Question

Respond to the following in a minimum of 175 words:

• Explain the tax implications of compensation in the form of salary and wages from the perspectives of the employee and employer.

Answer 1

In absence of detail regarding that from which country this question has been asked, answer to the question is provided as per the Indian Income Tax Act.

Compensation in the form of salary or wages to employees is the amount paid or payable to employees for the work done by them for the business of the employer. It is more than their pre-decided amount of salary or wage but also includes the.basic pay and other benefits (i.e. bonus, commissions, etc.) provided by the employer to their employees in any form, either in cash or in-kind, provided that the compensation amount should be reasonable with respect to work performed by the employee and should not be illegitimate.

The amount of compensation paid by the employer is allowed to be claimed as an expense of the business and hence, it is a reduction from the profits of the business. However, the year in which this compensation should be claimed as an expense depends upon method of accounting followed by the employer. If the cash method of accounting is followed, the compensation should be claimed as an expense in the year in which the payment has been made to the employees by the employer. If accrual method of accounting is followed, the compensation should be claimed as an expense in the year in which the services has actually been performed by the employees irrespective of the fact that payment has been made or it is payable later on.

From the perpective of an employee, the amount received as compensation is taxable income and is taxable as normal salary inocme under the head of salary.