Allowance In Salary: Types of Taxable and Non Taxable Salary Allowances
Updated: Jul 5
While understanding the meaning and structure of your salary, allowances are a very important part in your total compensation package. The allowances may have a huge effect on your take-home pay and the tax liability. Hence, it is important to understand which part of your salary is taxable and which is not.
In this article, we will try to understand this complex world of salary allowances by breaking down various types that one might find on a salary slip. Be it house rent allowance, leave travel allowance, or others; the key is to understand which allowances will reduce your tax burden and which ones will increase it.
Table of content
Understanding Allowance In Salary
Allowances are normally predetermined payments that the employer reimburses the employee for incurring certain types of expenses incurred while rendering services. Unlike basic pay, which is usually fixed for all employees at the same position, allowances could differ in regard to job position, location, seniority, or company policy.
Role of Allowances in Salary Packages
Compensation for Expenses: Most of the allowances are given to compensate for certain expenditures incurred by the employee. For example, a transport or conveyance allowance is given to compensate the cost of commuting between residence and workplace. A medical allowance is provided in order to help employees with expenses on health-related issues.
Retention and Motivation: Such allowances can thus be effectively utilized by an employer to retain and attract talent. For instance, a high-cost city compensatory allowance is usually offered to those personnel working in metropolitan areas where the cost of living is pretty high, thereby making the job offers very attractive.
Tax Benefits: Some allowances have associated tax benefits for the employer or the employee. For example, House Rent Allowance and Leave Travel Allowance are structured in such a manner that, under certain conditions, they will get relief through tax deductions, providing more tax efficiency in the salary packaged deal.
Flexibility and Personalization: Allowances help the employer in personalizing the compensation package, based on requirements and needs that many different employees will have, which may be more rewarding or beneficial to him alone. For instance, an education allowance makes more sense for a person who has children than for those without dependents.
Common Taxable Allowance In Salary
Below is a summary of the standard taxable salary allowances and their conditions under which they become taxable:
Dearness Allowance (DA):
Dearness allowance is mainly aimed at compensating for the rise in the cost of living based on inflation to maintain the purchasing power of individuals receiving such an allowance. DA differs in various employment sectors, but the most common case is amongst government employees.
DA is fully taxable with your salary. It forms a part of the gross salary and is factored while computing tax liability.
Suppose, an employee receives a basic salary of INR 50,000 per month and DA of INR 5,000 per month, then from both such components, the total amount chargeable to tax would be INR 55,000 per month.
Overtime Allowance:
Overtime Allowance is the remuneration paid for hours spent working in excess of the standard hours of working as defined by the employer. It is generally computed at a higher rate than the regular rate of pay.
Overtime allowance is taxable under the head: "Income from Salaries." In other words, it is subject to tax at the individual's applicable income tax rate.
For example, if an employee receives an hourly wage of INR 200 and receives INR 300 per hour by way of overtime allowance for extra hours spent on work, this amount of INR 3,000 by way of overtime allowance will be wholly taxable for 10 overtime hours worked.
City Compensatory Allowance (CCA):
City Compensatory Allowance is provided to the staff to offset the expensive cost of living associated with metropolitan cities or expensive urban areas.
No tax exemptions are offered on CCA; hence, it is fully on the taxability head "Income from Salaries."
Suppose, an employee working in, say, Mumbai, could get a CCA of INR 2,000 per month [might be administered through reimbursement of actual expenditure incurred subject to a maximum limit] and would be added to gross income, which is then taxed at standard rates applying to the employee's total income.
Special Allowance:
Special allowance is a residual category that could include all types of allowances, such as entertainment allowance, internet allowance, etc., given for specific purposes or of general use.
Unless expressly exempt, all special allowances are taxable. Any special allowance that is not directly related to reimbursement of expenses gets taxed as a part of the taxable income.
Example: If an employee receives a special allowance of INR 1,000 per month for miscellaneous expenses without showing bills, then it is added up to salary and tax deducted on such income.
Common Non-Taxable Allowance In Salary
Here is the detailed look at common non-taxable salary allowances and what they can do for you:
House Rent Allowance (HRA)
Calculation of HRA Exemption:
Under Section 10(13A), the exemption in HRA is the least of the following:
Actual HRA received
40% of salary (50% if staying in metro cities like Delhi, Mumbai, Kolkata, or Chennai)
Rent paid minus 10% of salary (salary being Basic + DA if any).
