Salary Arrears Calculation: Formula, Tax and Form 39 Relief

Salary arrears are the difference between what an employee should have been paid for past months and what they were actually paid, settled in a later payroll. The calculation is the revised monthly pay minus the old pay, month by month, for every month from the effective date to the month before payment, adjusted for unpaid days. The whole amount is taxed in the tax year it is paid. If that pushes the employee into a higher slab, they can claim relief under section 157 of the Income-tax Act, 2025 by filing Form 39. From 1 April 2026 these took the place of section 89 and Form 10E.

The common case is a mid-year increment: the appraisal closes in June, the revision is effective from 1 April, and the July payroll pays three months of difference on top of the new salary. The subtraction is the easy part. Mistakes usually come from LOP days and the PF ceiling, and employees tend to notice the extra TDS before anything else. Engage's payroll software works out arrears on a backdated increment from the salary structure each employee is already paid on, and the free TDS calculator shows the tax effect before you announce the payout.

Go straight to the month-by-month increment example, the Form 39 relief calculation or the payroll checklist.

Written for private employers; government pay commission and DA arrears follow their own orders. Not legal or tax advice. The Income-tax Act, 2025 and Income-tax Rules, 2026 apply from 1 April 2026 (tax year 2026-27), and the Labour Codes from 21 November 2025. Law as at 12 November 2026.

What are salary arrears?

Salary arrears are pay earned in an earlier period and paid in a later one, usually because a decision with a past effective date was taken after payroll for those months had closed.

In a private company, arrears usually come from one of these:

• An increment or promotion approved after its effective date.
• A wage settlement with a union, signed months after the date it applies from.
• A state minimum wage or VDA revision that payroll picked up late. Our minimum wages pages list current state rates.
• A component missed for some months, or a wrong pay grade found later.

The word is also used the other way round, for amounts an employee owes the employer. Those are recoveries, covered in our salary advance recovery guide. The arrears glossary entry covers the general meaning.

How do you calculate salary arrears? The formula

Arrear for a month = (revised monthly pay minus old monthly pay) × paid days in that month ÷ the divisor used for that month

Total arrears = sum of the monthly arrears from the effective date to the last month paid at the old rate

Four points decide whether the figure is right.

• Work head by head. Compute the difference separately for basic, DA, HRA and every other component. PF, gratuity and the HRA exemption each depend on particular heads.
• Use the paid days of that month. If the employee had two days of loss of pay in May, the May arrear is for 29 of 31 days. Use the divisor the May payroll used. Our LOP calculation guide explains the divisors.
• Recompute anything driven by the rate. Overtime is paid at twice the rate of wages, so overtime worked in the arrear months needs a top-up. So does leave encashed in that period.
• Stop at the right month. The arrear period ends with the last payroll that ran at the old rate.

The formula is the same for an increment, a settlement and a minimum wage revision. What changes is the treatment of leavers: a contractual increment and a legal duty are handled differently, as explained under payments that change on a backdated revision.

How do you calculate increment arrears month by month? A worked example

The figures below are illustrative. Rohan's increment is approved in the June 2026 appraisal cycle, effective 1 April 2026, and paid in the July 2026 payroll. His company uses calendar days as the divisor and contributes PF on the capped wage ceiling.

Rohan had two days of loss of pay in May, so he was paid for 29 of 31 days.

The May basic arrear is ₹8,000 × 29 ÷ 31 = ₹7,483.87, rounded to ₹7,484. The July payslip shows the new salary plus two lines, basic arrears ₹23,484 and HRA arrears ₹11,742, labelled April to June 2026. Our payslip format guide explains why arrears need their own lines.

PF on Rohan's arrears

Rohan's basic was already above the ₹15,000 ceiling that applied from April to June, so on capped contributions the arrears add no statutory PF. If his employer contributes on full basic under a joint option, the employee share on the basic arrear is 12% of ₹23,484, which is ₹2,818, with a matching employer share. Pension wages were already capped, so all of it goes to EPF.

Tax on Rohan's arrears

At the revised rate, Rohan's salary for the year is about ₹15,75,484 and his taxable income under the new regime, after the ₹75,000 standard deduction, is ₹15,00,484. The arrears sit in the 15% slab, so they add about ₹5,495 of tax including cess. All of the arrears relate to tax year 2026-27, the year they are paid in, so there is nothing to spread back and no relief under section 157. Relief only applies when arrears belong to an earlier tax year, as in Neha's example below.

