How does a pay slip look like? Here is an example:
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
| Sno | Allowance | Description | Taxability |
|---|---|---|---|
| 1 | City Compensatory Allowance | This 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 |
| 2 | Fixed Medical Allowance | Medical 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 |
| 3 | Tiffin/Lunch/Dinner/ Refreshment Allowance | It is given to employees for lunch as coupons or added as part of salary. | Fully taxable |
| 4 | Servant Allowance | It is fully taxable whether or not servants have been employed by the employee. | Fully taxable |
| 5 | Dearness Allowance | This 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 |
| 6 | Overtime Allowance | When an employee works for extra hours over and above his normal hours of duty, he is given overtime allowance as extra wages. | Fully taxable |
| 7 | Entertainment allowance | Entertainment 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 |
| 8 | Other allowances | Include 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.no | Section/Rule of exemption | Particulars | Benefits |
|---|---|---|---|
| 1 | 10(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. |
| 2 | 10(13A) /Rule 2A | House 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 |
| 3 | 10(14)(i) | Conveyance Allowance granted to meet the expenditure on conveyance in performance of duties of an office | Exempt to the extent of expenditure incurred |
| 4 | 10(14)(i) | Any Allowance granted to meet the cost of travel on tour or on transfer | Exempt to the extent of expenditure incurred |
| 5 | 10(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 |
| 6 | 10(14)(i) | Helper/Assistant Allowance | Exempt to the extent of expenditure incurred |
| 7 | 10(14)(i) | Research Allowance granted for encouraging the academic research and other professional pursuits | Exempt to the extent of expenditure incurred |
| 8 | 10(14)(i) | Uniform Allowance | Exempt to the extent of expenditure incurred |
| 9 | 10(14)(ii)/Rule 2BB | Children Education Allowance | Up to Rs. 100 per month per child up to a maximum of 2 children is exempt |
| 10 | 10(14)(ii)/Rule 2BB | Hostel Expenditure Allowance | Up to Rs. 300 per month per child up to a maximum of 2 children is exempt |
| 11 | 10(14)(ii)/Rule 2BB | Transport allowance granted to an employee to meet expenditure on commuting between place of residence and place of duty | Up to Rs. 1,600 per month (Rs. 3,200 per month for blind and handicapped employees) is exempt. |
| 12 | 10(14)(ii)/Rule 2BB | Transport 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. |
| 13 | 10(14)(ii)/Rule 2BB | Special 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. |
| 14 | 10(14)(ii)/Rule 2BB | Border 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 |
| 15 | 10(14)(ii)/Rule 2BB | Tribal 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 |
| 16 | 10(14)(ii)/Rule 2BB | Compensatory 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 |
| 17 | 10(14)(ii)/Rule 2BB | Compensatory 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 |
| 18 | 10(14)(ii)/Rule 2BB | Counter 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 |
| 19 | 10(14)(ii)/Rule 2BB | Underground Allowance is granted to employees working in uncongenial, unnatural climate in underground mines | Up to Rs. 800 per month |
| 20 | 10(14)(ii)/Rule 2BB | High 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) |
| 21 | 10(14)(ii)/Rule 2BB | Highly active field area allowance granted to members of armed forces (Subject to certain conditions and locations) | Up to Rs. 4,200 per month |
| 22 | 10(14)(ii)/Rule 2BB | Island 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 |
| 23 | 10(45) | Allowances to Retired Chairman/Members of UPSC | Exempt 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 |
| 24 | 16(ii) | Entertainment allowance in case of government employees | Least 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
| Sno | Exemption Section | Allowance | Taxability |
|---|---|---|---|
| 1 | 10(7) | Foreign allowances or perquisites paid or allowed by Government to its employees (an Indian citizen) posted outside India | Fully exempt |
| 2 | 10(7) | Allowances to Judges of High Court/Supreme Court | Fully exempt, subject to some conditions |
| 3 | 10(7) | Compensatory allowance received by a Judge under article 222(2) of the Constitution | Fully exempt |
| 4 | 10(7) | Salary and allowances received by a teacher /professor from SAARC member state (Subject to certain conditions). | Fully exempt |
| 5 | 10(45) | Allowances paid by the UNO to its employees | Fully exempt |
| 6 | 10(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
Really helpful