Have you ever found yourself dealing with payroll issues like delayed salary hikes or missed payments? If you have, you know how frustrating and confusing salary arrears calculations can be. For employers, it’s not just about clearing the dues. It’s about understanding the meaning of salary arrears and managing the process correctly to avoid complications for the team or the business.
So, what exactly are salary arrears? Why do they happen? And most importantly, how do you calculate them without making mistakes or running into compliance issues? As a founder, HR professional, or finance manager, these are questions you can’t afford to overlook. Mismanaging salary arrears calculation can lead to unhappy employees, payroll errors, and even tax penalties.
In this blog, we’ll break down everything you need to know about salary arrears. You’ll learn the meaning of salary arrears, why they occur, and how to calculate them step by step. We’ll also cover tax implications and tips to handle arrears smoothly while staying compliant. Let’s dive in and simplify this for you.
Salary arrears are payments made to employees for work they’ve already done but weren’t fully paid for at the regular pay cycle. These arrears can happen for various reasons, such as delays in salary hikes, payroll errors, or adjustments made due to retrospective policy changes. Simply put, salary arrears are a way to correct missed or delayed payments owed to employees.
Understanding how to calculate salary arrears accurately is one way to manage the efficiency of the payment process. Employers need to see that the calculations are fair, precise and cover all associated statutory and labour law compliances. Here’s a clear step-by-step guide to help you handle this process:
1. Identify the Revised Salary
First, find out the employee’s revised salary. This change could result from a salary increment, a promotion, or an updated company policy. Make sure you note both the new salary amount and the date the change took effect.
2. Calculate the Salary Difference
Subtract the old salary from the revised salary to determine the difference. Then, multiply this amount by the number of months or pay periods for which the arrears apply.
Example: If an employee’s salary increased from ₹45,000 to ₹50,000 per month, and the change is subsequent for three months, the arrears calculation would be ₹5,000 × 3 = ₹15,000.
3. Account for Allowances and Bonuses
If the revised salary includes adjustments to allowances, benefits, or bonuses, make sure you include these in the calculation. Overlooking these components can lead to inaccurate payments.
4. Double-Check the Total
Review the calculation to ensure all details are accurate. To avoid errors, verify the salary differences, the number of months involved, and any additional payments or allowances.
5. Simplify with Payroll Software
Calculating arrears manually can be time-consuming and prone to mistakes, especially for large teams. Using payroll software can automate the process, ensuring accuracy and compliance with tax laws.
Now, let’s take a closer look at the tax implications of salary arrears and how to handle them.
When you understand the salary arrears calculation, it’s also important to know how arrears affect taxes. Since arrears are paid after they were originally due, they can sometimes create tax complications for employees. As an employer, handling this correctly is mandatory to ensure compliance and avoid confusion. Here are the key points to keep in mind:
1. Arrears Are Taxed in the Year They Are Paid
Salary arrears are not taxed in the year they were earned, but in the year they are received. This means the arrears are added to the employee’s income for the current financial year. In some cases, this can increase their taxable income and push them into a higher tax bracket.
2. Relief Under Section 89(1)
Employees can apply for relief under Section 89(1) of the Income Tax Act to reduce the tax burden caused by arrears. This provision spreads the arrears over the years they were due, helping reduce the overall tax impact for the current year.
3. The Role of Form 10E
Filing Form 10E is necessary to claim tax relief on arrears. Without submitting this form, employees cannot benefit from the tax relief under Section 89(1). Employers should make sure employees know about this form and assist them with the process if needed.
Managing the tax implications of salary arrears is important for both compliance and employee satisfaction. Next, we’ll look at the steps employees and employers can follow to claim tax relief on arrears efficiently.
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When salary arrears are received, they can significantly impact an employee's tax liabilities. To ensure employees aren't penalized for receiving arrears late, they can claim tax relief under Section 89(1). Below is the step-by-step process for claiming tax relief on salary arrears:
Step 1: Calculate Tax Payable on Total Income, Including Salary Arrears, for the Current Year
Start by calculating the total income for the current year, which includes the salary arrears received. This total income will be subject to the regular income tax calculation for the year.
