Salary arrears are complex. HRs need to calculate multiple complex parameters to ensure that arrears are paid on time. Whenever there was a delay in payment of employee salary or miscalculation, it needs to be paid in arrears.
However, it is easier said than done since these arrear calculations require manual calculations depending on each scenario.
Processing the salary arrears is crucial for improving the trust and morale of your employees. It increases your employees’ confidence and helps them understand that their company will ensure that their salaries are paid even in cases where some human error might have caused issues in the compensation being paid on time.
We will be discussing the various aspects of salary arrears in India, in this article.
What are Salary Arrears?
Wikipedia defines the word ‘arrear‘ as ‘a legal term for the part of a debt overdue after missing one or more required payments.
It is generally used concerning periodic payments such as bills, salaries, rents, royalties, etc. In this context, the term ‘salary arrears’ refers to the payment compensating the employees’ salaries that should have been paid earlier.
A typical example of a salary arrear is an employee’s monthly salary hike that was not given on time. In this scenario, the employee receives the hiked amount in the next month rather than on the same month their salary was hiked. In this case, we can say that the employee was paid in salary arrears of their wages.
A common consensus regarding the term is that it is the payment that the company pays the employee for missing out on paying them at the right time.
It may happen due to a variety of scenarios which we will discuss later. Because of the missed payment, the employee is bound to receive the amount as arrears from the company because of the delay in receiving income as expected.
To understand the concept better, let us take the example of an employee who has a salary of ₹20,000 and gets an increment of ₹2,000 in June.
Let us assume that the company had to do some extra accounting because they could not provide the hiked salary along with June month’s salary. Hence, they will give it the next month’s salary. As a result, that employee will receive:
₹22,000 (July Month Salary) + ₹2,000 (June Salary Arrears) = ₹24,000 (July In-Hand Salary)
Scenarios for Salary Arrears
There are several scenarios in which a company will be required to compensate their employee with the help of arrears, in India.
Although some of these instances result from human errors while processing and disbursing payroll, some might result in delays related to bureaucracy.
It is also possible that there might have been a wrong or insufficient payment to the employee due to mismatch of documents or misinformation.
In such cases, the amount under question is kept with the company until such disputes are resolved. Such safeguards ensure that others do not take undue advantage of any errors.
Some of the common scenarios for the employees to receive arrears are:
The company may have missed paying the employee some component of the salary the employee is legally eligible to receive.
It might occur in the cases of dynamic components of the salary such as bonuses, incentives, etc. In such cases, the employee is paid the pending amount via arrears in their next month’s salary.
Another common scenario is when the company cannot reimburse the employee for some expense undertaken on their behalf.
Delays in payment of reimbursements usually happen in cases where there might be some discrepancy in the proof of charges or delays in processing the payments on time.
Arrears might also be required in cases where there may have been a wrong tally of the number of days the employee was present in the company for a salary cycle.
In such cases, the employee will be paid their entitled salary and the next month’s salary in arrears.
Another major issue happens when there are errors with the calculation or disbursal of dynamic payments such as bonuses, incentives, etc.
Such matters would lead to decreased trust in the company. Hence, it is essential to ensure these payments are made in the next salary cycle in arrears.
It is another cause of concern for the employee when they are not paid the overtime salary to which they are entitled. It causes additional emotional damage realizing that your employer has not paid for the extra efforts you put in for your company.
Even in such cases, arrears help remove the feeling of distrust the employee may develop knowing that their company has paid for their extra efforts. It revitalizes that their employer has not forgotten their contribution and values them.
Processing Salary Arrears
Calculating the arrears of the employee’s salary is a critical step in arrears disbursal as the employee receiving the arrear has already undergone an unpleasant experience with the company. Hence, care must be taken to ensure they do not have a bad experience again.
To calculate the arrears, you need to consider the following parameters:
- Find the exact basic salary amount for the concerned employee.
- Find the exact amount that an employee was supposed to receive at the end of the last salary cycle
- Cross-verify the amount with the actual amount that the employee received.
- The difference between these amounts should be paid in arrears to the employee in the current salary cycle.
Consider an example where an employee’s salary was hiked from ₹50,000 to ₹55,000 in the last salary cycle. However, due to some calculation error, the hike amount was not paid to the employee.
In this case, the employee is bound to receive the current month’s salary (₹55,000) and their hike amount (₹5,000) as an arrear. Hence, the employee will be receiving ₹60,000 this month as salary.
Paying Salary Arrears
Salary arrears are usually paid in the next salary cycle to which any component of the salary was not given. It is essential to pay the employees their arrears at the earliest since the payment was already delayed.
Human errors may be unavoidable in processing payroll, but having the option to provide arrears significantly increases the employee’s trust in their company.
Although they would not like the fact that the amount was not paid at the end of the correct salary cycle, they would still understand that their company corrects its mistakes by paying the amount in arrears.
Using Form 10E in the Arrear Payment Process
Form 10E helps the taxpayer avoid paying extra income tax on arrears or advance salary, as these are not considered part of their standard income. This tax relief under section 89 (1) ensures taxpayers do not incur additional tax payable on the total income earned or received during the financial year, through arrears and advance salaries.
It is mandatory to fill the Form 10E to ensure that you avail the tax benefits. It needs to be filed before filing the Income Tax Return and can be submitted online only. All registered taxpayers can avail of the benefits of Form 10E to claim relief under Section 89 of the Income Tax Act of 1961. The Form 10E is divided into seven parts:
- Personal information: PAN and contact details of the employee
- Annexure I (Arrears) – Details of salary or Family Pension received in arrears
- Annexure I (Advance) – Details of salary or Family Pension received in advance
- Annexure II & IIA (Gratuity) – Details of payments in nature of a gratuity
- Annexure III (Compensation) – Details of payments in nature of compensation from the employer or previous employer.
- Annexure IV (Pension) – Payment in commutation of pension
- Declaration of the authenticity of the data provided.
IT Relief under Section 89 (1)
Since the tax is calculated on the total income earned or received in the current financial year, you might face issues with the arrears you receive from the financial year prior to the current one. You will incur additional tax burden on salary arrears in the year you received the arrears.
You would be concerned about paying additional tax on salary since arrears are a form of taxable income you are receiving, as it might lead to shifting to a different tax bracket from a lower tax bracket for the year in which you get it. To remove this fear, the Income Tax department has a special provision under Section 89 (1) of the Income Tax Act, 1961.
You need not pay extra taxes for the delay by your company in paying your salary on time. The employer can work out this amount when deducting the tax at the source. You simply have to provide the details of the salary arrears for the year you received it, with the help of Form 10E, as discussed above.
Arrears play a vital role in maintaining the employees’ trust in their company. It acts like a rectification system that helps correct human errors that may have led to miscalculations and payment delays. Since salary is one of the critical factors in any employee’s satisfaction index, arrears help ensure that it does not decrease.
Arrears are like a safety net to ensure that the employees are paid their salaries, even though they will be getting it with a delay. However, it is still better than having no safety net. It also gives the employee additional time if the issue happened due to negligence or mistake. In both cases, they can rectify the problem by discussing the options with their HR and undertaking the required formalities.