Simplifying Tax for C.A's and Taxpayers
Computing Salary Income under Income Tax Law: A Spotlight on Treatment of Various Allowances

Computing Salary Income under Income Tax Law: A Spotlight on Treatment of Various Allowances

How does a pay slip look like? Here is an example:

PaySlip

As we can see in above pay slip, a major chunk of pay is comprised of allowances. To ensure better tax planning, we need to understand the nature of allowances as well as their treatment under the Income Tax Act.

What do we mean by “Allowances”?

Allowance is a fixed monetary amount paid by the employer to the employee (over and above basic salary) for meeting certain expenses, whether personal or for the performance of his duties. As a general rule, all these allowances are to be included in the gross salary unless specific exemption is provided in respect of such allowance. For the purpose of tax treatment, we divide these allowances into 3 categories

Category I: Fully taxable allowances

SnoAllowanceDescriptionTaxability
1City Compensatory AllowanceThis allowance is paid to employees who are posted in big cities. The purpose is to compensate the high cost of living in cities like Delhi, Mumbai etc. Fully taxable
2Fixed Medical AllowanceMedical allowance is fully taxable even if some expenditure has actually been incurred for medical treatment of employee or family.
This is different from the term “Medical reimbursement’.
Fully taxable
3Tiffin/Lunch/Dinner/ Refreshment AllowanceIt is given to employees for lunch as coupons or added as part of salary.Fully taxable
4Servant AllowanceIt is fully taxable whether or not servants have been employed by the employee.Fully taxable
5Dearness AllowanceThis allowance is paid to compensate the employee against the rise in price level in the economy. Although it is a compensatory allowance against high prices, the whole of it is taxable.Fully taxable
6Overtime AllowanceWhen an employee works for extra hours over and above his normal hours of duty, he is given overtime allowance as extra wages.Fully taxable
7Entertainment allowanceEntertainment Allowance is the amount paid to employee to use it for the purpose of hospitality of customers.Fully Taxable in case of non-government employee
8Other allowancesInclude telephone allowance, project allowance, deputation allowance etc.Fully taxable

Category II: Partially exempt allowances

These allowances are included in gross salary and then the same is reduced by the amount of exemption as provided and as applicable.

S.noSection/Rule of exemptionParticularsBenefits
110(5) Leave travel assistance (LTA)The amount actually incurred on performance of travel on leave to any place in India by the shortest route to that place is exempt. This is subject to a maximum of the air economy fare or railway AC 1st Class fare (if journey is performed by mode other than air) by such route, provided that the exemption shall be available only in respect of two journeys performed in a block of 4 calendar years.
210(13A) /Rule 2AHouse Rent Allowance (HRA)Least of the following is exempt:
a) Actual HRA Received
b) 40% of Salary* (50%, if house situated in Mumbai, Calcutta, Delhi or Madras)
c) Rent paid minus 10% of salary

* Salary= Basic + DA (if part of retirement benefit) + Turnover based Commission

Note:
i. Fully Taxable, if HRA is received by an employee who is living in his own house or if he does not pay any rent
ii. Report PAN of the landlord to the employer if rent paid is more than Rs.1 lakh. In case the landlord does not have a PAN, a declaration to this effect from the landlord along with the name and address of the landlord should be filed by the employee.
iii. Form 12 BB has been notified vide Notification 30/2016 dated April 29, 2016 to furnish the details of evidence for HRA claim made by the employee

