In addition to the basic salary, there are various other salary components such as taxable benefits offered by employers to employees. Under the IT Act of 1961, taxable benefits can be broadly classified into two broad categories – allowances and perquisites. An allowance is usually the money paid to the employees for meeting the expenses incurred by them as part of their work. Perquisites, on the other hand, are various other facilities provided by the employer to its employees. In the context of taxation, allowances or benefits can be classified into three categories – fully taxable, partly taxable and tax exempt.
Fully Taxable Allowances
Dearness allowance or DA is the allowance given by certain employers to their employees to compensate for an increase in the cost of living. The purpose of this allowance is to reduce the impact of rising inflation. It is usually paid in the form of a fixed percentage of basic salary. As per the Income Tax Act, the entire amount of DA received is taxable and has to be declared at the time of filing income tax returns. In October 2019, the DA of central government employees and pensioners was increased to 17% from the earlier 12% of basic salary.
The percentage of dearness allowance payable is revised twice a year i.e. in January and in July. The formula for calculating dearness allowance is different for Central Government employees and Public sector employees.
D.A. Calculation for Central Government employees:
Dearness Allowance % = [Average of AICPI (Base Year 2001=100) for the past 12 months -115.76]/115.76*100
Where AICPI stands for All India Consumer Price Index
D.A. Calculation for Central public sector employees:
Dearness Allowance % = [(Average of AICPI (Base Year 2001=100) for the past 3 months -126.33]/126.33*100
It is not mandatory for private sector companies to provide D.A to its employees. However, every government employee irrespective to his position or rank is entitled for D.A. Further, the government sector pensioners are also eligible to receive dearness allowance.
City Compensatory Allowance
CCA or City Compensatory Allowance is offered by companies to their employees to help them bear the high cost of living in metropolitan areas or large cities. It is usually offered to employees of Tier 1 cities however, it may be offered in Tier 2 cities also as per the employer’s discretion. There is no exemption limit for CCA, hence it is fully taxable as per the Income Tax Act.
It is the allowance paid by the employer to the employees who are engaged in a specific project to compensate for the expenses incurred due to their engagement in the project. Project allowance is usually a temporary allowance and fully taxable for the employees.
Overtime allowance is the amount paid by the employees for working overtime, i.e. beyond their normal working hours. In most cases, the overtime rate is higher than the normal rate received by employers. Any overtime allowance received by the employee is fully taxable.
It is an amount paid by an employee to its employees for the purpose of hospitality of the customers. Tax treatment of entertainment allowance is different for Government employees as compared to other employees. Entertainment allowance, if received, is fully taxable for private sector employees.
Government employees can claim tax exemption for the entertainment allowance under section 16 (ii) but only upto the least amount among the following:
- Actual Allowance Received
- One-fifth of basic salary (20% of the basic salary)
- Rs. 5,000
Fixed Medical Allowance
Any amount received as medical allowance is fully taxable. Medical allowance is a fixed part of your monthly salary structure that gets paid irrespective of actual medical expenditure.
Other allowances such as telephone allowance, holiday allowance, interim allowance, etc. received by the employees are fully taxable as per the Income Tax Act.
Partially Taxable Allowances
House Rent Allowance (HRA)
This is possibly the most common type of allowance received by a salaried individual. Typically HRA or house rent allowance is the amount paid by the employer for rental expenses incurred by the employee for his accommodation. As per Section 10(13A) of the Income Tax Act, the employee can claim exemption on the HRA received to the extent of whichever is least among the following:
- Actual HRA received
- Rent paid less 10% of basic salary (inclusive of DA)
- 50% of the basic salary in case of metros (i.e. Delhi, Mumbai, Chennai and Kolkata) and 40% of the basic salary in case of non-metro cities
Example, if an employee has a basic salary of Rs.1,00,000, DA of Rs. 20,000 and HRA received is Rs. 40,000 and rent paid is 40,000
Amount of HRA exempt will be lower of the following:
- Actual HRA received, i.e. 40,000
- Rent paid less 10% of basic salary (inclusive of DA), i.e. 28000 (40000 – 10%(100000+20000))
- 40% of the basic salary, i.e. 48000 (40%(100000+20000))
Amount of HRA exempt is the lowest among the above i.e. Rs. 28,000 hence taxable HRA will be 12000 (40000-28000).
