The Rs 7.50 lakh myth: Why employer's NPS contribution must be included in salary for claiming deduction under Section 80CCD(2)

As the income tax return (ITR) filing season for AY 2026-27 draws to a close for most salaried taxpayers, with the due date of 31 July fast approaching, one issue that continues to generate confusion is the tax treatment of an employer's contribution to the National Pension System (NPS) and the deduction available on such contribution under Section 80CCD(2) of the Income-Tax Act, 1961.

The issue has practical implications for taxpayers filing returns under both the old and the new tax regimes, since deduction under Section 80CCD(2) is available under both regimes, subject to the prescribed conditions and limits.

Several misconceptions continue to persist. Many employees and even some employers believe that the deduction under Section 80CCD(2) from the gross total income is a standalone benefit available whenever the employer contributes to their NPS account, much like deductions under other provisions of Chapter VI-A, such as Section 80C.


Others believe that the employer's contribution becomes part of salary only when the aggregate employer contribution to specified retirement funds exceeds Rs 7.50 lakh in view of provisions of Section 17(2)(vii). Yet another view is that there is no rationale for first including the employer's contribution in salary and then allowing a deduction for the same amount under Section 80CCD(2).

A closer reading of the statutory provisions, however, shows that none of these views fully reflects the legislative scheme.

Employer's NPS contribution is salary

Section 17(1) of the Income-Tax Act, 1961 provides an inclusive definition of the term "salary". Clause (viii) thereof specifically includes the employer's contribution to an employee's account under the National Pension System (NPS) as part of the employee's salary.

The significance of this provision is often overlooked.

By virtue of Section 17(1)(viii), an employer's contribution to an employee's NPS account forms part of the employee's salary. Importantly, this inclusion is not linked to the Rs 7.50 lakh threshold prescribed under Section 17(2)(vii). Section 17(1)(viii) independently provides for the inclusion of such contributions in salary.

In other words, the employer's NPS contribution becomes part of salary because Section 17(1)(viii) specifically says so. It does not depend on whether the contribution is taxable as a perquisite under Section 17(2)(vii).

How Section 80CCD(2) works

Section 80CCD(2) of the Income-Tax Act, 1961 provides a deduction from the gross total income of an employee in respect of the contribution made by the employer (Central Government, a State Government, or any other employer) to an employee's account under the National Pension System (NPS), subject to the prescribed limit.

Deduction under Section 80CCD(2): At a Glance

Employer	Old Tax Regime	New Tax Regime [Section 115BAC(1A)]
Central Government / State Government	Up to 14% of salary	Up to 14% of salary
Any other employer (Private Sector, PSUs, etc.)	Up to 10% of salary	Up to 14% of salary

"Salary" for the purpose of computing deduction under section 80CCD(2) means basic salary and dearness allowance, to the extent the latter enters into the computation of retirement benefits.

A key point that is often overlooked is that Sections 17(1)(viii) and 80CCD(2) operate as part of the same statutory scheme. Section 17(1)(viii) first brings the employer's contribution to NPS within the ambit of salary. Section 80CCD(2) then grants a deduction in respect of that contribution, subject to the prescribed limits.

Accordingly, the deduction under Section 80CCD(2) cannot be viewed as a standalone benefit independent of the salary provisions. The deduction follows the inclusion of the employer's contribution in salary under Section 17(1)(viii).

Why the confusion?

Much of the confusion stems from Section 17(2)(vii) of the Income-Tax Act, 1961, which provides for the taxation, as a perquisite, where the aggregate employer contributions to the following retirement funds exceed ? 7.50 lakh during a financial year;

• Recognised Provident Fund (RPF);
• the National Pension System (NPS) referred to in Section 80CCD(1); and
• Approved Superannuation Fund.

The excess becomes taxable as a perquisite.

It is important to appreciate that this provision serves a different purpose.

Section 17(2)(vii) does not determine whether the employer's contribution to NPS forms part of salary. That issue is specifically addressed by Section 17(1)(viii), which includes the employer's contribution to NPS within the ambit of salary.