310(14)(i)Conveyance Allowance granted to meet the expenditure on conveyance in performance of duties of an officeExempt to the extent of expenditure incurred
410(14)(i)Any Allowance granted to meet the cost of travel on tour or on transferExempt to the extent of expenditure incurred
510(14)(i)Daily Allowance to meet the ordinary daily charges incurred by an employee on account of
absence from his normal place of duty
Exempt to the extent of expenditure incurred
610(14)(i)Helper/Assistant AllowanceExempt to the extent of expenditure incurred
710(14)(i)Research Allowance granted for encouraging the academic research and other professional pursuitsExempt to the extent of expenditure incurred
810(14)(i)Uniform Allowance Exempt to the extent of expenditure incurred
910(14)(ii)/Rule 2BBChildren Education AllowanceUp to Rs. 100 per month per child up to a maximum of 2 children is exempt
1010(14)(ii)/Rule 2BBHostel Expenditure AllowanceUp to Rs. 300 per month per child up to a maximum of 2 children is exempt
1110(14)(ii)/Rule 2BBTransport allowance granted to an employee to meet expenditure on commuting between place of residence and place of dutyUp to Rs. 1,600 per month (Rs. 3,200 per month for blind and handicapped employees) is exempt.
1210(14)(ii)/Rule 2BBTransport Allowance to an employee working in any transport business to meet his personal expenditure during his duty performed in the course of running of such transport from one place to another place provided employee is not in receipt of daily allowance.Amount of exemption shall be lower of following:
a) 70% of such allowance; or
b) Rs. 10,000 per month.
1310(14)(ii)/Rule 2BBSpecial compensatory Allowance (Hilly Areas)
(Subject to certain conditions and locations)
Amount exempt from tax varies from Rs. 300 per month to Rs. 7,000 per month.
1410(14)(ii)/Rule 2BBBorder area allowances, Remote Locality
allowance or Disturbed Area allowance or
Difficult Area Allowance (Subject to certain
conditions and locations)
Amount exempt from tax varies from Rs. 200 per month to Rs. 1,300 per month
1510(14)(ii)/Rule 2BBTribal area allowance given in (a) Madhya
Pradesh (b) Tamil Nadu (c) Uttar Pradesh (d)
Karnataka (e) Tripura (f) Assam (g) West Bengal
(h) Bihar (i) Orissa
Rs. 200 per month
1610(14)(ii)/Rule 2BBCompensatory Field Area Allowance. If this exemption is taken, employee cannot claim any exemption in respect of border area allowance (Subject to certain conditions and locations)Rs. 2,600 per month
1710(14)(ii)/Rule 2BBCompensatory Modified Area Allowance. If this
exemption is taken, employee cannot claim any exemption in respect of border area allowance (Subject to certain conditions and locations)
Rs. 1,000 per month
1810(14)(ii)/Rule 2BBCounter Insurgency Allowance granted to members of Armed Forces operating in areas away from their permanent locations. If this exemption is taken, employee cannot claim any exemption in respect of border area allowance (Subject to certain conditions and locations)Rs. 3,900 per month
1910(14)(ii)/Rule 2BBUnderground Allowance is granted to employees
working in uncongenial, unnatural climate in
underground mines
Up to Rs. 800 per month
2010(14)(ii)/Rule 2BBHigh Altitude Allowance is granted to armed
forces operating in high altitude areas (Subject to certain conditions and locations)
a) Up to Rs. 1,060 per month (for altitude of 9,000 to 15,000 feet)
b) Up to Rs. 1,600 per month (for altitude above 15,000 feet)
2110(14)(ii)/Rule 2BBHighly active field area allowance granted to
members of armed forces (Subject to certain conditions and locations)
Up to Rs. 4,200 per month
2210(14)(ii)/Rule 2BBIsland Duty Allowance granted to members of
armed forces in Andaman and Nicobar and Lakshadweep group of Island (Subject to certain conditions and locations)
Up to Rs. 3,250 per month
2310(45)Allowances to Retired Chairman/Members of UPSCExempt subject to maximum of Rs. 14,000 per month for defraying the services of an orderly and for meeting expenses incurred towards secretarial assistant on contract basis.
The value of residential telephone free of cost and the number of free calls to the extent of 1500 per month shall be exempt
2416(ii)Entertainment allowance in case of government employeesLeast of the following is deductible :
a) Rs 5,000
b) 1/5th of salary (excluding any allowance, benefits or other perquisite)
c) Actual entertainment allowance received

Category III: Fully exempt allowances

SnoExemption SectionAllowanceTaxability
110(7)Foreign allowances or perquisites paid or allowed
by Government to its employees (an Indian
citizen) posted outside India
Fully exempt
210(7)Allowances to Judges of High Court/Supreme CourtFully exempt, subject to some conditions
310(7)Compensatory allowance received by a Judge under article 222(2) of the ConstitutionFully exempt
410(7)Salary and allowances received by a teacher /professor from SAARC member state (Subject to certain conditions).Fully exempt
510(45)Allowances paid by the UNO to its employeesFully exempt
610(45)Following allowances and perquisites given to serving Chairman/Member of UPSC is exempt from tax:

a) Value of rent free official residence
b) Value of conveyance facilities including transport allowance
c) Sumptuary allowance
d) Leave travel concession
Fully exempt

Hope you find the article useful.

Sources: www.incometaxindia.gov.in

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