Which payments change when a salary revision is backdated?

Any payment worked out on the old rate during the arrear period may need a top-up.

Employees who left before the arrears were paid. For a statutory revision, such as a minimum wage applied late, the difference is wages they were legally owed, so pay it. For an increment, the revision letter or policy decides. A policy that pays increment arrears only to employees on the rolls on the approval date is easier to defend when it is written down and applied to everyone. If exited employees are included, the F&F is reopened and gratuity on the revised last drawn wages comes up. The Code on Social Security does not deal with a revision announced after exit, so take advice before deciding. See our F&F guide and gratuity calculation guide.

Is PF deducted on arrears of salary?

Yes, on the part of the arrears that counts as PF wages, and only up to the ceiling that applied in the month the arrear relates to. PF wages follow section 2(88) of the Code on Social Security, 2020: basic, DA and retaining allowance, with excluded items such as HRA, conveyance and overtime added back if they exceed half of total remuneration. Arrears of basic and DA therefore carry PF, and arrears of HRA usually do not. Where arrears flow from a union settlement or award, look at exclusion (g) in section 2(88) with your adviser.

The due month is the month the arrears are paid out. EPFO's FAQs on the revamped ECR (circular dated 8 October 2025, Q15) say so directly. Arrears paid with the November 2026 salary are November 2026 contributions, due by 15 December 2026. They go in the arrear return on the employer portal, not in the regular ECR. The same FAQ separates arrears from belated wages, which EPFO treats as a default.

Which PF ceiling applies to arrears?

The ceiling rose from ₹15,000 to ₹25,000 on 17 September 2026 under S.O. 5109(E). EPFO's FAQ describes arrear contributions as relating to the earlier wage period, so the common reading is that each arrear month is tested against that month's ceiling. Confirm it with your PF consultant before a large settlement. Take Meera, with illustrative figures. Her basic rises from ₹20,000 to ₹22,000 from 1 August 2026, the increase is paid in November, and her employer contributes on capped wages.

The employee share on the arrears is ₹352, with a matching employer share split between pension and provident fund as in any month. September is prorated by days, as EPFO's ceiling FAQs require. Our PF calculation guide covers the split month.

Does ESI apply to arrears of salary?

ESIC's own answer, in its 2018 FAQ booklet (Q16), is that when wages are raised from a retrospective date, contribution on the higher wages is payable from the month the increase is announced, and no contribution is needed on the arrears for months before that. If the increase crosses the ₹21,000 ceiling, coverage continues to the end of that contribution period.

That booklet was written under the Employees' State Insurance Act, 1948, which the Code on Social Security, 2020 has since repealed, and the booklet says it cannot be quoted as a legal document. We have not found an ESIC clarification on arrears under the Code as at 12 November 2026, so follow this position and confirm it with your ESIC branch office if the amounts are large. Our ESI calculation guide explains contribution periods and the ceiling.

Is arrear salary taxable?

Yes. Section 15(1)(c) of the Income-tax Act, 2025 charges any arrears of salary paid in the tax year, if they were not charged to tax in an earlier year. Section 15(2) treats a former employer as an employer, so arrears paid to someone who has already left are still salary, and TDS applies.

The year of receipt matters because of slabs. Under the new regime, the default under section 202, the rate rises five points for every ₹4 lakh above ₹4 lakh, up to 30% above ₹24 lakh, and the rebate makes income up to ₹12 lakh tax-free. A large arrear can move an employee from the 15% slab to 20%, or past ₹12 lakh so the rebate is lost. Section 157 relief deals with that.

Arrears are not exempt in either regime, and nothing in section 157 or rule 73 limits relief to the old regime. Our guide to income tax on salary under the old and new regimes sets out the slabs, the rebate and marginal relief.

How is TDS on arrears calculated in the month of payment?

The employer adds the arrears to the year's estimated salary, recalculates the annual tax and deducts the extra. Section 392(1) requires TDS at the time of payment at the average rate on the estimated salary income of the year of payment, and section 392(5)(c) lets the employer adjust any excess or shortfall later in the same year.

You can deduct the whole extra tax in the arrear month, which keeps later months steady, or spread it over the rest of the year. Both fit section 392 if the year's total is right. Arrears paid in February or March leave little room to spread, so warn employees before the payslip arrives.

