1. Now you don’t need to pay income tax on notice period pay cut

Now you don’t need to pay income tax on notice period pay cut

Many salaried taxpayers change their jobs in the hope of better future prospects. Generally the main motive behind any change of job is a higher pay package. But when an employee joins or leaves a company, he is bound by the terms of employment.

By: | Published: April 27, 2017 10:44 AM
Most of the time we see that the employment agreements have a clause that if an employee wishes to leave the company before serving the stipulated notice period, he will have to pay the amount equivalent to the unserved notice period.

Many salaried taxpayers change their jobs in the hope of better future prospects. Generally the main motive behind any change of job is a higher pay package. But when an employee joins or leaves a company, he is bound by the terms of employment. An employee is usually required to serve the agreed notice period before he can leave the company.

Most of the time we see that the employment agreements have a clause that if an employee wishes to leave the company before serving the stipulated notice period, he will have to pay the amount equivalent to the unserved notice period. This notice pay is recovered/ deducted from the salary payable to such employee. “Under the tax laws, any payment received from the past/ present or future employer is taxable as salary and it is taxable on due basis. Therefore, the regular salary received by an employee gets taxed on due basis (when it is paid every month). On the other hand, the recovery of the notice period happens only after the employee leaves the job. By that time the entire salary is already taxed by the employer on due basis,” says Chetan Chandak, Head of Tax Research, H&R Block India.

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Unfortunately the tax laws only provide for two types of deductions from salary – 1. Entertainment allowance and 2. Profession tax payment. “Other than this, it does not provide any specific deduction for the notice pay recovered. This was posing a lot of challenges to job hoppers who were getting taxed on this component of notice pay which was actually not received by them,” says Chandak.

A similar issue came for adjudication in front of ITAT Ahmadabad in the case of Shri Nandinho Rebello Vs. DCIT, Circle-14, Ahmedabad. The assessee served with Reliance Communication for some period and received a total salary of Rs 1,64,636, out of which Rs 1,10,550 was recovered as notice pay. Therefore, the assessee declared salary income of Rs 54,086 after deducting the notice pay of Rs 1,10,550. Thereafter, he joined Sistema Shyam Teleservices Ltd and received a total salary of Rs 13,95,880, out of which Rs1,66,194 was deducted as notice pay when he left the company during the same year without serving the required notice period. Therefore, the assessee claimed a total Rs 2,76,744 deduction for the notice pay recovered from his salary by assessee’s previous employers as mentioned above. But both the assessing officer and CIT(A) was of the view that no such deduction is available under Section 16 of the Act and the salary income is taxable on due basis or on paid basis.

After considering the facts as quoted above, ITAT observed that this is a case of recovery of the salary which is already made to the assessee and there is no need to refer to Section 16 of the Act and the assessee has actually received the salary from his previous employers only after deducting the notice pay. Therefore, ITAT held that the actual salary received by the assessee is only taxable.

“In this case the ITAT Ahmedabad laid down an important principal that the assessee has actually received the salary from his previous employers only after deducting the notice pay (as per the job agreement with them) and therefore only the actual salary received (net of notice pay) by the assessee will be taxable,” says Chandak.

This will provide a big relief to a lot of job hoppers who switch the job in search of better economic prospects and have to pay the notice period pay. But there is a contrary order of ITAT Chennai in the case of S.S.N.Ravi vs ACIT Cir III Chennai Dt. 6 May 2016, where in the ITAT held that the Joining Bonus recovered from an employee on leaving the job before the stipulated period will be taxable on due basis and there is no specific provision under the IT Act under which a deduction can be claimed for such recovery.

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Though the fact of the two cases are a bit different, as in the case of Nandinho Rebello the issue is relating to Notice Pay while it was about Joining Bonus in the current case. But in principal both the claims are in the nature of salary recovered back by the employer. “However, in our view, the assessee should be able to claim the deduction for notice pay recover based on more beneficial and logical consideration in the case of Shri Nandinho Rebello Vs. DCIT,” says Chandak.

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