Step 2: Calculate Tax Payable on Total Income, Excluding Salary Arrears, for the Current Year
Next, calculate the total income excluding the salary arrears for the same year. This helps to determine what the tax liability would have been if the arrears had not been received in the current year.
Step 3: Calculate the Differential Tax Liability Created Due to Arrears
Subtract the tax liability from Step 2 (excluding arrears) from the tax liability in Step 1 (including arrears). The difference between these two amounts shows the differential tax liability created due to the salary arrears.
Step 4: Calculate Tax Payable on Total Income, Excluding Arrears, for the Year to Which the Arrears Relate
Now, look at the year or years to which the salary arrears relate. First, calculate the tax payable for those years, excluding the arrears. This gives the original tax liability for that year before the arrears were considered.
Step 5: Calculate Tax Payable on Total Income, Including Arrears, for the Year to Which the Arrears Relate
Next, calculate the tax payable for the same year(s), including the arrears. This will show the tax liability for that year as it would have been had the arrears been received on time.
Step 6: Calculate the Differential Tax Liability for the Year to Which the Arrears Relate
Subtract the tax liability calculated in Step 4 (excluding arrears) from the tax calculated in Step 5 (including arrears). This will give the differential tax liability for the year to which the arrears relate.
Step 7: Claim Relief Under Section 89
If the employee has paid more tax in the current year (Step 3) than what would have been payable for the arrears-related year(s) (Step 6), they are eligible to claim relief. The amount of relief is the excess tax paid in the current year, which can be claimed under Section 89(1).
Example Process for Claiming Relief
Let us consider two examples below:
Example 1:
Annual Salary for FY 2025-26: ₹12,00,000
Arrears for FY 2025-26: ₹2,00,000
Total Earnings for FY 2025-26: ₹14,00,000
Tax Payable on ₹14,00,000 = ₹81,900 & on ₹12,00,000 = ₹0
Example 2:
Annual Salary for FY 2024-25: ₹10,00,000
Arrears: ₹2,00,000 (received in FY25-26)
Total Earnings: ₹10,00,000
Tax Payable on ₹10,00,000 = ₹44,200 & on ₹12,00,000 (with arrears) = ₹71,500
Differential tax liability = Tax in Step 1 (with arrears) - Tax in Step 2 (without arrears)
Refund = ₹81,900 - (₹71,500-₹44,200) = ₹81,900 - ₹27,300 = ₹54,600
Claim Relief Under Section 89 = ₹54,600
This process ensures the employee pays taxes fairly without being penalised for receiving arrears late.
Claiming tax relief on arrears helps ease the financial burden for employees. Next, let’s explore real-world examples of salary arrears situations to see how they’re handled in different scenarios.
Salary arrears happen when employees don’t get paid the full amount they are owed on time. This can happen for different reasons—some are simple mistakes, while others are tied to company policies or external factors. Whatever the cause, dealing with arrears properly keeps employees satisfied and payroll records accurate. Here are the most common reasons:
1. Delayed Salary Increases
A pay raise is approved but not processed on time. If an employee was supposed to start receiving a higher salary in January, but the system update happens in March, the company owes back pay for January and February. This is one of the most common cases of salary arrears.
2. Payroll Errors and Missed Bonuses
Human error plays a big role in salary arrears. Someone might forget to update payroll records or miscalculate an employee’s salary. Missing out on bonuses due to slow approvals or miscommunication also creates arrears. If a company announces a performance bonus but takes months to pay it, that delayed payment becomes an arrear.
3. Attendance and Leave Mistakes
Errors in attendance tracking can lead to underpayments. If paid leave is incorrectly marked as unpaid, the payroll system reduces the salary. Once the mistake is caught, the company needs to pay the difference as arrears.