If the employee gives the employer Form 39 particulars, section 392(4)(a)(ii) and rule 73(4) require the employer to take the relief into account, which reduces TDS. Run the revised annual figure through the TDS calculator before you release the payslip.

What is relief under section 157 and Form 39?

Section 157 of the Income-tax Act, 2025 replaced section 89 of the 1961 Act. Where arrear or advance salary, salary for more than twelve months in one tax year, profits in lieu of salary or arrears of family pension cause income to be taxed at a higher rate, the Assessing Officer grants relief on the employee's application. Rule 73 of the Income-tax Rules, 2026 (formerly rules 21A and 21AA) gives the formula, and Form 39 replaced Form 10E.

Rule 73(4) and section 392(4)(a)(ii) cover government servants and employees of a company, co-operative society, local authority, university, institution, association or body. A partnership firm or proprietorship should check with a tax adviser whether it falls within that list before giving relief in TDS. The employee can still claim it in the return.

How do you calculate relief on arrears of salary? A worked example

Rule 73 works in four steps. Find the years the arrears relate to and the amount for each. Work out A, the extra tax the arrears cause in the year of receipt. Work out E for each earlier year, the extra tax that year's share would have caused, and add them to get B. Relief is A minus B, if A is larger.

The figures below are illustrative. Neha's revision was effective 1 October 2025 at ₹20,000 more a month, but it was approved only in May 2026 and paid in June 2026. The arrears are ₹1,20,000 for October 2025 to March 2026, all relating to FY 2025-26, and are received in tax year 2026-27. She was on the new regime in both years.

In 2026-27 the whole ₹1,20,000 falls in the 20% slab. In 2025-26 it would have fallen in the 15% slab. The relief is the five-point gap on ₹1,20,000 plus cess. If Neha gives these particulars to her employer through Form 39, payroll reduces her TDS for the year by ₹6,240.

The earlier year is recomputed only for this calculation; the 2025-26 return is not reopened. Use the regime and rates that applied in each earlier year, so an employee on the old regime in 2025-26 has E worked out under the old regime. Relief can also be nil: if the earlier year's rate was the same or higher, A is not more than B. Relief is at its largest when the earlier year's income, arrears included, stays within that year's rebate limit (₹12 lakh under the new regime for 2025-26). E is then nil, so the employee gets back the whole of A.

What should the arrears statement and payslip show?

The employee needs a year-wise breakup to claim relief, and it is easiest to produce in the arrear month. Give each employee a short statement with:

• The reason and dates, such as "Annual increment, approved 18 June 2026, effective 1 April 2026".
• Each arrear month with paid days, old and revised amounts per head, and the arrear.
• Subtotals by tax year. This is the line the employee copies into Form 39.
• PF on the arrears, the wage month it relates to and the month it was deposited.
• TDS on the arrears, and whether Form 39 relief was applied in payroll.

At year end the arrears appear in the salary breakup of the employee's TDS certificate (Form 130, which replaced Form 16), and any relief given through payroll appears in the relief line of that breakup. Our Form 16 guide for employers walks through the annexure. Record the increment in a revision or promotion letter that states the effective date.

What do employers ask most about salary arrears?

Is arrears salary taxable?
Yes. Arrears are taxed under section 15(1)(c) of the Income-tax Act, 2025 in the year they are paid, if they were not taxed earlier. Where that pushes the employee into a higher rate, section 157 relief through Form 39 removes the extra tax.

Is relief available in the new tax regime?
Yes. Section 157 and rule 73 do not limit relief to the old regime. The calculation uses the regime the employee was on in each year.

Is there relief on arrears for months in the same tax year?
No. If an April increment is paid in July of the same tax year, the arrears are taxed in the year they relate to, so A equals B and relief is nil.

An employee wants the arrears paid next April to keep this year's tax down. Can we agree?
Deferring payment does not reliably move the tax year. Section 15(1)(a) taxes salary in the year it falls due, whether paid or not, and the common view is that arrears under an approved revision are due once it is approved. Wages due also have to be paid on time under section 17 of the Code on Wages. Confirm with a tax adviser before agreeing.