Also Read: How to calculate your HRA?
Children Education Allowance
This is the amount given by the employer for the education of the children of the employees. Exemption from children education allowance is available to the extent of Rupees 100 per month per child for maximum 2 children. Any amount received over and above the aforesaid limit is taxable.
Hostel Expenditure Allowance
This is the amount given by the employer for the hostel expenses of the employee’s children. Exemption from hostel expenditure allowance is available to the extent of Rupees 300 per month per child for maximum of 2 children. Tax is payable on any amount received over and above the aforesaid limits.
It the allowance is given by the employer for the expenditure incurred by the employees on commutation between residence and office/ place of work. Exemption from allowance is available to the extent of Rs. 1600 per month. However, in case of blind, deaf, dumb and handicapped employees the exemption limit is Rs. 3200. Any amount received in addition to the above limit is taxable.
Allowance for the Employee of a Transport Company
Amount paid by the employer to the employee of a transport company; for the personal expenses incurred by the employee during his duty in course of running of such transport from one place to another is known as transport allowance. The amount of transport allowance received shall be exempt from income tax to the extent of lower of the following:
- 70% of such allowance or
- Rs. 10,000 per month
- Any amount received in addition to the aforesaid exemption limit is taxable. However, such exemption shall not be applicable in case the employee receives a Daily Allowance.
Food Coupons/ Meal Allowance
Food provided by employers to employees in office premises or through non-transferable vouchers that can be used only at the eating joints provided by the employer may be tax exempt. However, this exemption is applicable only if the cost to the employer is up to Rs. 50 per meal. In case the cost of the free meal is greater than Rs. 50 then the excess amount becomes taxable.
It is the amount paid to an employee towards covering daily expenses incurred by an individual while they are on tour and is exempt to the extent of actual expenditure incurred by the employee.
It is the amount paid by the employer to reimburse the conveyance expenses incurred by an employee during the course of his/her duties. Exemption on conveyance allowance is available to the extent of actual expenses incurred.
Tour or Travel allowance
Any amount paid by the employer to an employee in lieu of travel expenses incurred during an official tour/transfer in the form of allowance is exempt to the extent of actual expenditure incurred.
This partially taxable allowance is paid to compensate for the expenditure incurred by the employee for hiring a helper/ assistant to aid the performance of his duties. Helper/ assistant allowance is taxable to the extent of actual expenses incurred.
Research allowance is granted to encourage academic research, training and other professional pursuits in the research institutions and is exempt to the extent of actual expenses incurred on the research. Any amount left after bearing the cost of such research is taxable under the Income Tax Act.
Uniform allowance is the allowance given by the employer to the employee for the purchase and maintenance of the uniform which he is supposed to wear during the performance of his/her duty. Such allowance is exempt to the extent of actual expenditure incurred on purchase and maintenance of uniform, any amount received over and above the actual expenditure is liable to tax.
Special Compensatory Allowance (Hilly Areas)
It is a special allowance given to employees in hilly areas or at high altitude. The amount exempt under income tax depends on the location and other factors. The exemption varies from Rs. 300 per month to Rs. 7000 per month. For example, in the case of employees in the Siachen area of Jammu and Kashmir, exemption of Rs. 7,000/- is available.
Border Area Allowance / Remote Locality Allowance / Disturbed Area Allowance / Difficult Area Allowance:
This allowance is similar to a special compensatory allowance; however it is given to the employees situated in difficult areas. The amount exempt under income tax depends upon location and other factors. The exemption varies from Rs. 200 per month to Rs. 1300 per month. For example, in the case of employees located in the Exclusive Economic Zone of India, exemption of Rs. 1,100/- is available.
Tribal Area Allowance
This is a partially taxable allowance given to employees posted in tribal areas of Madhya Pradesh, Tamil Nadu, Uttar Pradesh, Karnataka, Tripura, Assam, West Bengal, Bihar and Orissa. In this case, tax exemption is allowed up to Rs. 200 per month. Any amount received as an allowance under this head in excess of the prescribed limit is fully taxable.
