If you are a salaried employee, you must have come across the term "salary arrears" in your career. But, what exactly does payment in arrears mean? It's a bit of accounting jargon that everyone should know but is often misunderstood. Let's break it down and look at what the term means.
This article will provide details about salary arrears in India.
What are Arrears?
An arrear is a term used in finance. A value of money that should have been paid in the past and was missed out is called arrears. Arrears are payments made to compensate for not paying salaries on time. Employees are given arrears when they earn a wage increase in a month but do not receive the money in the following month. In this situation, the overdue money is referred to as arrears since it is given at a later period.
Total arrears is the aggregate of all invoices that have accrued since the initial payment was due. If the product or service has been delivered and the bill payment is due after the specified time, the account is considered to be paid in arrears. A worker, for instance, gets paid in arrears since the job must be performed and finished before any compensation can be paid.
There are several advantages to paying staff in arrears. It enables more equitable, equal, and precise payment and better cash flow management. Arrears are simply wage increases carried over from the previous month of payment to the current payment month.
To compute arrear payments for your staff correctly, you must do the following:
- Begin with the usual monthly wage of the staff.
- Compute the sum from the conclusion of the preceding month to the effective arrears date.
- Deduct the sum you have previously paid up to the effective date of the arrears.
- The rest amount is the arrears portion.
- Include any bonuses, such as overtime, tips, or incentives.
Payment in Arrears
There are two commonly used definitions for payment arrears accounting. Arrears can be defined in two ways:
- Arrear Payment can relate to paying a service provider following the conclusion of the agreement's obligations. This utilisation of arrear payment accounting suggests that reimbursement will be paid after a specified period instead of paying in advance. These same rules apply to arrear payments.
- Arrear payments can also relate to a company's inability to make payments. In this circumstance, the arrear payment amount is deemed to be accruing from the deadline of the initial missed payment. When an invoice is paid in arrears, each succeeding payment is added to the previous payment until the outstanding account is "up to date."
Payment in Arrears vs. Payment in Advance
Arrears in Payroll
An arrear is a term that is commonly used in payrolls. This context relates to compensating a person for work accomplished in a prior pay period instead of the current one. Assume, for instance, that your company pays their employees on 1st May for tasks accomplished over the whole month of April. Here, the employees are paid in arrears since they receive their payments after the task has finished.
Many firms like to create a payroll schedule in this manner. When staff is paid in arrears every month, the company has more time to compute gratuities, bonuses, and additional incentives. The other option to compensate employees is to 'compensate in the present,' which implies the employees are compensated for the number of hours they are expected to work under the contract. Instead of depending on a logbook of working hours, the company compensates for what the employee is expected to do. Thus, to remove the expectation portion, companies employ the system of paying in arrears.
Arrears in Accounting
In the context of accounting, arrear payment has a somewhat different connotation. Arrears are payments made for products and services following their reception. Assume you buy products from a supplier who accepts a 30-day payment term. This implies you get 30 days after obtaining the product to make your payment. The supplier decides to be compensated in arrears according to their agreement or invoice conditions. Arrear payment provides your company more flexibility and improves cash flow. You may make additional sales to earn money to make the payment if you have a longer period to pay.
Nevertheless, this can also relate to delayed payments that were not mutually agreed upon. If your company is late on its invoices, the payment will be considered to be in arrears until it is completed. Paying late isn't a smart idea in this situation. You may be charged late penalties, and your goodwill in the market may suffer.
Income Tax on Arrear Payments – Section 89 (1) Relief
The taxpayer's entire income generated or received throughout the fiscal year is used to compute the tax. If an assessee receives a portion of his "pay in advance" or "pay in arrears" or family pension arrears, the IT Act permits you to seek tax savings under Section 89(1). A taxpayer's tax obligations are computed based on the income earned throughout the fiscal year. Past dues levied in the present year may be included in this revenue. Tax rates rise over time, and the tax assessee may be required to pay more taxes in such instances. In such cases, assessees are entitled to tax savings under Section 89(1) of the IT Act.
Here is how you can calculate your tax saving under Section 89(1):
- Compute the tax payable amount on the entire income in the receiving year, including bonus salary, arrears, or reimbursements.
- Determine the tax owed on the entire income earned in the year, omitting any additional compensation.
- Deduct the Step 2 amount from the Step 1 overall salary calculation.
- Determine the taxes due on the whole revenue for the year in question, eliminating any arrears.
- Determine the taxes due on overall revenue and arrears for the fiscal year when the arrear payments pertain.
- Next, compute the difference between Steps 4 and 5.
- The sum surplus in Step 3 over the sum in Step 6 will be the tax savings you will receive. However, if the sum in Step 6 turns out to be greater than the sum in Step 3, you will not receive any tax relief.
Tax Savings on Arrear Salary
If you get an arrear payment, it affects your income tax status. While you are technically in a particular income tax bracket, it may cause you to ascend in the tax slab. The tax slab may be greater since the government changes the tax bracket every year. However, to receive the tax savings under Section 89(1), Form 10E must be filed.
To recap, payment in arrears is not something strange or unusual. It is just that the service providers are paid after their services are received. If anything, it makes the compensation method so much more reasonable. Instead of being paid for your expected level of service, you are compensated for your actual level of service.
It is very common to find payrolls paid in arrears. As such, you should not be too concerned if you get your money a couple of weeks late. It is far more important than you are paid correctly, and that is regardless of the order in which they are issued. This article was focused on providing the basic idea of arrear payments. Overall, this information should help anyone who is interested in learning more about arrear payments, and hopefully, allay some misconceptions regarding this payment method.
Frequently Asked Questions
What does paying salaries in arrear mean?
Paying salaries in arrears means the employer is compensating the employees after they have provided their services.
Is it helpful for a company to pay employees in arrear?
Yes. Paying in arrear allows companies to have constant cash flow while also providing them more time to finalise employee invoices with additional bonuses and incentives.
Do I need to pay taxes on arrear payments?
Yes. Taxes on arrear payments need to be paid just like any other income source.
What is Form 10E?
Form 10E is a document you need to submit to your company in order to enjoy tax savings under Section 89(1) of the Income Tax Act.
Is it necessary for me to file Form 10E?
Yes. Submitting Form 10E is required in order to seek tax deduction under Section 89(1)
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