Salary Arrears: Meaning, Causes, Calculation & Tax Implications
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In India, understanding salary arrears is essential for both employers and employees. Employees must understand what arrears in salary are to verify their pay and plan their finances. At the same time, employers rely on accurate arrears of salary for regulatory compliance and accurate payroll management.
People are unclear about salary arrears meaning, so this guide explains payment in arrears, its causes, examples, tax rules, and steps to avoid disputes.
Key Takeaways
- Salary arrears represent pending payments owed from previous payroll cycles.
- They typically arise from salary hikes, payroll mistakes, or retroactive adjustments.
- Arrears are taxable in the year they’re paid, not when earned.
- Section 89(1) allows tax relief on arrears through Form 10E.
- HR must ensure accurate calculations and transparent communication with employees.
- Payroll automation tools help avoid errors and maintain compliance.
- Proper documentation and regular payroll audits reduce disputes and legal risks.
What is Salary Arrears?
Salary arrears are amounts that should have been paid to an employee but were delayed or missed in an earlier payroll cycle due to payroll delays, salary revisions, errors, or retrospective policy adjustments. These delayed payments can include basic arrears, allowances, bonuses, or other pending salary components.
What is Arrears in Salary Slip?
Salary arrears on payslips include payments for amounts an employee was entitled to receive in the past but did not receive on time for any reason. Late salary increments or payroll errors can delay the payment of salary arrears. When these arrears are paid, they are mentioned in an employee’s payslip for the month in which they are paid. The salary slip shows the net payment amount owed from previous payroll cycles. The payslip will include:
- A separate component is named “Salary arrears” or “August Increment Arrears”.
- This amount on the salary slip is the difference between what was paid previously and what should have been paid.
- For example, an employee is supposed to receive a salary of ₹75,000, but received only ₹70,000. The outstanding amount will be adjusted in next month’s salary, and the payslip will include arrears of ₹5,000.
What are the Scenarios for Salary Arrears?
Some instances might result in delays in compensating employees during payroll processing. These scenarios require HR professionals to process salary arrears promptly and address any resulting employee queries or disputes.
Salary Hike & Pay Commission Recommendations
Salary arrears arise when an employee’s salary increase is delayed. An employee’s payroll is revised, and the difference is identified for each month. The difference is paid in the next payroll cycle along with last month’s salary.
Back Pay for Unpaid Overtime/Vacation
Another scenario can be payment to an employee for overtime and vacation time. It involves calculating the salary for work that has already been performed, but the employee is not compensated according to labor laws.
Administrative Errors & Payroll Mistakes
Payroll errors can occur due to miscalculation and incorrect attendance data. These errors result in missed overtime or bonuses, as employees are underpaid.
Retrenchment & Full-And-Final Settlements
In cases of full and final settlement (FnF) and retrenchment, the employer is required to pay all outstanding dues to an employee. This includes any pending amount or reimbursements, up to the last working day of the employee.
Bankruptcy or Insolvency of Employer
If an employer is declared insolvent or bankrupt, salary arrears must be considered a preferential debt. Employees are paid before creditors, which includes unpaid wages and certain benefits.
How to Calculate Arrears of Salary
Accurately calculating arrear salary simplifies the payroll process and ensures fairness. Here is a step-by-step guide to calculate pay arrears:
Identify the Revised Salary
The first step is to record the new salary and the effective date of implementation. The revision may result from an increment, promotion, or updated company policy.
Calculate the Salary Difference
This step includes subtracting the old salary from the new salary and multiplying it by the number of months for which arrears of salary are due.
Salary Difference = New Salary − Old Salary
Arrears = Salary Difference × Number of Months
Include Allowances and Bonuses
If the revised salary includes adjustments to allowances, benefits, or bonuses, include them. If the HR or payroll teams overlook these components, it can cause an incorrect arrear amount in salary.
Double-Check the Total
Review the calculation carefully to avoid any disputes or conflicts. Verify salary differences, the number of months involved (arrear days, if applicable), and any extra payments.
Use Payroll Software
Lastly, manual calculations can take time and may have errors. An arrear salary calculator can simplify the process and ensure compliance.
Example of Arrear Salary Calculation
Mr. Z had a monthly salary of ₹30,000, which was revised to ₹36,500. This increment was effective from March, but the change was paid in June.
Monthly difference = ₹36,500 − ₹30,000 = ₹6,500
Arrear amount payable for March, April, May = ₹6,500 × 3 months = ₹19,500
This total of ₹19,500 will be added to the June payslip, along with the revised June salary. This demonstrates what is arrears in salary slip are and how arrears in salary calculation work in practice.