Tax Implications:
If you are staying in a rented house, HRA can cut down a significant portion of your taxable income. Collect the rent receipts and a copy of the rental agreement as well, as both may be asked for by the Income Tax Department.
Leave Travel Allowance (LTA)
Rules to avail LTA
LTA reimburses the traveling expenses of an employed employee during his or her leave from work.
It is exempt only on the travel costs within India, and the exemption includes travel by air, rail, or public transport.
The exemption can be claimed for 2 journeys in a block of 4 calendar years.
Tax Implications:
LTA is non-taxable only when claimed for travel fare and does not extend to boarding, lodging, or other expenses during the travel.
Uniform Allowance
Circumstances Under which Uniform Allowance is Granted:
Uniform allowance is granted to those employees whose job conditions require them to wear specific uniforms.
Tax Implications:
This allowance is not taxable only to the extent of expenditure incurred for purchasing or maintenance of such uniform, which will not represent normal wear.
Conveyance Allowance
Eligibility Criteria:
All employees who are not provided by the employer with any type of Travel facilities are eligible for such allowance.
Tax Implications:
Conveyance allowance is given to staff to pay them for their expenditure towards/for commutation from home to workplace.
This allowance is non-taxable subject to a limit of INR 1,600 per month or, say, INR 19,200 per year, with no need to present bills for the same.
Medical Allowance
Explanation of Non-Taxable Limit:
Medical allowance shall be provided to employees towards their medical expenses.
This amount is non-taxable up to INR 15,000 per annum, subject to the condition that medical bills have to be submitted to the employer as proof of medical expenses incurred.
Taxable Allowances Based on Conditions
Understanding the conditionally taxable allowances is important in affecting your taxable income and, in turn, how much tax you end up paying. What we do here is discuss some of the common allowances—that is, education allowance and food coupons/meal vouchers—and under what conditions these allowances can be exempt from taxes.
Education Allowance
Conditions for Tax Exemption:
The education allowance is normally given by different employers to help an employee in his children's education expenses.
Its exemption limit is, however, relatively low. Exemptions of up to INR 100 a month per child, up to a maximum of two children are currently allowed. So, you can actually exempt INR 2,400 per year per child from taxes using this allowance.
Taxability Based on Documentation and Usage:
To claim this exemption, proof of expenditure incurred on education in the form of tuition receipts or receipts of school fees generally has to be submitted.
Any amount in excess of the exemption limit is taxable—that is INR 100 per month per child, up to two children—and gets added to the income from salaries of the employee.
Example:
If an employee receives INR 200 per month as an education allowance for one child, INR 100 of that amount can be exempted, and the remaining INR 100 per month will be taxable.
Food Coupons/Meal Vouchers
Limits to Tax Exemptions and Conditions:
Food coupons or meal vouchers like Sodexo or Ticket Restaurant are some common fringe benefits given by most employers.
It is exempt from tax up to INR 50 per meal. These coupons need to be availed on working days, which would amount to two meals for each working day to avail optimum benefit.
Taxability depends upon proof/documentation and actual usage:
This would be on condition that the coupons are utilized strictly to obtain meal access in office cafeterias or affiliated restaurants.
It is essential that these coupons be utilized for the intended purpose; otherwise they may be fully subject to income tax. For example, this may include scenarios where the provision of the vouchers is made but not used or coupons used to acquire things other than meals where their full value may be included in the taxable income.
Example:
An employee gets meal vouchers worth INR 2,200 a month. Now, assuming that it is a month with 22 working days, the tax exemption may well be worked out at 2 meals × INR 50/meal × 22 days = INR 2,200, hence making the entire amount non-taxable, subject to the condition that the vouchers are used as stipulated.
How to Maximize Tax Benefits from Allowances
Careful planning and structuring of your remuneration package are necessary to derive maximum tax benefit from salary allowances. Understanding which allowances are taxable and non-taxable and, accordingly, using them can help reduce tax payable significantly. Hereinbelow are some tips on structuring these allowances for maximum tax efficiency and advice for the purpose of documentation and claiming tax returns.
