Salary Arrears Explained: Causes, Taxes & Quick Fixes
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When it comes to employment laws in India, dealing with salary arrears is important for both employers and employees. Employees should understand how salary arrears help them verify their compensation and plan their finances accordingly. For employers, salary arrears are essential to maintain compliance with labor laws and manage payroll accurately. Organizations can avoid legal consequences and financial penalties arising from incorrect payroll processing.
Many individuals are confused about the term “salary arrears”, which is often misunderstood. This guide also explains what payment in arrears means and its causes. It also covers various scenarios along with tax implications in India. If organizations face arrears disputes, the blog specifies some practical steps to prevent them. Ultimately, the goal is to give everyone the knowledge and resources to effectively and fairly address the deficit.
What are Salary Arrears?
Salary arrears are the unpaid amounts that were due to an employee but were not paid on time. These payments are compensated later, and this happens when there is a delay in payroll processing. Some reasons for delay in payroll processing could be due to incorrect attendance data or an employee receiving a raise that is applied in the current month, but paid in the next payroll cycle.
To understand the concept more clearly, let us consider an example. An employee’s salary is increased effective from April, but the raise is paid starting in June; the total amount for April and May will be paid as salary arrears. This is to ensure that every employee is paid their full pay.
What are the Causes & Scenarios for Salary Arrears?
Some instances might result in delays in compensating employees during payroll processing. Due to this, HR professionals need to pay salary arrears and resolve the disputes. Some of the common scenarios for the employees to receive arrears are:
Salary Hike & Pay Commission Recommendations
Salary arrears arise when there is a delay in paying an employee’s salary increase. 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 lead to missed overtime or bonuses as employees are underpaid.
Retrenchment & Full-And-Final Settlements
In times of full and final settlement (FnF) and retrenchment, the employer is supposed to pay all dues owed 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, there are salary arrears that need to be considered as a preferential debt. Employees are paid before creditors, which includes unpaid wages and certain benefits.
To understand salary arrears clearly, here is an example with a calculation.
An employee’s monthly salary is ₹50,000 and received a salary hike to ₹55,000 starting from January. Due to some delay in payroll processing, this increased amount will be paid in March. The employee has not received the increment of ₹5,000 in January and February.
For January, arrears = ₹5,000
For February, arrears = ₹5,000
Total arrears for two months = ₹10,000
New salary of March = ₹55,000 + ₹10,000
Total payment in March = ₹65,000
Salary Arrears on Payslips
Salary arrears on payslips include payments for amounts an employee was supposed to receive in the past but did not get on time for any reason. Late salary increments or payroll errors can lead to a delay in 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 additional money paid to an employee that was owed from previous payroll cycles. The payslip will include:
- A separate component should be 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 is adjusted in next month’s salary, and the payslip would include a ₹5,000 arrear.
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 might face a delay in cash flow. |
| Risk & Trust | Requires trust since payment is before service. | This approach requires less trust as payment is 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 in India are taxable as salary income in the year of receipt. An employee’s tax slab and the amount of money received as arrears will determine the tax implications.
The Income Tax Act, 1961 (the “Act”) provides for the following IT sections applicable to salary arrears:
- Section 192: This section requires employers to deduct tax at source from the salary paid to their employees. The rate of TDS will depend on the employee’s tax slab.
- Section 89(1): Taxpayers can claim tax relief on arrears if the deficit results from an employer’s payment delay. The tax relief is derived by comparing the overall income tax liability, including the deficit, to the entire income tax liability, excluding arrears.
From the tax implication perspective, salary arrears should be handled as follows:
- The employer must calculate the tax liability on the arrears, including TDS.
- The employer should pay the tax liability to the government.
- Form 16, issued by the employer to the employee, should show the arrears received and the tax deducted at the source.
- As a final step, the employee should claim tax relief under Section 89(1) if applicable.
Practical Steps to Handle Arrears Disputes
Organizations need to manage salary arrears professionally and maintain compliance with labor laws. This section states some of the practical ways to handle arrears disputes.
Step-1: Communicate Internally
- HR professionals should confirm the exact amount owed to employees and review the previous month’s payslips. The changes in salary should be explained to employees clearly to avoid confusion in the calculation.
Step-2: Provide Quick Resolution
- If an issue in arrears is identified, companies need to take corrective actions to resolve it. This helps prevent escalation of the problem to legal complications and maintains the good faith of the employee.
Step-3: Verify Claims Thoroughly
- Before HR professionals take corrective actions to resolve the issue, the arrears should be verified through payroll records and contracts. For example, overtime payment can be identified from the attendance data, which helps ensure accuracy and a fair resolution.
Step-4: Use Internal Grievance Methods
- Take corrective actions through internal grievance redressal committees to help settle disputes before they escalate into legal issues.
Step-5: Respond to Legal Notices
- If an employee sends a legal notice for salary arrears, respond with a settlement to avoid legal proceedings.
Step-6: Legal Compliance and Timely Payment
- Organizations should understand applicable labor laws and make timely salary payments to maintain compliance. This will help prevent disputes in the first place.
Step-7: Take Legal Advice (if Necessary)
- In some cases, if the matter escalates, businesses should seek legal advice to understand claims and court-related issues under the relevant laws.
Conclusion
Understanding salary arrears is essential for organizations in maintaining employee trust and compliance with labor laws. Employers need to calculate and disburse arrears and provide guidance to employees on how arrears are mentioned in the payslip. Salary arrears arise due to miscalculations or payment delays, which should be rectified before they escalate.
Salary arrears serve as a method to ensure employees are paid their rightful amount despite payment delays and to practice fair payroll management. This system helps maintain employee remuneration and maintain trust between employers and employees.
FAQs
Why do Salary Arrears Happen?
When an employee is owed money for salary that was due in the past but was not paid on time for any reason, this is how salary arrears occur. Some reasons can be:
- Payroll errors
- Delayed salary increments or promotions
- Missed bonuses
- Unpaid overtime
- Reimbursement delays
- Attendance or leave miscalculations
- Policy changes that affect pay
How are Arrears Calculated?
Salary arrears are calculated when there is a difference between the amount that should have been paid and the amount that was paid. The difference arises due to a salary hike or a delayed payment. To calculate salary arrears, deduct the previous salary from the revised salary and find the difference. This difference should be multiplied by the number of months in arrears.
What if My Employer Refuses to Pay Arrears?
The law states that timely payment of the salary components is necessary, and employees can take action if these are withheld for an extended period. If an employer refuses to pay arrears, the employee has some legal options in India. These are:
- Send a Legal Notice
- Approach the Labour Commissioner
- File a Case in Labour or Civil Court
- Summary Suit (Order 37 CPC)
- Writ Petition
- Criminal Complaint
- NCLT for Large Amounts
- Interest on Delayed Payment
How do I Apply for Tax Relief on Arrears?
An individual first needs to submit Form 10E online before filing their Income Tax Return (ITR). An employee should first calculate the tax, including and excluding arrears. The difference is then compared to last year’s income details, and if the previous year’s amount is greater, no relief is allowable.
Who to Contact for Unresolved Arrears?
An individual can contact these for unresolved arrears.
- Financial Services/Banking Ombudsman
- Customer Care or Regional Grievance Redressal Forum
- Employer’s HR or Accounts department
- Money Advice and Budgeting Service (MABS)
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