Contents
- Overview & the “fairness” question
- Constitutional framework – Article 14 and rational classification
- How the Income-tax Act classifies income
- Salaries – computation, deductions and compliance burden
- Profits & Gains of Business or Profession (PGBP) – computation, deductions and anti-abuse checks
- Why the two bases differ – economic and administrative logic
- Recent reforms that narrow the gap (Standard Deduction ₹75,000; new tax-regime tweaks)
- Comparative global snapshot
- Practical take-aways & policy suggestions
- Conclusion
“Equality does not mean identity of treatment but equality of burden, viewed in the context of the object of the tax.” – Supreme Court (various rulings)
1. Overview & the “fairness” question
Every April, salaried taxpayers ask why they cannot claim electricity bills, laptop costs, or commuting expenses whereas business owners deduct almost every rupee “wholly and exclusively” spent. At first glance the system looks tilted. Yet, when we unpack constitutional tests, statutory design, anti-avoidance safeguards and recent Budget changes, the differential scheme emerges as both legally valid and policy-driven – though ripe for incremental reform.
2. Constitutional framework – Article 14 and rational classification
Article 14 requires that equals be treated equally and unequals differently if there is a rational nexus between classification and legislative objective. Tax statutes enjoy wide latitude so long as:
- (i) the classification is intelligible, and
- (ii) it bears nexus with revenue objectives.
Indian courts have repeatedly upheld disparate treatment across taxpayer classes (e.g., hotel luxury tax slabs, different surcharges), emphasising that perfect symmetry is not a constitutional mandate
Putting salary and business income in separate buckets passes this two-fold test:
| Test | Salary vs Business |
|---|---|
| Intelligible basis | Employees earn consideration for personal service; businesspersons deploy capital/enterprise and incur costs to generate profit. |
| Nexus with object | Gross‐receipt taxation of salaries minimises leakage (TDS) and simplifies assessment; net-profit basis encourages enterprise by allowing legitimate cost recovery. |
No reported Supreme Court case has struck down the distinction; hence the scheme stands constitutionally robust.
3. How the Income-tax Act classifies income
Section 14 groups income under five heads. Two are relevant here:
| Head | Charging section | Key rule |
|---|---|---|
| “Salaries” (Ss. 15–17) | Income is taxed on due or receipt, before personal outgoings; only statutory deductions allowed. | |
| “Profits & Gains of Business or Profession” (Ss. 28–44DB) | Income = Receipts – Expenses incurred “wholly & exclusively” for business (S. 37). Many specific disallowances safeguard revenue (S. 40, 40A, 43B, 14A, etc.). |
Thus, the law itself embeds the computational asymmetry.
4. Salaries – computation, deductions and compliance burden
- Gross salary components – basic, DA, bonus, leave encashment, etc.
- Exemptions (Chapter III): HRA, LTA, food coupons, employer PF contribution, gratuity limits (S. 10).
- Standard deduction:
Old regime – ₹50,000 (unchanged).
New regime – ₹75,000 from FY 2024-25 onwards Press Information Bureau. - Other deductions: professional tax, entertainment allowance (Govt employees).
- TDS u/s 192 ensures near-zero evasion; employer shoulders reporting compliance.
Result: most work-related costs are already embedded in the remuneration package or provided as tax-efficient allowances; hence additional expense deductions would duplicate relief.
5. Profits & Gains of Business or Profession (PGBP)
- Revenue recognition – mercantile or cash.
- Expense test – “wholly & exclusively for business” (S. 37).
- Capital vs revenue expenditure split; depreciation schedule (S. 32).
- Specific disallowances & caps – e.g., cash payments > ₹10,000 (S. 40A (3)), interest to related parties > arm’s-length (S. 40A (2)), CSR spend (no deduction), etc.
- Anti-avoidance – GAAR, Thin capitalisation (S. 94B), transfer-pricing, S. 14A.
