Got a pay cut? You may still be taxed on your original CTC

If a pay-cut is not reflected in the components of your salary, you may still be taxed on your original CTC.

It is important that individuals get a clarification from their employer as to whether the deduction from salary is a pay cut or merely deferral of payment.
As many companies are cutting their employees' pay it is advisable for the employees of such companies that the pay cut is reflected in the components of their salary (basic, HRA etc.) as well. If the pay-cut is made via any other arrangement then the income tax department may not take into account such cuts and consider it as salary due as per some chartered accountants. Others opine that taxation of salary in such a case would depend on whether the salary reduction is a pay cut or a deferral. Still others say that this is a grey area and that the Form 16 would be the final word on taxation of salary.

According to income tax laws, salary is taxed on the basis of due or received whichever is earlier. On the other hand, TDS is deducted at the time of making a payment. However, in the time of pay cuts due to coronavirus, it is important that individuals ensure that their company has communicated the received CTC (cost to company) to their employees showing revision in the salary components as well, say chartered accountants. Further, it is important that individuals get a clarification from their employer as to whether the deduction from salary is a pay cut or merely deferral of payment.

ET Wealth online spoke to experts on how salary would be taxed in case an employee's salary is cut.


Chartered Accountant Naveen Wadhwa, DGM, Taxmann.com says, "As per income tax laws, salary is taxable on the basis of due or received, whichever is earlier. Therefore, any salary amount due to you will be taxable in your hand, even if not received. If the CTC of an employee undergoes any revision (cut or hike), then such revision should be reflected in the individual's salary slip as well i.e. the components of the salary such as basic, HRA, special allowance etc. should be revised in the similar fashion. If the components are not revised, then the taxability of individual's salary will be computed on the basis of the amount shown in the salary slip against those components, irrespective of the actual payment received by him. The income tax department will consider payslips as proof to determine the amount due and/or received against the components in your salary slips and thereby, the tax liability on it."

Gopal Bohra, Partner, NA Shah Associates LLP says, "As per income tax laws, an individual is liable to pay tax on the salary amount due to him as per terms of employment, irrespective whether the salary is received by him or not. The tax liability will be calculated on the basis of the amount due to him as per the components of the salary structure and any tax-exemption available against it. If the individual's salary undergoes any cut then the employer should communicate the same in writing to employee and the cut should be reflected in the components of the salary (basic, HRA etc.) as well. If the components of the salary are not revised, then the income tax department will consider the amount not received as due and ask the employee to pay tax on it."

Sachin Vasudeva, a Delhi-based practising chartered accountant holds: "The taxability of salary in the hands of the employee would depend upon whether the employer has deferred the salary or reduced the salary. In case salary is deferred and not paid during FY 2020-21 then the employee would be liable to pay tax on his gross salary as per his appointment letter as the Form 16 would also show the gross salary but the actual amount received by the employee would be less to the extent of deferment of salary."

This would be a double whammy for the employee.

Vasudeva explains: "In case the salary is reduced, then the employer should amend the appointment letter to that extent. If that is not done then there will be a mismatch between the form 16 issued by the employer and the appointment letter of the employee. This could create an issue for the employee in his personal assessment. The assessing officer might want to tax the salary as per the appointment letter on the contention that salary is taxable on due basis and what is due to the employee is mentioned in the appointment letter. The counter to this is that income is accrued only when there is a right to receive that income. In case of reduction of salary the employee does not have any right to receive the salary that has been reduced by the employer and the appointment letter, being a contract, would get modified by the conduct of the employer and employee, with regard to giving of reduced salary by the employer and the acceptance of the same by the employee."

S. Vasudevan, Partner, Lakshmikumaran & Sridharan Attorneys says, "As per Section 15 of the Income Tax Act, income by way of salary is chargeable to tax in the year in which it becomes due or is paid, whichever is earlier. Therefore, what is crucial is whether the so-called "salary cut" is actually a reduction in salary due or a mere deferment of payment. If the salary is reduced without any firm commitment from the employer to pay the shortfall at a later point in time, then the same can be said to be reduction in salary due for the current year. In such a case, only the reduced salary will be taxable in the hands of the employee in the current year. In case the shortfall is paid to the employee in any subsequent year, the same would be taxable only in the year of receipt."

On the other hand, if the employer merely defers the payment of a portion of the salary, then the salary due to the employee will continue to be the full salary otherwise payable to him, including the deferred portion, said Vasudevan. "Thus, the taxable income will also include the amount of salary that is deferred, irrespective of the fact that this portion of the salary may be paid later. The employer will also be required to deduct tax as applicable on the full salary. Though from tax standpoint, it may appear as if reduction is better than deferment of salary, the former could be detrimental to the employees in as much as their legal/contractual right to claim the full salary would be completely taken away. In that sense, a deferral is always better that an outright reduction," Vasudevan added.
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In case of deferment, however, the tax implications can potentially rub salt into the employees' wounds. "Hence, the Government should consider amending the law so that the salary remaining unpaid during the year is not taxed in the hands of the employees. This can be achieved by introducing a special deduction or exemption towards such unpaid salary. Moreover, if it is indeed a reduction in salary, then it is advisable for the employer to provide revised breakup of the components in salary structure like basic salary, HRA, other allowances, etc. This will avoid any potential disputes regarding computation of tax on salary. If no such breakup is provided, then the reduction may be applied to each component of salary on proportionate basis for tax computation purposes," said Vasudevan.

However, not all chartered accountants agree with the above view. According to some experts, the taxation of salary will be determined via amount mentioned via Form-16, i.e. TDS certificate given by an employer to employee.
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Dr. Suresh Surana, founder, RSM India, "If an employee has undergone a salary cut (due to revision in salary components or in any other way), it is the net salary due to the employee after such deduction which needs to be considered for tax purposes. A salary cut is different from a salary deferral as in case of salary cut, the deducted amount is not payable at all whereas in case of deferral, the deducted amount is payable later by the employer. In case of salary cut (presuming it is not contested by the employee), the tax liability would be based on the net amount after considering the salary cut. This will also be consistent with Form 16 to be submitted by the employer for each financial year. It may be pointed out that while it is a common practice for companies to issue written communication for the terms of employment as well as any change in the same, it is not a legal requirement. In fact, the government has indicated that in the new Wage Code, it would be necessary for every employer to issue a formal written appointment letter but there is no requirement under the income tax law to this effect at present."

Abhishek Soni, CEO & founder, Tax2win.in says, "There is an inconsistency in the law regarding the taxation of salary and TDS on it. As per current income tax laws, salary is taxable in the hands of the employee on 'due or received' basis, whichever is earlier. However, TDS on salary is deducted at the time of payment only. Further, it is not clear whether an employer is required to mention the amount due to an employee in the Form-16 or not. Therefore, a clarification from the tax department is necessary in this regard."

Only fixed CTC taxable as due
Bohra adds, "Individuals should remember that only the fixed component of your CTC which is due to you will be liable for tax. Any variable component of CTC such as bonus or reimbursements will not liable for tax unless it becomes due to you."

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