Payment in Advance vs Payment in Arrears
Here is a table showing the difference between payment in advance and payment in arrears.
| Aspect | Payment in advance | Payment in arrears |
|---|---|---|
| Timing of Payment | It is paid before the goods/services are delivered or the period begins. | It is paid after the goods/services have been delivered or the period ends. |
| Cash Flow Impact | The customer pays beforehand and provides immediate cash flow to the provider. | The provider receives payment after the service and may experience cash flow delays. |
| Risk & Trust | Requires trust since payment is before service. | This approach requires less trust as payment is made after the service is delivered. |
| Accounting | Recorded as prepaid | Recorded as an expense |
| Examples |
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Tax Implications of Salary Arrears
Salary Arrears are Taxed
Salary arrears are taxable in the year they are paid, not the year they were actually earned. This can increase the total income shown in that financial year. As a result, the tax deducted at source (TDS) may also be higher.
Potential for Higher Tax
Many employees notice a sudden increase in tax deductions when arrears are processed. Since the arrears salary is added to the current year’s income, the overall taxable amount can increase. This may place the employee into a higher tax slab, leading to more tax deductions.
89 (1) Relief
Relief under Section 89(1) helps employees reduce the additional tax burden arising from delayed payments. It works by spreading the arrears amount over the years to which they actually belong. To claim this benefit, employees must submit Form 10E to their employer or the Income Tax Department.
How to Claim Tax Relief on Salary Arrears?
When a financial year includes salary or pension paid in arrears or advance, tax relief under Section 89 can be claimed. To claim this relief, Form 10E must be filed online.
Steps to File Mandatory Form 10E
Step 1: Log in to the Income Tax portal at www.incometax.gov.in using your User ID and password.
Step 2: Go to e-File > Income Tax Forms > File Income Tax Forms.
Step 3: Select the tab for Persons not having any business/professional income and choose Form 10E.
Step 4: Select the correct Assessment Year and click Continue.
Step 5: Click Let’s Get Started to begin filling the form.
Step 6: Choose the relevant sections based on your arrear details and click Continue.
Step 7: Open each link shown on the next screen and enter the required information for every section.
Step 8: After all details are filled, click Preview to review the form.
Step 9: Once everything is verified, proceed to e-verify and submit the form.
Step 10: After submission, a confirmation message will appear with the transaction ID and acknowledgement number.
HR and Employer Checklist for Handling Salary Arrears
- Establish Transparent Payroll Guidelines: Employers must set clear rules for salary revisions, bonuses, and reimbursement to avoid confusion or errors.
- Leverage HRMS/Payroll Automation for Accuracy: Use payroll software or an arrear salary calculator to calculate arrears correctly, reduce manual mistakes, and ensure compliance.
- Conduct Routine Payroll Compliance Audits: Schedule regular payroll audits to detect missing payments or discrepancies in salary, attendance, or bonus payments.
- Ensure Clear & Consistent Employee Communication: Inform employees about issues or delays with their pay. Transparent communication builds trust and keeps employees informed.
- Upskill Your Payroll and HR Personnel: Train your HR and payroll teams on payroll processes, arrears calculations, tax rules, and using payroll software.
- Track and Implement Latest Labor Law Updates: Stay updated with changes in wage laws, tax rules, and compliance standards to protect your business from penalties and legal action.
- Maintain Organized and Audit-Ready Documentation: Keep all salary revision records, applications for arrear salary, approvals, and payroll reports ready for audits.
Conclusion
Salary arrears ensure employees receive the pay they were rightfully owed, even if delayed due to payroll revisions or administrative errors. Understanding how arrears are calculated, taxed, and reflected in payslips helps both employers and employees maintain transparency and trust. With the right processes and ideally an automated payroll software, organizations can ensure accuracy, reduce disputes, and stay compliant with labour and tax regulations. Ultimately, proper arrear management supports fair compensation and a more efficient payroll ecosystem.
FAQs
What is Basic Salary Arrear?
A basic arrear is the portion of the salary difference resulting from a revision in the basic pay. Salary Arrears: Meaning, Calculation & Tax ImplicationsThis amount for previous months is paid along with the revised salary.
Are Arrears of Salary Taxable?
Yes, the arrears amount is considered part of an employee’s total income for the financial year in which it is received. Thus, salary arrears are subject to the same income tax rules as regular salary payments.
How are Arrear Payments Made?
Arrear payments are usually made in the next salary cycle once the delay is identified. They may be added to the monthly salary or issued as a separate payout, and are clearly labelled on the salary slip.
How Can HR Avoid Disputes Related to Arrear Payments?
HR can avoid disputes by:
- Maintaining clear payroll policies.
- Communicating changes and calculations to employees.
- Keeping accurate records of salary revisions and approvals.
How Long Can a Company Delay Salary Arrears?
The exact limit for clearing arrears amounts depends on company policy or an employment agreement; however, companies should pay arrears as soon as possible, as unnecessary delays can violate labor laws.
What are the Benefits of Salary Arrears?
Salary arrears ensure:
- Employees receive the correct pay.
- Previous payroll errors are corrected.
- Trust between employees and employers.
Is TDS Applicable to Arrears of Salary?
Yes, tax is deducted at source on arrears in the year they are paid. Employees can claim relief under Section 89(1) using Form 10E if needed.
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