I will post an answer from the Indian context, which should be of interest to the asker, who is from India. Of course, a huge chunk of the answer could be relevant to other countries as well.
Indian employees typically receive two kinds of payments from their employer:
- Salary/wages: This typically also covers annual bonus, performance linked incentives, performance awards, and such.
- Out of pocket expenses: This typically covers reimbursements for various expenses that the employee incurs "in the line of duty" (if you will). It includes taxi fare for client location visits, home internet expenses when employee works from home, passport or visa processing fees, lunch or dinner allowances when working overtime, etc.1
In your case, I strongly suspect that your employer is trying to shoehorn your salary into the "out of pocket expenses" category. This typically happens due to some silly corporate policy or, rather disappointingly, due to
SAP software limitations, which prevents your manager from handing you an "off-cycle" hike.2
The problem arises because out of pocket expenses are typically reimbursements for expenses you have incurred, which means two things:
- These payments do not, and should not, count as your salary.
- More importantly, from the Government of India's perspective3, this expense has already been taxed elsewhere.
This shoehorning is not necessarily illegal4, but you need to be careful of a few things.
- If you can encash this "extra salary cheque" only in cash, then congratulations, you just got paid in black money.
- If this "extra salary" can only be credited to a bank account, then it is still white money.5 All you have to do is declare this extra income in your Income Tax Return and pay the so-called Self Assessment Tax on it, and you should be clear. However, the Income Tax Department may still have some polite questions for your employer.4
You have a few options to deal with this situation:
Ask your manager to give you an off-cycle hike: You mentioned your manager already said this cannot be done, but there's a chance she isn't aware of it. Your manager may have worked previously at a company with no off-cycle hike policy, but your company may have one, buried two civilisations deep into the "Corporate Policy for Managers" handbook.
Ask for your next 8 salary slips to include a "performance reward" or "one time bonus": I wouldn't consider this as lying or unethical, because technically the 40% salary hike is a reward for your performance.
- Ask for the 9th salary slip to include the "performance reward": As a last resort, you could ask for the "extra salary" of next 8 months to be reflected on the 9th salary slip. As long as your settle the scores by end of the Financial Year, the Income Tax Department is usually cool with it.4
- Don't bother: If none of the above works, you just file your Income Tax Return correctly, and move on. Let the employer deal with the tax issues at their end. They most likely hire professionals to deal with that thing. It would be prudent to keep a written record of all that you did to convince your employer to pay you cleanly.
As nvoigt points out, your "extra salary" reflecting in your salary slip could be important for things such as your home loan eligibility, insurance premiums, or credit card eligibility and limits. However, I personally don't feel strongly enough about this issue to quit your job, especially not right away when you seem to be doing well.
1 This varies from employer to employer. I have had the privilege of working for an employer who offered all these privileges, and some 20 more. :)
2 The above employer who once offered me off-cycle hikes in two consecutive years (in addition to the regular annual hikes), leading to my salary more than doubling in those two years!
3 Their perspective is always more important than most other things. This is most certainly not restricted to India alone.
4 Disclaimer: I am not a lawyer. I wouldn't offer free legal advice online even if I were one.
5 You cannot legally open a bank account in India without linking it to a Permanent Account Number (PAN), which by the way, is the number that the Income Tax Department identifies you and your money with.