An employee has left and cannot be traced. What happens to their arrears?
If the arrears are wages due, such as a late minimum wage revision, they still belong to the employee. Section 44 of the Code on Wages sends dues that cannot be paid because the employee's whereabouts are not known to the nominee, or to the prescribed authority. Under rule 46 of the Code on Wages (Central) Rules, 2026, the employer deposits them with the Deputy Chief Labour Commissioner (Central) within fifteen days after six months from the date they became payable. That rule applies where the Centre is the appropriate government; state rules name their own authority. Deduct TDS first, because arrears paid to a former employee are still salary under section 15(2).

How long can an employee claim unpaid arrears?
Three years from the date the claim arises, under section 45(6) of the Code on Wages, and later if the delay has sufficient cause. Section 45(2) lets the authority add compensation of up to ten times the amount, so a missed minimum wage revision is expensive to ignore.

We paid excess arrears by mistake. Can we recover them?
Yes. Section 18(2)(f)(i) of the Code on Wages permits deductions to adjust an overpayment of wages, within the 50% cap on all deductions in a wage period under section 18(3). A large recovery has to be spread over months.

Salary arrears checklist for payroll

• Record the effective date and approval date in writing, and list everyone covered, including leavers in the arrear period.
• Settle the policy for leavers before announcing the revision. For statutory revisions, pay them.
• Compute the difference head by head for each month on paid days, with that month's divisor.
• Top up overtime and leave encashment paid in the arrear months.
• Work out PF on the PF-wage part against each month's ceiling, file the arrear return for the month of payment and deposit by the 15th of the next month.
• Apply ESIC's position on retrospective increases and note anyone crossing ₹21,000.
• Add the arrears to projected annual salary and recompute TDS under each employee's regime.
• Collect Form 39 particulars where arrears relate to an earlier tax year and apply the relief in TDS.
• Issue the year-wise arrears statement with the payslip, and remind those employees to file Form 39 before the return due date.
• Check the variance report against the arrear register before you disburse.

In Engage, salary components can be set as a percentage of basic, gross or another head, so changing basic once updates every head that depends on it, and the arrear lines on the payslip use the same formulas as the regular ones. Arrears can be uploaded in bulk with the month's other variable inputs, the variance report flags the jump before disbursement, and every change carries an audit trail. Engage projects annual tax under the regime each employee has selected and adjusts monthly TDS as declarations, proofs and variable pay change. It is built for organisations with 50 or more employees, and pricing is on the site.

Related reading: how to calculate payroll in India, CTC breakup in India, the salary calculator and the compensation policy template.

Sources

• Income-tax Act, 2025, as amended by the Finance Act, 2026. Income Tax Department. Section 15 on salaries and arrears; section 157 on relief when salary is paid in arrears or in advance; section 202 on the new tax regime; section 263(1)(c) on the return due date; section 392(1), (4) and (5) on TDS from salaries; section 536 on repeal and savings.
• Income-tax Rules, 2026. G.S.R. 198(E), 20 March 2026, in force from 1 April 2026. Rule 73 on relief under section 157(1), including the A minus B formula in the Table, serial 1, and Form 39 in sub-rules (3) and (4).
• Form 39: Frequently Asked Questions. Income Tax Department. Form 10E to Form 39, rule 21AA to rule 73, and filing rules.
• Guidance Note on Form 39. Income Tax Department. Form structure and the defective-return risk.
• Income-tax Rules, 2026: table of new and old rule numbers. Income Tax Department. Rule 73 against rules 21A and 21AA of the 1962 Rules.
• Code on Wages, 2019. Ministry of Labour and Employment. Section 2(y) on wages; section 17 on time limits for payment; section 18(2)(f) and (3) on deductions for overpayment and the 50% cap; section 44 on undisbursed dues; section 45(2) and (6) on claims and compensation.
• Code on Wages (Central) Rules, 2026. G.S.R. 343(E), 8 May 2026. Rule 46 on deposit of undisbursed dues.
• Code on Social Security, 2020. Ministry of Labour and Employment. Section 2(88) on wages.
• Notification S.O. 5109(E), 17 September 2026. Ministry of Labour and Employment. ₹25,000 wage ceiling for Chapter III of the Code on Social Security, 2020.
• EPFO, FAQs on the Revamped Electronic Challan-cum-Return System. Circular No. Compliance (V.6)/e-office-704368/2025/13202, 8 October 2025. Q15 on the arrear disbursal date and the due month.
• ESIC, Frequently Asked Questions on ESI Scheme. Booklet issued in 2018 under the Employees' State Insurance Act, 1948. Q16 on a retrospective increase in wages.