Know which Allowances are Fully Taxable, Partially Taxable, or Completely Exempt: Before you plan, know which allowances are fully taxable, partially taxable, or completely exempt. This information shall help you make your decisions regarding how to avail these allowances to your benefit.
Increased use of Non-Taxable Allowances: HRA, conveyance, and LTA should be used to the maximum limit. Suppose you stay in a rented house; ensure you structure a good amount of your compensation as HRA, which could be kind of high if you stay in a metro city.
Use Special Allowances Wisely: Special allowances like uniform allowance, education allowance, or meal vouchers have conditions that will give you tax exemption if used strictly by the laid-down guidelines.
Adjust Allowances based on Life Changes: Review and change your allowances from time to time based on any life changes. For instance, if you move from a rented house to your own, change the HRA, and if your child starts going to school, then use the education allowance.
Avail Standard Deduction: Ensure availing standard deduction given to salaried employees that can offset some taxable allowances.
Legal Considerations
The employer and employee should be aware and update themselves on recent developments in the taxation of salary allowances. This will help an employer or an employee ensure compliance with tax laws while optimizing the tax benefits accruable from all types of allowances. Following is a brief overview of the key legal considerations and the most recent updates in the area relating to taxable and non-taxable salary allowances.
Legal Consideration in Salary Allowance
Compliance with Income Tax Act: Every allowance that is given by an employer is subject to the provisions of the Income Tax Act, 1961. The employer has to ensure that allowance paid to the employee is as per the act and duly accounted for in the payroll system.
Documentary Evidence: In most cases, proof may be required to be furnished by the employee, such as through bills and receipts, to support the exemptions claimed under these allowances. In their absence, the allowances will be taxed.
Perquisite Taxation: Some allowances may amount to perquisites or fringe benefits, which will be taxable subject to certain conditions of the Income Tax Act. The employer has to determine whether any allowance has to be treated as perquisite.
Employment Contracts: Allowances are usually specified in the employment contract. Notifications and changes to such allowances have to be in accordance with employment law, so as to avoid any dispute.
Minimum Wages Act: The remuneration exclusive or inclusive of allowances should be in accordance with minimum wages prescribed by state or central acts. This is extremely necessary to avoid legal penalties.
FAQ
Q1. What is a salary allowance?
Allowance is a monetary benefit provided to an employee in addition to the normal salary. It typically seeks to meet a certain expenditure incurred on account of employment.
Q2. Which common allowances are taxable?
Dearness Allowance, City Compensatory Allowance, Overtime Allowance are some of the common allowances which are considered as salary and, hence, are liable to tax.
Q3. Are there any non-taxable allowances?
Yes, some allowances like HRA, Travel Allowance, and Uniform Allowance, are exempt from tax, subject to certain conditions and limits laid down in the taxation laws.
Q4. How is House Rent Allowance computed for exemption from tax?
The exemption in tax for HRA shall be computed as the minimum of: the actual HRA received, 40% (or 50% for metros) of salary, and the actual rent paid minus 10% of salary.
Q5. What is a Conveyance Allowance, and is it taxable?
Conveyance allowance is given to staff to compensate them for travel expenses from residence to work and back. It is non-taxable subject to a certain limit as per tax rules.
Q6. Can medical allowances be exempt from tax?
Fixed medical allowance is generally taxable. Reimbursements against actual medical bills can, however, be non-taxable up to INR 15,000 per annum.
Q7. What comprises special allowances and how are they taxed?
Special allowances are taxable as they form a part of the salary unless they are exempt under the Income Tax Act. This would include a bonus or incentives.
Q8. Is Leave Travel Allowance taxable?
LTA is non-taxable on travels taken during leave and within India, subject to conditions like mode of travel and frequency of claims.
Q9. What documentation has to be provided in order to claim non-taxable allowances?
For claiming non-taxable allowances, bills or receipts are to be furnished by the employee as proof for the expenditure incurred, such as hotel bills in the case of LTA or rental agreements in the case of HRA.
Q10. Are educational allowances for employees' children taxable?
Educational allowances are taxable unless they are reimbursements for actual expenses up to a limit of INR 100 per month per child for a maximum of two children.
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