written by | April 21, 2022

Complete Arrears Guide - Arrears Meaning, Calculation, Tax on Arrear Salary

Have you ever received a long due payment from your employer while your hiked salary is taxed higher? Well, that is a common issue. The salary arrears come in a lump sum amount that creates that hike. And unfortunately, it is also taxable. But there is a relief that you can claim. First, more on what arrears mean and arrears of salary

Let's get started.

Did you know?

You can get a refund of your hiked arrears salary. Form 10E can bring you relief under Section 89(1) of the Income Tax Act.

What is the Meaning of Arrear?

As a general term, arear means being delayed of late. In a more true-to-life sense, arrears would be an obligation or a duty that is yet to be fulfilled. 

In the financial world, arrears mean an overdue debt or overdue payment. It is a term more commonly used in a legal context. Some would also define arrears payments as if one or more payments have been due or missed in the scenario where regular payments are made. For example, EMIs, rent, etc., keep in mind that being in arrears payment is not a negative thing all the time, as if the payment is due at the end of the service is rendered.

Payment in Advance vs Payment in Arrears

The difference between advance payments and arrears payments is fairly simple.

Advance payment would mean that the payment is made before the complete rendering of the service or receiving a good, whatever the case may be. An example of payment in advance would be – rent.

But on the other hand, arrears payment means that after the services have been rendered or the goods received, the payment is made. Whether that payment was due or supposed to be paid later on in the first place, it also differs from past due payments. An example of arrear payment would be – the electricity bill. 

Also Read: Salary Revision in Jobs and Recovery of Arrears

Common Terms Related to Arrears

Now that we have a brief idea about what arrears mean and payment in arrears. Let’s go over a few financial industry terms that have different meanings and purposes.

Annuities in Arrears: As you would know that an annuity is a periodic payment that is made in equal intervals and equal amounts over a set period. Those payments are to be made in an annuity if paid at the end of a specified period defined arrears in allowances.

An example of such a scenario can be a transition that requests the payment of ₹10,000 in equal payments in 5 months. And the payment of ₹2000 is made at the end of each month.

Call in Arrears: If you have ever been a shareholder or have been working in a place with a lot to do with shareholders, you might have heard about the call. A call is basically when the company asks for money in exchange for the ownership of a company's share. Call in arrears refers to the shareholder who defaulted on such payment by the due date. 

Dividends in Arrears: It is quite similar to the call in arrears, but it applies when a public company delays the payment of dividends to its shareholders on an agreed date. The reasons behind this could be many.

Arrears of Salary: Compensation due to an employee, whether in a company or a public organisation, such as left out or overdue payments are made in arrears payment.

What Does Arrear Mean in the Context of Payrolls?

Arrears of salary or arrear payment in the context of payrolls defines arrears as a carry on due payment of a prior month to a month after it. It creates a subtle hike in the pay for the following months. Generally, owed amounts are paid to employees later than the due date, known as arrears. Employees pay arrears when they get a raise in one month but receive the amount another month.

Let’s go over a few practical situations when an employee might need to be paid in arrears.

  • The company has missed a payment to the employee.
  • Reimbursement claims are not settled on time.
  • A problem in the attendances record of an employee.
  • Problems in transfers of bonuses or other forms of compensation to the employee.

Calculation of Arrears in Salary

Let’s look at Mr Sharma working in KYL Ltd., who has a salary of ₹10,000 in January, and he gets an increment of ₹2,000 in January? Due to some backend salary processing issues, the amount is reflected in August. So, in August, along with the increased salary of ₹12,000, arrears for the month that did not show the incremented salary amounting to ₹12,000 will be credited to Mr Sharma’s account. 

Hence, in August, the total amount received by Mr Sharma would be (₹10,000 + ₹2,000 x 8) = ₹26,000.

Also Read: Claiming Relief under Section 89(1) on Salary Arrears

Tax on Arrear Salary

Salary arrears is treated in the income tax relief under section 89 (1). The employee will have to provide the necessary particulars of salary arrears to his present employer in Form 10E. There is an exemption for you if you were in a lower tax bracket for the year you received the payment and there was a delay in payment. It is possible to work out and apply for the relief at the time of tax deduction at the source by his present employer in the year in which he receives arrears.

Financial year

Total Income (in ₹)

Tax (in ₹)

Arrears (in ₹) 

Accrued Income (in ₹)

Tax on Accrued income (in ₹)

2015-16

200,000

 

100,000

3,00,000

3,090

2016-17

400,000

10,300

100,000

5,00,000

20,600

2017-18

6,00,000

33,475

200,000

800,000

74,675

2018-19

8,00,000

75,400

300,000

1,100,000

1,48,200

2019-20

9,00,000

96,200

300,000

1,200,000

1,79,400

2020-21

21,00,000

460,200

-10,00,000

11,00,000

1,48,200

TOTAL

50,00,000

6,75,575

 

50,00,000

5,74,165

Here is a small illustration to make you understand how an arrears salary will be treated on tax.

As you can observe in the table above, first there is the income that a person receives and at the last financial year receives arrears payment of the salary. That has hiked the salary of that particular year 2020-21 to ₹21,00,000. Based on that, the tax is also increased. In the column of arrears, we have the arrear payment, which was supposed to be paid each year starting from 2015-16. The accrued income has been given, and the tax is calculated differently than it was earlier. It becomes clear that there is a difference in the tax for both calculations. The difference (₹1,01,410) in them is what is refundable through Form 10E. 

Conclusion

Seems like arrears are not that complex, are they? We know that arrears exist in different contexts and have different technical terms. Thought to put it simply, we know that arrears payments are deferred payments. And are not always of a negative nature. Arrears payment would also require an accurate and regular booking practice. The payment to be made later on needs to be justified. Arrears of salary is a practical situation that occurs quite often. We have discussed how arrears of salary can be calculated and supposed to be handled in taxation.

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FAQs

Q: Is arrear salary taxable?

Ans:

Yes, your arrear of salary is still your income, which you have just received later on than you should. Thus, that makes it taxable. But since you received it in a lump sum, it would probably increase your tax for that financial year. But don’t worry, there is a relief for such cases.

Q: What to do if arrear salary is taxed heavily?

Ans:

If you have just received an arrear of salary, which may have made your salary taxable on a higher slab. You can calculate your arrears and apply the form 10E to claim the relief provided under it.

Q: Is arrears payment only limited to salary?

Ans:

No, it can be applied in different aspects when it comes to the accounting sense of arrears payments. Depending on the palace and context, it can be called different terms.

A form 10E is a form you can fill as per section 89(1) of the Income Tax Act. It allows you relief for your delayed arrears payment of salary. You may not submit it to your employer or fill it out independently.

Q: What are arrears?

Ans:

Arrears are increased salary carried forward from the previous months to be paid in the current month. For example, suppose a revised salary letter or increment letter is received in the June salary but effective from April. In that case, you will calculate the arrears for April and May.

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