Income tax returns: Good news – no tax on notice period pay cut

By: |
Published: May 12, 2017 3:24:00 AM

The Ahmedabad bench of Income Tax Appellate Tribunal has recently held that since an employee receives salary after deduction of notice period pay, only actual salary received is taxable

As per the terms of the employment agreement between you and your ex-employer, you are bound to pay for the notice period not served.

Leaving a job and joining a new one comes with exhilaration around higher emoluments and greater opportunities for growth. But if the new employer is in a hurry, you may not be able to serve the notice period agreed with your  previous employer.

As per the terms of the employment agreement between you and your ex-employer, you are bound to pay for the notice period not served. In most of the cases, the ex-employer waives the notice period pay cut. However, if it does not happen, then in such circumstances, the ex-employer would deduct the notice period pay from your full and final settlement pay. But does it mean that you would pay tax only on the remaining amount of salary that you receive? Or would you be liable to pay tax on the amount of salary that you never received? Also, if your new employer agrees to bear the brunt and reimburse the notice period pay cut, will that be also taxable in your hands? Let’s find answers to these questions.

Taxability of income

Taxability of income is on accrual or receipt, whichever is earlier. The Income Tax Act provides that salary income is chargeable to tax on due basis, whether received or not. Also, there is no specific deduction allowed from taxable income for notice period pay cut from your salary. Hence, if we read the law as is written in a strict sense, tax has to be paid on such notice pay cut and also on the notice period reimbursement received from your new employer.

Surely this sounds like a hardship as the income on which you are being asked to pay tax was never received. In a case where your notice period was, say, two months, technically you will be liable to pay tax on 14 months salary; i.e., salary for more than 12 months without any deduction available to you.

Argument offered by the revenue authorities to tax the notice period pay cut, is that once the salary becomes due, the same is liable to tax and the deduction of the same from payment on account of notice period pay cut is merely an application of income by the employee and hence should not be allowed as a deduction while computing taxable income. From taxpayer’s perspective, suggestions have been made in the past to resolve this anomaly and insert specific provisions in the law, so that income from notice period pay is charged to tax in the hands of ex-employer and deduction of the same amount is available to the employee as he has not effectively received that income.

Ruling by appellate tribunal

Dealing with this issue, the Ahmedabad bench of Income Tax Appellate Tribunal has recently held that since the taxpayer has actually received the salary from his previous employer after deducting the notice period pay as per the job contract, only the actual salary received by assessee is taxable in his hands. This is a welcome ruling dealing with this vexed issue and providing relief to those facing hardship of excess taxation.

Though this ruling is binding only on the tax authorities of Ahmedabad, persuasive value may be drawn while dealing with cases falling in other jurisdictions as well. Accordingly, it is imperative that the apex tax administrative body of India, i.e., CBDT, issues a clarification in this regard and clarifies the law on taxability of notice period pay cut. Once a circular is issued by the CBDT, it will become binding on tax authorities pan India, and taxpayers in other jurisdictions, would become eligible to claim the beneficial provisions of such a circular. In the recent past, we have seen that CBDT is prompt in issuing timely clarifications to put an end to unwarranted litigation and improve the tax environment.

The writer is partner, Nangia & Co.

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.