Section 146: deduction for additional employee cost

Introduction

Section 146 allows a deduction linked to additional employee cost for three consecutive tax years, subject to new-employment and reporting conditions. The employee definition, monthly pay ceiling, minimum days and payment mode determine the eligible cost.

Key takeaways

The deduction

Subject to the conditions in sub-sections (2) and (3), where the gross total income of an assessee to whom section 63 applies includes profits and gains derived from business, a deduction equal to 30% of additional employee cost incurred in the course of that business in the tax year is allowed.

The deduction is allowed for three consecutive tax years, beginning from the tax year in which the employment is provided.

When the deduction is not allowed

The deduction is not allowed if:

• The business is formed by splitting up, or the reconstruction, of an existing business.
• The business is acquired by the assessee through transfer from any other person or as a result of any business reorganisation.
• The assessee does not furnish, before the specified date referred to in section 63, a report of an accountant giving the prescribed particulars.

Exception for re-established businesses

The "splitting up or reconstruction" disqualification does not apply to an undertaking that is re-established, reconstructed or revived by the assessee in the circumstances and within the period specified for the corresponding Section 140(4) exception.

What counts as "additional employee" and "additional employee cost"

"Additional employee cost" means the total emoluments paid or payable to additional employees employed during the tax year, or - if the tax year is the first year of a new business - emoluments paid or payable to employees employed during that year. It is nil for an existing business if there is no increase in the total number of employees from the last day of the preceding tax year, or if emoluments are paid otherwise than by account payee cheque, account payee bank draft, electronic clearing system, or other prescribed electronic mode.

"Additional employee" means an employee employed during the tax year whose employment increases the total headcount from the last day of the preceding tax year - but excludes:

• An employee whose total emoluments exceed ₹25,000 per month
• An employee for whom the Government pays the entire contribution under the Employees' Pension Scheme (notified under the Employees' Provident Funds and Miscellaneous Provisions Act, 1952)
• An employee employed for less than 150 days in a tax year, for an assessee engaged in manufacturing apparel, footwear or leather products (unless employed for that many days in the immediately succeeding tax year, in which case they are deemed an additional employee of that succeeding year)
• An employee employed for less than 240 days during the tax year, for any other assessee (with the same succeeding-year deeming rule)
• An employee who does not participate in a recognised provident fund

What counts as "emoluments"

"Emoluments" means any sum paid or payable to an employee in lieu of employment, by whatever name called, but excludes employer contributions paid or payable to any pension, provident or other fund mandated by law for the employee's benefit, and lump sum payments paid or payable on termination of service, superannuation or voluntary retirement - such as gratuity, severance pay, leave encashment, voluntary retrenchment benefits or commutation of pension.

Step-by-step flow for applying Section 146

1. 1

   Does Section 63 apply to the assessee, and does gross total income include business profits?

   • No: Section 146 does not apply.
   • Yes: Go to the next step.
2. 2

   Is the business barred by Section 146(3)?

   Formed by splitting up or reconstruction of an existing business (subject to the Section 140(4) revival exception in Section 146(4)), or acquired by transfer or business reorganisation.

   • Yes: No deduction.
   • No: Go to the next step.
3. 3

   (Existing business) Did total headcount increase over the last day of the preceding tax year, with emoluments paid through banking or prescribed electronic modes?

   For a new business in its first year, emoluments of employees employed during that year are the additional employee cost (Section 146(5)(a)(ii)). For an existing business, additional employee cost is nil if there is no increase in headcount or if emoluments are paid other than by account payee cheque, account payee bank draft, ECS or prescribed electronic mode.

   • No: Additional employee cost is nil; no deduction.
   • Yes: Go to the next step.
4. 4

   Which new employees are "additional employees"?

   Exclude anyone with emoluments above ₹25,000 per month, anyone whose entire Employees' Pension Scheme contribution is paid by the Government, anyone not in a recognised provident fund, and anyone employed for less than 240 days (150 days for apparel, footwear or leather manufacturing) in the year.

5. 5

   Compute 30% of their emoluments and file the accountant's report

   Emoluments exclude employer contributions to statutory funds and terminal lump sums. The accountant's report must be furnished before the Section 63 specified date. The deduction runs for three consecutive tax years beginning with the year the employment is provided.

Practical checklist

Glossary

Additional employee cost

Qualifying emoluments for additional employees under subsection (5), with a nil rule in specified circumstances.

Additional employee

A new employee increasing the employer's headcount and meeting the section's pay, service and pension tests.

Frequently asked questions