Explained: Section 17(3) of Income Tax Act, 1995 | Income from Salary

Present Article explains the rationale of Section 17(3) of the Income Tax Act, 1995 i.e. Income from Salary.

What Section 17(3) of Income Tax Act, states?

Any payment received or due in addition to the salary or wages from your employer; is profit in lieu of salary. Section 17 (3) of income tax act defines profit in lieu of salary as follows;

1. the amount of any compensation due to or received by an assessee from his employer or former employer; at or in connection with the termination of his employment or the modification of the terms and conditions relating thereto;
2. any payment [other than any payment referred to in clause (10), [clause (10A),] [clause (10B),] clause (11), [clause (12) [, clause (13)] or clause (13A)] of section 10], due to or received by an assessee from an employer or a former employer or from a provident or other fund [* * *], to the extent to which it does not consist of contributions by the assessee or [interest on such contributions or any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy.

Income from Salary

Compensation due/received from the employer/former employer by an assessee; as a result of loss/termination/resignation from employment.

Compensation accrued or received, due to modification of the employment terms.

If company takes keyman insurance in assessee name; and assessee received money as a result of such policy, that amount will be taxable.

During prejoining/post termination, if employee received payment from employer/former employer, it will be taxable under this head.

Any other amount received from employer will be treated as profit in lieu of salary unless; and until that particular amount is specifically exempted under any section of the income tax act.

Employer-Employee Relationship

In order to bring the taxability under this head of ‘Salary’, it is necessary to establish an Employer-Employee Relationship. In short, if a transaction has to be put under the lense of ‘Income from Salary’; for the purpose of taxation. It becomes mandatory to prove that the transaction was the result of; employer-employee or master-servant relationship.

In Dharan Chemicals work ltd. v. State of Saurashtra; Court held that the Prima Facie test for Relationship; is the existence of master’s right to supervise and control work of his servant.

In Summons v. Heather Laundry Company, Court held that Greater control of power will be there if there is an existence of service contract. If there is greater independence then higher chance is of professional service.

In Laxminarayan v. Government of Hyderabad, Court held that, the Status of agent is much like independent contractor. He undertakes work for principle and he earns commission/remuneration based on his work. He does the work in his manner and the earning is not counted under the heading of ‘income under salary’.

In CIT v. Navtoj Bai Tata, Court held that:

• Merely having office doesn’t prove the existence of Employer-Employee Relationship.
• A director may have office of his own but he is not servant or employee of the Company
• Director’s earning is taxable under Section 56 of the Income Tax Act. (Income from other sources)

In Ram Prasad v. CIT, Court held that if contractual relationship of master-servant is created between company and managing director; his earning will be taxable under ‘Salary’.

Income of Advocate General

In CIT v. Govinda Swaminathan, Court held that Advocate General is not an employee of Government. He serves a professional service. He holds office on Governor’s wish. His earning will be taxable under the head of ‘Profits and Gains from Business and Profession’.

Income of Judges

In Justice Nandan Agarwala v. UOI, Court held that, the Judge’s salary is taxable under the head ‘Salary’, even if there exist no employer of a Judge. Article 125 and 221 of the Indian Constitution, express their earning as Salary.

Income of MLAs, MPs, etc.

The income of MLAs, MPs, etc, comes under the heading of “Income from other sources”.

Movie Actors / Actresses

The employment of Actors and Actresses are based on Contracts. Their employment is of particular tenure.

In case of CIT v. Mrs. Durga Khote, where the actress entered into various Contracts for the relevant year. Contractually she would become free from any obligations, if the terms of the Contract ends. Court held that, based on the nature of work, she will charged tax on her earning from profession and not from salary.

Difference between Salary or From Business

The question whether a particular income is from “salary” or is “income from business” is not always free from difficulty. At times the line between “business” and “employment” becomes rather thin, and the question has to be determined, on such material as may be available, whether the relationship between the assessee and the person from whom the money is received is that of a servant and master or that of two independent contracting parties.

The basic test

Several tests have been laid down as an aid to the decision of the question. In a contract of service there are three basic concepts which must be borne in mind. A servant does the work for his master and the work done by him is, therefore, not his own.

The control and supervision must necessarily be of the master, and the servant is bound to work according to his directions. The servant works for remuneration which may be paid in lump sum or on a commission basis or partly one and partly the other. The relationship of master and servant being, however, the result of a contract, it is possible to vary any or all the terms mentioned above by agreement.

But the basic idea of servant doing the work of the master for remuneration and under the supervision or control of the master is always there. On the other hand, a person carrying on a business cannot be said to be doing the Work of another; he has an interest in the business and can be said to be doing his own work.

He is entitled to the profits and is liable for the losses, and he also has a discretion to do his work in his own way. Even in the case of a business agreement, it is possible to vary all or any of these terms by contract and then the question whether it is a business activity or a contract of service becomes more difficult a question, to be decided by taking into account all the facts and the totality of circumstances

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