- Books & audit – Tax audit if turnover > ₹1 crore (or ₹10 crore if 95 % digital).
Thus, “deductible expenses” are far from carte blanche; the law polices abuse, albeit post-fact through assessments.
6. Why the two bases differ – economic & administrative logic
| Salary | Business |
|---|---|
| Nature of income – remuneration for personal services; no capital at risk. | Entrepreneurial risk; profit must be measured after recovering input costs. |
| Ease of verification – single employer, payroll records, TDS. | Millions of diverse transactions; costs necessary to earn revenue must be netted off to avoid cascading tax on gross turnover. |
| Leakage risk – low (withholding at source). | High; hence elaborate documentation & audit trail. |
| Policy intent – Simplicity for 6-7 crore salaried taxpayers. | Encourage enterprise; tax only surplus after legitimate costs. |
Both schemes aim at equitable burden by recognising the economic realities of each class.
7. Recent reforms that narrow the gap
- Higher standard deduction ₹75,000 (New Regime) – partial offset for everyday work expenses Press Information Bureau.
- Rebate under S. 87A extended – no tax up to ₹12 lakh (effectively ₹12.75 lakh for salaried after standard deduction) from AY 2026-27 Press Information Bureau.
- Optional regime choice (S. 115BAC) – employees can shift to old regime if allowances/Chapter VI-A deductions exceed the standard deduction.
- WFH allowances – post-COVID, many employers structure reimbursements (internet, furniture) within tax-free limits notified under Rule 3.
- Presumptive regimes for small businesses & professionals (Ss. 44AD/ADA/AE) – bring parity by taxing a percentage of turnover instead of scrutinising every voucher.
8. Comparative global snapshot
| Country | Employees taxed on | Business taxed on | Notable reliefs for employees |
|---|---|---|---|
| US | Gross wages minus pre-tax benefits (401k, health). Unreimbursed employee expenses deductible only if > 2 % of AGI (suspended till 2025). | Net profit (Schedule C). | Standard deduction US $14,600 (single, 2025). |
| UK | Gross salary less allowable employment expenses (strict list; must be wholly, exclusively & necessarily incurred). | Net profit. | £12,570 personal allowance; up-to £150/week WFH flat‐rate. |
| Australia | Gross salary minus specific deductions (home-office %, travel between sites). | Net profit. | A$18,200 tax-free threshold. |
India’s approach is broadly aligned with peer jurisdictions.
9. Practical take-aways & policy suggestions
| For salaried taxpayers | For policymakers |
|---|---|
| • Optimise salary structure – shift reimbursements to permitted allowances (HRA, telephone, LTA). • Evaluate new vs old regime annually – spreadsheet the break-even point. • Claim deductions under Chapter VI-A (80C, 80D, NPS) to mimic “expense deductions”. | • Consider indexing standard deduction annually to inflation. • Permit capped “actual employment expenses” (similar to UK) with e-invoice evidence. • Introduce a presumptive employee expense factor (e.g., 5 % of salary above ₹15 lakh) in lieu of itemised claims to address fairness without administrative overload. |
10. Conclusion
While the first-blush perception is that business owners enjoy preferential tax treatment, a closer look shows that both groups are taxed on their economic gain – the form differs to suit their income-earning process. Salaried individuals receive relief via exemptions, standard deduction and a friction-free compliance pathway; businesspersons face onerous bookkeeping, audit and the risk of deduction disallowance. The differential scheme has survived constitutional scrutiny because it is rooted in rational classification and revenue pragmatism.
That said, Budget measures such as the higher standard deduction and WFH allowances reflect a policy nudge toward closing the perceived equity gap. As digital reporting and e-invoice data mature, limited deduction for verifiable employee expenses could be the next evolutionary step – upholding both fairness and administrative efficiency.
Authored by CA Prabhath Sharma. This article is for educational purposes; readers should consult their tax adviser for transaction-specific guidance.
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