When salary or other income arrears are received in any particular year, one’s tax liability for that year increases. Simply because one’s total income for that year has increased. Most salaried individuals will be able to identify with such situations. But having to pay a higher tax on account of arrears is unfair to the taxpayer. Had he originally received the money in the year(s) that he was supposed to receive it, the additional tax would have been staggered over this time, instead of converging in one year as a lump sum payment.
Our Income tax law has taken the same into consideration and allows a tax deduction under Section 89(1) for this additional tax burden on the tax payer. At times, the employee appraisal process (where the employee can expect a revised salary), takes longer than expected, and the actual payments are postponed. Also, commissions and other cash incentives for sales and marketing personnel, could be reconciled at a later date.
In other words, if the taxpayer is required to pay any additional amount of tax (in the year of receipt) than what he would have otherwise paid, had he received the money in the year(s) he was supposed to receive it, such additional tax can be reduced from the tax payable.