4. Unpaid Overtime and Back Pay
Employees who work overtime expect to be compensated. If extra hours are logged but not processed in the next paycheck, arrears build up. The same happens when back pay is owed due to changes in job roles or wage adjustments that take time to finalise.
5. Policy and Contract Adjustments
Salary structures, allowances, and benefits sometimes change due to new company policies or contracts. If a policy is revised with a retroactive effect, employees may be owed money for past months. This happens with travel allowances, housing benefits, or any compensation tied to changing agreements.
6. Public Sector Pay Revisions
Government employees often experience arrears when salary structures are revised. Negotiations with unions or government policy changes can take months. Once a new pay scale is finalised, employees receive arrears to cover the difference from the date the revision was supposed to take effect.
How to Handle Salary Arrears Efficiently?
Salary arrears are unavoidable at times, but they don’t have to be a headache. Keeping payroll records accurate, updating salary changes on time, and communicating with employees can prevent most issues. When arrears do happen, paying them out quickly and explaining the breakdown builds trust and keeps payroll stress-free.
Managing arrears manually increases the risk of errors and delays. Craze automates salary calculations, tracks pay revisions, and ensures arrears are processed without hassle. Schedule a demo today and see how Craze keeps payroll simple, accurate, and compliant.
To understand salary arrears more clearly, it's helpful to compare it with another payroll concept: salary advance. While these terms are often confused, they represent opposite payment practices. Below is a breakdown of their definitions, examples, and the impact they have on payroll management for salaried employees.
1. Payment in Arrears
Payment in arrears refers to payments made after the work or service has been completed. Salary arrears fall into this category because they are owed for past periods but paid at a later date. In most cases, salary arrears occur when an employee is owed money for salary increments, promotions, overtime, or bonuses from previous months.
Example: An employee receives ₹10,000 as arrears in March for a salary increment that was effective in January.
While salary arrears help rectify missed or delayed payments, they can complicate payroll calculations and tax compliance if not managed properly. Arrears need to be clearly documented and processed to ensure that they are taxed correctly and in the right period.
2. Salary Advance
A salary advance is when an employee receives a portion of their salary before the end of the pay period. This is usually requested by employees during times of need, such as emergencies or large expenses. A salary advance is deducted from their regular salary in the upcoming pay period, which means it’s essentially an early payout rather than additional income.
Example: An employee requests a salary advance of ₹20,000 in the middle of the month, which will be deducted from their next month’s salary.
Salary advances are often more straightforward in payroll management than arrears, but they do require careful tracking to ensure they are repaid correctly in the following pay period. Unlike arrears, salary advances don’t typically impact tax calculations since they’re considered part of regular earnings and deducted from future payments.
Key Differences
Aspect | Payment in Arrears | Salary Advance |
Timing | After work is completed | Before work is completed |
Purpose | To correct missed or delayed payments | To provide early access to salary |
Payroll Impact | Adds complexity to payroll management, requires careful tax calculations | Easier to manage, simply deducted from future salary |
Common Uses | Salary increments, overtime, bonuses | Employee requests for early salary payments |
Understanding how these payment methods work is important for keeping everything in order. Salary arrears help ensure employees are paid for any past underpayments, making sure they receive what they’re owed. Salary advances, on the other hand, let employees access part of their salary before payday, often to cover personal expenses. Both methods need clear communication and proper record-keeping to avoid confusion and ensure everything runs smoothly.
Handling salary arrears calculation the right way keeps payroll smooth and employees confident in their pay. Here’s how to manage arrears without delays or mistakes.
Handling salary arrears is about more than just catching up on missed payments. It’s about keeping your employees’ trust, ensuring statutory compliance, and running an efficient payroll system. By following these practical steps, you can manage arrears with confidence and prevent future issues:
1. Create Clear Payroll Policies
Clear policies reduce confusion and errors. Set rules for handling salary hikes, bonuses, and reimbursements. Make sure your team knows these policies and sticks to them.
