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For the Receipt of pay and allowances pertain to previous years as arrears, Income tax Act provides for a relief under Section 89(1) of the IT Act.
It works as follows.
Spread the arrears that you have received to the respective years. For example, if you have received arrears for the last two financial years and the current year break it into three (i.e) for the year 2006-07, 2007-08, and 2008-09.
Calculate income tax for the taxable income without including arrears for 2006-07 and 2007-08 seperately based on tax structure applicable during these years. Then add apportioned arrears to the respective year’s taxable income and again find the tax. Find the difference in tax on account of addition of arrears portion. this difference has to be calculated for 2006-07 and 2007-08 seperately. Then these two difference tax amounts have to be added to find out the total difference in tax on account of arrears portion added to the taxable income in the relevant years. This is the resultant amount calculated in “Calculation 1”
Then find out the income tax for the current year without including the arrears. Then find out the income tax for current year after including the total arrears received which relates to current year and also the previous years. Difference of these two tax amounts is the additional tax we have to pay on account of receipt the arrears for the current year and the previous years. This is the resultant amount calculated in “Calculation 2”
Now, subtract the resultant amount as per “Calculation 1” from the resultant amount as per “Calculation 2”. This gives your income tax relief under Section 89 (1). Obviously, if resultant amount as per “Calculation 1” is not less, relief is Nil.
This calculation gains significance as all of us have received the 6CPC arrears during this year which may add to our tax liability.
Since this calculation is little bit complex if not difficult, GConnect has come up with an application to calculate Income tax relief under Section 89(1).
Also, GConnect has a full-fledged Income Tax Calculation application for finding your tax liability for the year 2008-09 (Assessment year 2009-10)
Check this Income Tax Calculation for the year 2008-09