ‘Salaries.’
Suppose your annual income is ₹2,50,000. You pay a professional tax of ₹5,000 from it during the year. Thus, you can deduct ₹5,000 from the salary you received.
- The ITA allows the deduction of professional tax regardless of the amount paid.
- You can claim the deduction only in the year in which you pay the professional tax. If the tax is due, but you did not pay it yet, you cannot claim the deduction.
- For example, suppose you must pay ₹1,500 per annum as professional tax. You miss the payment in the previous financial year. But this financial year, you pay ₹3,000 as professional tax.
Thus, this financial year, ₹3,000 is deductible, not just ₹2,500.
What is the Need for Section 16 of the Income Tax Act (ITA), 1961?
Section 16 of the Income Tax Act (ITA), 1961 serves several important purposes:
1. Equity and Fairness
- Recognizes work-related expenses: Salaried individuals often incur work-related expenses like professional tax, transportation, and entertainment (in some cases). Section 16 allows deductions for these expenses, ensuring a fairer tax burden by recognizing that not all income received represents actual spending power.
- Reduces administrative burden: Claiming specific work-related expenses can be cumbersome and require extensive documentation. The standard deduction simplifies the process, reducing administrative burden for both taxpayers and the tax authorities.
2. Promotes Economic activity
- Increases disposable income: By lowering taxable income, Section 16 increases disposable income for salaried individuals. This can stimulate spending and boost economic activity.
- Attracts and retains talent: Offering tax benefits through deductions makes employment more attractive, helping companies attract and retain qualified talent.
3. Administrative Efficiency
- Standard deduction simplifies calculations: The flat standard deduction simplifies tax calculations for both taxpayers and the tax authorities.
- Reduces disputes: By eliminating the need to document and verify specific expenses, the standard deduction reduces potential disputes related to expense claims.
4. Encourages Compliance
- Makes tax system more user-friendly: A simpler and fairer tax system, as facilitated by Section 16, encourages voluntary compliance and reduces the need for enforcement measures.
Conclusion
Section 16 of the Income Tax Act (ITA), 1961, stands as a crucial pillar in the taxation framework, combining the imperative requirements of government revenue, fairness, and administrative efficiency. It can be seen as a tool used by the government to both benefit taxpayers and facilitate efficient tax collection. However, the specific deductions offered under any section are subject to change based on government policies and economic conditions. It is important to keep an eye out for any changes and avoid confusion during the tax filing season.
