Section 16 of the Income Tax Act (ITA), 1961
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Section 16 of the Income Tax Act (ITA), 1961

Section 16 of Income Tax Act (ITA), 1961: Understand the application of section 16 and how to determine the tax limit. The gross pay received is the basis for the deduction. Learn how it functions so that you can benefit from it.

  • Jun 16, 2022
  • 41,157 Views

A deduction from the income subject to tax under head salaries is offered under Section 16. It provides 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.

Under Section 16, the following deductions are permitted:

1. Standard deductions
2. Entertainment allowance
3. Professional Tax (Tax on employment)

You have to deduct these amounts from the total salary you receive to arrive at the sum taxable under the head ‘Salaries’.

1. 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

2.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 then 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’.

3. Deduction for professional tax paid on salary income under Section 16 (iii)

Certified Tax based on Section 16

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, then 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
  • Thus, your 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 allowances on transport or medical expenses. Thus, with a standard deduction, you can get significant tax relief.

Is there any limit to standard deduction?

The standard deduction amount cannot exceed ₹50,000. Even if your salary is more than this amount, you can deduct only 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 salaries 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?

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.

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.

1. Entertainment allowance [Section 16(ii)]

a) For government employees
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 for non-government employees.

3. 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.

Conclusion

Section 16 allows substantial savings on your tax outgo if you are a salaried individual. Knowing the rules will help you compute the exact tax amount to pay. Kotak Life offers a tax and savings guide to help individuals save on their taxes differently.

FAQ’s

What is the amount of professional tax payable on salary income?

Each financial year, a person may only be assessed a professional tax of a maximum of ₹2,500. A deduction from an employee’s gross wage income for professional tax paid is permitted under Section 16(iii) of the Income Tax Act of 1961.

Are any documents needed to claim standard deduction under Section 16?

There are no records needed for the standard deduction. To qualify for this tax credit, you do not have to provide any documentation of your expenses to your employer or the tax office. If you work for the federal government or a state government, you can deduct entertainment expenses from your pay.

Is standard deduction considered when the employer deducts TDS from salary?

Yes, TDS is subtracted from salaries each month. In accordance with Section 192, the employer will take TDS from the employee’s wage at the time of payment.

I switched jobs during the financial year. Can I claim a standard deduction independently on the salary received from each employer?

The standard deduction is a fixed amount that is deducted from the employee’s overall salary for that given fiscal year. No matter how many jobs the individual has had, it still applies. So, for the entire remuneration received from all companies, there is only one flat deduction permitted.

Is standard deduction available in the new tax regime?

Under the current system, significant exemptions and deductions are not allowed. Taxpayers do have the choice to pay lower tax rates, though. Additionally, the standard deduction from salary income is not permitted if the individual files a return under the new tax law.

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