Section 17(2)(vii) merely provides for the taxation of the excess employer contribution to the specified retirement funds over Rs 7.50 lakh as a perquisite.

Since perquisites themselves form part of salary under Section 17(1)(iv), the operation of Section 17(2)(vii) does not override or control the independent inclusion of the employer's NPS contribution in salary under Section 17(1)(viii).

Therefore, it would not be correct to read Section 17(2)(vii) as a condition precedent for including the employer's contribution to NPS in salary. Doing so would render the specific provision contained in Section 17(1)(viii) ineffective.

Salary inclusion and excess contribution taxation are distinct

Another important aspect that deserves attention is the relationship between salary and perquisites.
Section 17(1)(iv) specifically provides that "salary" includes any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages. Consequently, perquisites taxable under Section 17(2) are themselves chargeable to tax under the head "Salaries".

This makes it clear that the concepts of salary and perquisites are not mutually exclusive. An amount taxed as a perquisite continues to form part of salary for the purposes of the Act.

Accordingly, the fact that the excess employer contribution is taxable as a perquisite under Section 17(2)(vii) does not affect the independent inclusion of the employer's contribution to NPS in salary under Section 17(1)(viii) or the corresponding deduction available under Section 80CCD(2).

Why does the ITR utility insist on including the employer's NPS contribution in salary first?

Because that is the sequence prescribed by the Income-tax Act. Section 17(1)(viii) first includes the employer's contribution in salary, and Section 80CCD(2) thereafter allows the corresponding deduction, subject to the prescribed limits. Unless the employer's contribution is first reflected as part of salary, the deduction mechanism under Section 80CCD(2) cannot operate.

Thus, Sections 17(1)(viii), 17(2)(vii) and 80CCD(2) operate in different fields and must therefore be read harmoniously to give effect to the legislative scheme.

The correct legal position: At a glance

Issue	Correct Legal Position
Is the employer's contribution to NPS part of salary?	Yes, it forms part of salary by virtue of Section 17(1)(viii).
Is deduction available under Section 80CCD(2)?	Yes, deduction is available under both the old and the new tax regimes, subject to the prescribed limits and conditions.
What does Section 17(2)(vii) do?	It taxes, as a perquisite, the excess of the aggregate employer contributions to specified retirement funds over ₹7.50 lakh in a financial year.
Does Section 17(2)(vii) affect the deduction under Section 80CCD(2)?	No. Section 17(1)(viii) governs the inclusion of the employer's contribution in salary, whereas Section 17(2)(vii) deals only with the taxation of excess employer contributions as a perquisite.
Why does the ITR utility not allow deduction immediately?	Because Section 80CCD(2) operates after the employer's contribution has been included in salary under Section 17(1)(viii)

What this means for taxpayers

The debate surrounding Section 80CCD(2) is a reminder that the provisions of the Income-Tax Act, 1961 cannot be interpreted in isolation. The tax treatment of an employer's contribution to NPS becomes clear only when Sections 17(1)(viii), 17(2)(vii) and 80CCD(2) are read as part of a coherent statutory framework.

Section 17(1)(viii) brings the employer's contribution to NPS within the ambit of salary. Section 80CCD(2) then allows the corresponding deduction, subject to the prescribed limits, while Section 17(2)(vii) serves a different purpose by taxing excess employer contributions as a perquisite. This statutory sequence also explains why the ITR utility permits deduction under Section 80CCD(2) only after the employer's contribution has been reflected as part of salary.

For taxpayers filing their returns for AY 2026-27, the takeaway is straightforward: the employer's contribution to NPS must first form part of salary under Section 17(1)(viii), following which, the eligible deduction under Section 80CCD(2) can be claimed in accordance with the Act. A proper understanding of this legislative framework will help taxpayers avoid common misconceptions and claim the deduction correctly.

The author, O.P. Yadav, is a former IRS officer with over 36 years of experience in tax administration, education, and training. He is presently associated with Prosperr. io as Tax Evangelist. The views expressed are personal.