Arrears of salary: What are they and how are they calculated

Ensuring timely salary payments is a key responsibility for employers and many successfully manage this process with the help of payroll software. However, during the salary revisions season, some adjustments may be necessary. In cases where a portion of the salary is left unpaid, it is carried forward and paid in the next payroll cycle. This unpaid portion of salary is known as salary arrears. 

In this article, we will learn what arrears of salary is, its calculations, and the taxability of salary arrears, so you can process accurate salaries even during extraordinary times.

What are arrears of salary?

Salary arrears are payments owed to an employee that were delayed or not paid in a previous payroll cycle.

Arrears typically arise when you grant an employee a salary increment, but the updated salary is applied in a later month. The difference between the previous and new salaries for the earlier months is then paid to the employee as arrears after the salary revision. In simple terms, arrears represent the unpaid portion of an employee's earnings, which is later on added to their current month's salary.

Different reasons for salary arrears

In India, several situations may result in a company paying employees salary arrears, such as appraisals, procedural delays, or other administrative issues.

Here are some common scenarios where employees may receive arrears:

• Salary revisions

Many companies follow a systematic procedure for revising salaries, which includes budgeting, determining the percentage increase, and communicating the revised salaries to employees. These steps take time and can lead to delays in the salary revision process.

Once completed, companies calculate salary arrears based on the month the revision took effect and pay the arrears in the next payroll cycle.

Learn more about the salary revision process.

• Reimbursements

Arrears may arise when a company hasn't yet reimbursed an employee for expenses made on its behalf. These delays often occur due to discrepancies in the submitted proof, but once resolved, the reimbursement is processed smoothly.

• Attendance

Sometimes, errors in recording an employee's attendance during a salary cycle can result in arrears. In such cases, the company will adjust and compensate the employee with  the correct amount in the next month’s salary.

Standing arrears meaning

In payroll management, standing arrears refer to unpaid amounts that are owed to employees but have not yet been disbursed. These may arise from missed payroll deadlines, temporary cash flow challenges, or administrative oversights.

For example, if regular allowances or bonuses owed to an employee are not paid for several months, the accumulated unpaid amount becomes standing arrears. In certain regions, employers may be required to pay interest on delayed wages to ensure fairness and statutory compliance.

How are salary arrears calculated?

Calculating salary arrears is an important task as it helps resolve past pay discrepancies, ensuring employees receive the compensation they are due.

To calculate salary arrears, follow these steps:

1. Determine the employee’s correct basic salary: Start by identifying the basic salary amount the employee should have received.
2. Review the expected salary: Calculate the salary the employee was supposed to receive in the previous cycle.
3. Cross-check with actual payment: Compare this expected salary with the amount actually paid.
4. Calculate the arrears: The difference between the expected and actual salary should be paid as arrears in the current salary cycle.

For example, if an employee’s salary was increased from ₹50,000 to ₹55,000 but the hike wasn't reflected in the last cycle, the employee should now receive ₹55,000 plus the ₹5,000 missed, totaling ₹60,000 for the current month.

How are arrear payments made?

Salary arrears are typically paid in the following salary cycle after the missed payment is identified.

They are added to the employee's regular payroll or processed as a separate payment, depending on the company’s payroll process. These payments are clearly marked as “arrears” on the salary slip for easy distinction.

Are arrears of salary taxable?

Yes, arrears of salary are taxable in India. When employees receive salary arrears, the amount is considered part of their total income for the financial year in which it is received.

This means that arrears are subject to the same income tax rules as regular salary payments. Employees must report these arrears in their income tax returns, and they will be taxed according to their applicable income tax slab.

Additionally, if the arrears are received in a different financial year than when they were earned, employees may be eligible to claim tax relief under Section 89 of the Income Tax Act, which allows for the adjustment of tax liability for income received in arrears.

Arrears exemption in income tax

Receiving overdue salary payments from previous financial years in the current year can increase an employee’s total income and potentially push them into a higher tax bracket. To prevent this additional tax burden, the Income Tax Act provides relief under Section 89(1).

This section allows taxpayers to claim relief if the arrears would have placed them in a lower tax bracket had they been paid on time. To avail this relief, taxpayers need to submit Form 10E.

Form 10E is essential for those who want to avoid paying extra income tax on arrears or advance salary since these amounts are not part of their regular income. By using Form 10E, taxpayers can claim relief under Section 89(1) of the Income Tax Act, ensuring they do not face any additional tax liabilities on their total income during the financial year due to arrears or advance salaries. The form must be filed online, and all registered taxpayers can use it to claim this relief.

Form 10E is structured into seven sections:

1. Personal information: Includes the employee’s PAN and contact details.
2. Annexure I (Arrears): Contains details of salary or family pension received in arrears.
3. Annexure I (Advance): Includes details of salary or family pension received in advance.
4. Annexure II & IIA (Gratuity): Contains Information on gratuity payments.
5. Annexure III (Compensation): Encompasses details of compensation payments from the current or previous employer.
6. Annexure IV (Pension): Information on pension commutation payments.
7. Declaration: A statement affirming the accuracy of the information provided.

Employers should ensure that employees are aware of the importance of filling out Form 10E to benefit from the available tax relief.

Learn more about Form 10E.

A quick summary

Understanding and properly managing salary arrears is crucial for maintaining employee trust and ensuring compliance with tax regulations. As an employer, it is essential to calculate and disburse arrears promptly while also guiding employees on how to benefit from available tax reliefs.

To streamline this process and ensure accuracy in payroll management, use Zoho Payroll. With its comprehensive features, Zoho Payroll simplifies the calculation of salaries, tax deductions, and compliance with labour laws. Invest in Zoho Payroll to handle your payroll needs seamlessly and keep your employees satisfied.