Compensatory Field Area Allowance
Compensatory field area allowance is paid to employees located in certain specific areas of Arunachal Pradesh, Manipur, Nagaland, Sikkim, Himachal Pradesh, Uttar Pradesh and Jammu & Kashmir. In this case, exemption available is Rs. 2600 per month. Any amount received over and above this prescribed limit is taxable as per applicable rules. However, it is to be noted that in case the taxpayer avails an exemption for compensatory field area allowance, no exemption can be claimed with respect to border area allowance.
Compensatory Modified Field Area Allowance
Compensatory modified field area allowance is allowed in certain specific areas of Punjab, Rajasthan, Haryana, Himachal Pradesh, Arunachal Pradesh, Assam, Mizoram, Tripura, Sikkim, West Bengal, Uttar Pradesh and Jammu & Kashmir. In this case, an exemption is available to the extent of Rs. 1000 per month and any additional amount are applicable for income tax calculation. In case the employee claims an exemption from this allowance, he cannot claim exemption from border area allowance.
Counter Insurgency Allowance
This allowance is provided to the members of the armed forces operating in areas away from their permanent locations. Exemption from this allowance is available to the extent of Rs. 3,900. Any amount received in excess of the limit prescribed will attract income tax. Also, Border area allowance cannot be claimed in case the benefit of exemption under this allowance taken by the employee.
This allowance is provided to the employee working in uncongenial, unnatural climate in the underground. Exemption from this allowance is available to the extent of Rs. 800 per month. Any amount received in excess of the limit prescribed is chargeable under the applicable income tax slab.
High Altitude Allowance
This allowance is offered to armed forces operating in areas of high altitude. The amount of exemption that can be availed depends upon certain specific conditions and location. Hence, for the altitude of 9,000 feet to 15,000 feet, exemption of Rs. 1,060 per month can be considered. And for altitude above 15,000 feet, exemption to the extent of Rs. 1,600 per month can be considered.
Highly active field area allowance
This allowance is provided to the members of the armed forces and known as special compensatory highly active field area allowance. The allowance depends upon certain specific conditions and location. The amount of exemption that can be claimed from this allowance is Rs. 4,200 per month.
Island Duty Allowance: This is a special allowance granted to the members of armed forces operating in islands, i.e. Andaman and Nicobar and Lakshadweep group of Islands. The allowance depends upon certain specific conditions and location. The amount of exemption that can be claimed from this allowance is Rs. 3,250 per month.
Fully Exempt Allowances
In addition to the above-mentioned completely taxable or partially taxable allowances, there are certain other allowances which are fully exempt from tax. These allowances are usually paid to government employees. Examples of these allowances are:
- Allowances paid by the government to its employees located outside India
- Allowances paid to the judges of Supreme Court and High Court
- Allowances to Retired Chairman or Members of UPSC
- Allowances paid by the UNO to its employees
- Is reimbursement under Children Education Allowance is admissible for the third child if either of the first two children is disabled to the extent that they can’t go to school?
Ans. No, you can not claim the allowance for your third child even when either of the first two children is disabled. However, you can claim for Children Education Allowance for the third child when either the birth of the second child results in multiple births or 3rd child is born due to the failure of sterilization operation.
2. What is the difference between medical reimbursements and medical allowances?
Ans. Medical allowance is a fixed component of your salary that you get every month if your employer has included it in your salary structure. Medical allowances are fully taxable and there is no need to furnish medical bills to get the medical allowance. Whereas medical reimbursements are tax-exempt upto a limit of Rs.15,000 but can only be claimed with valid bills.
However, Budget 2018-19, tax deduction claims under medical reimbursements and transport allowance were subsumed under the Standard Deduction head upto a limit of Rs.40,000. In the interim budget 2019-20, the standard deduction limit was raised to Rs. 50,000 irrespective of the salary of the individual. Therefore, there is no provision for tax deductions on medical reimbursement at present.
3. I own a house in my name but live in rented accommodation. Can I claim HRA on that?
Ans. Yes, even you own a house but living in rented accommodation and paying rent, you can claim for HRA benefits. In case you have taken a home loan on the house you own, you can claim for the tax deduction on interest paid on such loan along with HRA.such loan along with HRA