New Financial Year, New Rules: How TDS & Compliance Changes Will Impact Salaries and Cash Flows | Exclusive Article

The Central Board of Direct Taxes (CBDT) has notified the Income-tax Rules, 2026 (“New IT Rules”) to operationalise the Income-tax Act, 2025 (“New IT Act”), effective from tax year 2026–27. These changes introduce a significant shift in salary taxation, perquisites, and compliance requirements, directly impacting employers, HR teams, and employees.

Key Implications for Employers

• Default TDS computation under the new tax regime unless employees opt otherwise
  

• Increased administrative responsibility to capture employee declarations

• Need to reconfigure payroll systems and deduction mappings
• Transitional challenges despite largely unchanged tax rates
  

Timing of salary payment determines applicable law

Under TDS provisions, tax is deducted at the time of payment, not accrual. Accordingly, the applicable law depends on the payment date:

• Salary for March 2026, if paid on or before 31 March 2026, will be governed by the previous law

• Salary for April 2026, if paid on or after 1 April 2026, will fall under the New IT Act

• This creates a transitional overlap requiring careful payroll planning and system accuracy

HRA and allowances – Key changes

While the basic method for calculating House Rent Allowance (HRA) exemption remains unchanged, the New IT Rules introduce important updates:

• Expansion of cities eligible for 50% HRA exemption: Delhi, Mumbai, Kolkata, Chennai, Bengaluru, Hyderabad, Pune, and Ahmedabad

• Other cities will continue with the 40% exemption limit

• Mandatory disclosure of relationship with the landlord

• Requirement to maintain adequate supporting documentation

Employers must update payroll systems to reflect these changes to ensure accurate tax computation and reduced taxable income where applicable.

Also Read: Absorbing the Shock Due to WAR: What India’s Latest Fuel Tax Cut Really Signals

Perquisite valuation – Motor cars and beyond

The valuation framework for perquisites has been significantly revised, particularly for motor cars (including electric vehicles):

• Increase in fixed monthly taxable values

• Introduction of a more structured valuation mechanism

• Likely increase in taxable perquisite value, impacting employee take-home pay

Additionally, the New IT Rules provide clarity on taxable perquisites, which include:

• Employer-provided accommodation
  

• Motor vehicles

• Interest-free or concessional loans

• Employee Stock Option Plans (ESOPs) and equity-linked compensation

• Club memberships and utilities

• Reimbursement of personal expenses

• Gifts and non-cash benefits exceeding prescribed thresholds
  

Evidence-linked allowances

A major shift under the new framework is the move towards evidence-based exemptions:

• Allowances such as travel, conveyance, and uniform are now strictly linked to actual expenditure

• Standard or assumption-based claims are no longer acceptable

• Employers must implement robust reimbursement processes

• Proper documentation is essential to support tax-exempt treatment

Foreign tax credit – Increased compliance

The compliance requirements for claiming foreign tax credit have been tightened:

• Where foreign tax paid exceeds INR 1 lakh, documentary evidence alone is insufficient

• A certificate from a Chartered Accountant is now mandatory

• This adds an additional compliance layer, especially for employees with cross-border income

Why FY 2026–27 Could Be the Costliest Year for Non-Compliance

The New IT Rules significantly elevate the compliance landscape, making FY 2026–27 a potentially high-risk year for employers who fail to adapt promptly. Increased complexity in payroll processing and stricter documentation requirements heighten the risk of errors.

Key areas of compliance risk:

• Misclassification of salary components

• Incorrect valuation of perquisites

• Inadequate documentation for exemptions

• Short deduction or delayed deposit of TDS

• Errors during the transition between old and new regimes

Potential consequences of non-compliance:

• Levy of interest and penalties

• Disallowance of expenses during audits and assessments

• Additional tax liabilities for employees

• Increased scrutiny from tax authorities

• Reputational risks for organisations

The emphasis on documentation and evidence-backed claims further increases the need for strong internal controls. Even minor lapses may lead to significant financial exposure.

Steps for employer compliance

To effectively align with the new tax framework, employers should undertake the following:

• Review and rationalise salary structures and compensation components

• Reassess perquisite policies in line with updated valuation rules

• Upgrade payroll and tax computation systems

• Strengthen documentation and verification processes

• Implement clear reimbursement policies for allowances

• Train HR and payroll teams on the new provisions

• Conduct periodic TDS reconciliations and internal audits

Conclusion

The New IT Rules mark a significant step towards modernising the tax framework by introducing greater clarity, structured valuation norms, and realistic thresholds. However, they also bring increased compliance expectations.

Employers and employees must proactively adapt by refining compensation structures, strengthening documentation, and ensuring timely compliance. Early and effective implementation will not only mitigate tax risks but also enhance organisational credibility in an increasingly regulated environment.

Views expressed by Prashant Thacker, Partner, Thacker & Associates