Example: State in your policy that all salary increments must be applied within the next payroll cycle after approval. This gives employees a clear timeline and avoids delays.
2. Use Payroll Software to Avoid Errors
Manual calculations can easily lead to mistakes, especially regarding arrears. Payroll software automates the process, calculates arrears accurately, and ensures compliance.
Why it helps: Automating payroll reduces human errors and saves time, especially when managing arrears for a large team.
3. Audit Payroll Records Regularly
Mistakes in salary, attendance, or bonus payments can go unnoticed without audits. Regular reviews help you spot and fix problems early before they lead to arrears.
Tip: Schedule payroll audits every three months to check for missing payments or discrepancies.
4. Communicate Openly with Employees
Employees want to feel informed when there are delays or issues with their pay. Be upfront about what happened, how you’re resolving it, and when they can expect payment.
Example: If there’s a delay in implementing a salary revision, send an email explaining how arrears are being calculated and when they’ll be paid. This transparency helps maintain trust.
5. Train Your Payroll Team
Your HR and payroll teams need the right skills to handle arrears efficiently. Provide training on arrears calculations, tax rules, and how to use payroll tools.
Why it matters: A trained team can manage complex payroll cases better and prevent delays or errors.
6. Stay Updated on Legal Requirements
Tax and labour laws often change, and payroll must keep up. Ensuring compliance protects your business from penalties and legal trouble.
Pro Tip: Partner with a payroll provider like Craze HQ to stay on top of compliance updates and simplify your payroll process.
Managing salary arrears well requires calculated steps to reduce mistakes, improve efficiency, and keep employees satisfied. A smooth payroll process is important for the success of your business.
Read More: Guide to Human Resource Management Systems (HRMS)
With these best practices, you can manage salary arrears with confidence.
Managing salary arrears doesn’t have to be a complicated process. By understanding the meaning of salary arrears, knowing how to calculate them, and following best practices, you can simplify payroll management and avoid common challenges. For employers, staying proactive and transparent about salary arrears builds trust with employees and ensures compliance with tax and legal requirements.
To make things even easier, tools like Craze can transform how you handle payroll. From automating arrears calculations to managing tax compliance seamlessly, Craze ensures your payroll runs smoothly while reducing the chances of errors. This means less time spent on payroll issues and more time to focus on growing your business.
Ready to simplify your payroll process? Schedule a demo with Craze and see how our platform can help you manage salary arrears and more, effortlessly.
1. What are salary arrears?
Salary arrears refer to the portion of an employee’s salary that was not paid in a previous period, usually due to payroll issues or discrepancies. These arrears are paid once the issue is resolved, often covering multiple months.
2. How is salary arrears calculated?
The calculation of salary arrears involves determining the unpaid salary for a particular period. Factors such as missed payments, changes in pay structure, and adjustments for overtime or bonuses must be considered.
3. Are salary arrears subject to tax?
Yes, salary arrears are taxable. They are taxed according to the employee’s income tax slab in the financial year in which they are paid. Employees may claim tax relief under Section 89 of the Income Tax Act, depending on the arrears’ amount and the year they belong to.
4. How can employees claim tax relief on salary arrears?
Employees can claim tax relief on salary arrears by submitting Form 10E along with their income tax return. This form calculates the relief under Section 89 of the Income Tax Act, which can reduce the tax burden. Craze HR Solutions can assist employers in generating the necessary forms and helping employees with the tax relief claim process efficiently.
5. What are the common causes of salary arrears?
Salary arrears can occur due to payroll errors, missed salary due to policy changes, delays in processing overtime or bonus adjustments, or issues with employee status changes (e.g., leave without pay).
6. How does salary arrears affect employees and employers?
For employees, salary arrears can cause financial strain and dissatisfaction, especially if payments are delayed. For employers, managing arrears is critical to maintaining trust and morale. Ensuring timely and accurate payments is key to a healthy workplace.
