Tax laws/rules regarding notice period salary recovery

I have a scenario where I want to understand upon whom income tax liability falls in case notice period salary is recovered by a company, as per the income tax act (or if there are any recent amendments or considerations done w.r.t such cases)

An employee's salary account is credited with regular monthly salary by his employer company.

Before crediting salary by the company, that amount of money was not taxed to the company. (if I am right)
After salary is credited to the employee's account that money is subjected to income tax payable by the employee.
In one case when the employee resigned the job the company takes back the previous two months' salary amount from the employee (as notice period penalty deduction) and the employee is also subjected to pay income tax on that deducted two months salary amount.

After that amount of money is received into the account of the company, as what such money is considered as?

Revenue?

Taxable income?

Loss recovery?

any other ?

If it is considered as revenue, and when no expenditure or loss can be shown on it, then that amount of money is subjected to tax payable by company. (if I am right)
In that case the employee also pays tax on the money deducted for him, and the company also pays tax on the same money it received.

So two times tax is paid on one same money.

Employee paid tax on the money he did not receive for himself.

Company paid tax on the money it recovered from that employee.

In such a case who is entitled for tax exemption?

Employee? (who did not get that money)

Employer? (who received that money)

None? (both have to pay tax)

Are there any tax laws&rules regarding notice pay recovery cases? Any section in the income tax act refer to such case?

Hi Naveen, this is a great question and a common point of confusion regarding notice period salary recovery and income tax implications.

Let me clarify the tax treatment and the applicable law:

Scenario Recap:

Employee receives salary (including notice period salary) — this amount is taxed in hands of employee.
Later, employee resigns and company recovers (deducts) two months’ salary from employee for not serving notice period.
Employee has already paid tax on the full salary credited.
Company receives recovery money back.
Question: Who pays tax on this recovery amount? Does double taxation occur?

Tax Treatment for Employee:

Salary credited to employee is income in the hands of employee and taxable accordingly.
When salary is recovered/deducted later, employee’s income remains grossed up as salary received.
Employee cannot claim deduction for the amount recovered because it is not an expense incurred to earn income; it is a recovery from salary already paid.
Hence, employee pays tax on the full amount credited (including the notice period salary), regardless of subsequent deduction/recovery.

Tax Treatment for Employer:

Amount recovered by employer from employee (for notice period salary) is not a fresh income or revenue for employer. It is recovery of an overpaid expense (salary).
Employer's salary expense reduces by the amount recovered.
For employer:
- Salary Expense = Total salary paid to employees - Recovery from employees.
- So, employer’s taxable profit is increased by the recovered amount indirectly as salary expense is reduced.
Employer does not pay tax on the recovery amount as income, because it's not income; it reduces expense.

Income Tax Act / Rules Reference:

Section 17(1) defines "salary" — taxed when received or due.
Section 37(1) allows deduction of expenses incurred wholly and exclusively for business.
Employer paying salary and then recovering it means salary expense is net of recovery.
There is no specific provision treating recovery from employee as employer’s taxable income.

Summary Table:

Party	Treatment of Notice Period Salary Recovered	Tax Implication
Employee	Salary credited fully taxable. Recovery is not deductible	Employee pays tax on full salary received, including recovered amount
Employer	Recovery reduces salary expense (not income)	Employer’s taxable profit increases by recovery amount as expense reduces, no direct tax on recovery