Tax on salary arrears is increasing

Deferred salary dues – whether from late salary increases or settlements – often push employees into a higher tax bracket when paid in the subsequent financial year. To mitigate this, the Income Tax Act, 2025 introduces Form 39, which will replace the current Form 10E from FY27.

Salary dues are taxed in the year of receipt, not when they were earned. This creates what experts call a “pooling of income” effect.

“When salary arrears are received in a later financial year, the entire amount is taxed in the year of receipt and not in the year it was earned, potentially pushing the taxpayer into a higher tax slab,” said Niyati Shah, vertical head, personal tax, 1 Finance.

Dipesh Jain, partner, Economic Law Practice, said the outstanding tax liability could increase either because income shifts to a higher slab or because of changes in tax rates between years.

Preeti Sharma, partner, global mobility services, tax and regulatory advisory at BDO India, said a lump sum receipt could increase the effective tax rate on incremental income, even if the underlying income relates to previous years.

How Form 39 helps in reducing the burden

Form 39 provides relief by recalculating the tax liability as if the dues were taxed in the years to which they actually relate.

“Form 39 allows the taxpayer to recalculate tax by allocating the dues of relevant previous years and neutralizing the additional tax arising due to timing difference,” Jain said.

In practice, this involves comparing:

• Tax payable in the year of receipt (including arrears)
• Tax payable if the outstanding is spread over previous years

“Due to timing, the additional tax arising in the current year is allowed as relief while ensuring neutrality,” Sharma said.

Chandni Anandan, tax expert at ClearTax, said this process may also lead to adjustment or refund of additional tax deducted at source (TDS) once the relief is implemented.

Common mistakes made by taxpayers

Despite the availability of relief, compliance errors often persist.

“One of the most common mistakes is not filing the prescribed forms before submitting the income tax return, which can lead to denial of relief,” Shah said.

Experts highlighted several recurring issues:

• Incorrect year wise allocation of arrears
• Using incorrect tax rates from previous years
• Form filing after due date
• Employers lack proper documentation

“Taxpayers often believe that employer-adjusted TDS is sufficient and skip filing the form, which can result in mismatches and investigations,” said Sudhir Kaushik, co-founder and CEO, TaxSpanner (a Zaggle company).

Jain said filing Form 39 with delayed or amended returns may render the claim defective and challengeable.

When benefits may be limited

Form 39 does not guarantee tax savings in all cases.

“If the dues do not put the taxpayer in a higher slab, the relief may be negligible or nil,” Shah said.

Benefits are also limited to specific types of income. “The relief does not apply to non-salary income like interest or capital gains,” Jain clarified.

Anandan said that even in salary cases, if the income level remains the same over the years, the tax impact – and hence the relief – may be minimal.

Filing process and timing

Experts emphasize that timing is of the essence when claiming relief.

“Form 39 will have to be filed online before filing the income tax return. Failure to do so may result in denial of relief,” Shah said.

This process typically includes:

• Getting year wise details of outstanding amount from employer
• Recalculating tax for relevant years
• Filing Form on Income Tax Portal

Claim for relief in ITR

From a cash-flow perspective, making early deposits can help reduce additional tax deductions. “If the details are provided to the employer on time, they can provide relief while deducting TDS,” Sharma said. Otherwise, taxpayers may have to claim refund later.

Overall, experts say the mechanism is designed to ensure fairness. “This protects taxpayers from being penalized for delayed payment by linking the tax liabilities with the period in which the income was actually earned,” Shah said.