Allowance- Meaning, Types and Treatment for Calculating Taxable Salary Income

Valuation of Allowances – for calculating Taxable Salary

Table of Contents

1.  Allowances- Income under the head Salaries

Allowance is a fixed monetary amount paid by the employer to the employee for meeting some particular expenses, whether personal or for the performance of his duties. These allowances are generally taxable and are to be included in the gross salary unless a specific exemption has been provided in respect of any such allowance. Specific Exemptions in respect of allowances are provided under the following sections:

(i)      House Rent Allowance— Section 10(13A)

(ii)     Prescribed special allowances — Section 10(14)

The above allowances shall be exempt either in full or upto a certain limit and the balance, if any, shall be taxable and thus included in gross salary.

Entertainment allowance, however, does not fall under section 10 and therefore it is not subject to any exemption. The entire entertainment allowance received by an employee is first included in gross salary and thereafter a deduction under section 16(ii) is allowed only to a government employee from gross salary on account of such entertainment allowance, already included.

The treatment of some of the allowances is as under:

1.1. House Rent Allowance [Section 10(13A) and Rule 2A]

(Exemption under Section 10(13A) shall not be allowed, if the employee opts to be taxed under section 115BAC)

Quantum of Exemption: Minimum of following three limits:

  Mumbai / Kolkata / Delhi / Chennai Other Cities
(i) Allowance actually received Allowance actually received
(ii) Rent paid in excess of 10% of salary Rent paid in excess of 10% of salary
(iii) 50% of salary 40% of salary

1.   Salary for this purpose includes dearness allowance if the terms of employment so provide but exclude all other allowances and perquisites. Thus, dearness allowance will be included to the extent it is part of salary as per terms of employment. All other allowances and perquisites will not be included. However, as per the Supreme Court decision, commission, if received as a fixed percentage of turnover achieved by employee, would form part of the salary [Gestetner Duplicators Pvt. Ltd v CIT (1979) 117 ITR 1 (SC)].

2.  Salary is to be taken on ‘due’ basis in respect of the period during which the rented accommodation is occupied by the employee in the previous year. The salary of any other period is not to be included even though it may be received and taxed during the previous year.

3.  Where the employee has not actually incurred expenditure on payment of rent or stays in his own accommodation, no exemption of H.R.A. is available.

The exemption in respect of HRA is based upon the following factors:

(1)       Salary

(2)       Place of residence

(3)       Rent paid

(4)       HRA received.

Since there is a possibility of change in any of the above factors during the previous year, exemption for HRA should not always be calculated on annual basis. As long as there is no change in any of the above factors it can be calculated together for that period. Whenever there is a change in any of the above factors, it should be separately calculated till the next change.

Example – 1 : (Where there is no change in any factor during the previous year) 

A is entitled to a basic salary of ₹25,000 p.m. and dearness allowance of ₹5,000 p.m., 40% of which forms  part of retirement benefits. He is also entitled to HRA of ₹10,000 p.m. He actually pays ₹10,000 p.m. as rent for a  house in Delhi. Compute the taxable HRA. 

Solution : 

The minimum of the following three amounts shall be exempt under section 10(13A):

  ₹.
(i) Actual HRA received (10,000 x 12) 1,20,000
(ii) Rent paid in excess of 10% of salary (1,20,000 – 32,400) 87,600
(iii) 50% of salary 1,62,000

Therefore, ₹87,600 shall be exempt and the balance ₹32,400 shall be included in gross salary. 

Working Note:

Salary for the above purpose is calculated as under: 

(i) Salary 25,000 x 12 3,00,000
(ii) Dearness Allowance 40% of 60,000 24,000
  3,24,000

Example -2 : (Where there is change in the rent paid) 

X is employed at Delhi as the Finance Manager of R Company Ltd. The particulars of his salary for the  previous year 2019-20 are as under: 

  ₹.
(i) Basic Salary 30,000 p.m.
(ii) Dearness Allowance (forming part of basic salary) 10,000 p.m.
(iii) Conveyance Allowance for personal purpose 5,000 p.m.
(iv) Commission @ 2% of the turnover achieved which was ₹.22,50,000 during the  previous year and the same was evenly spread. 45,000
(v) House Rent Allowance 15,000 p.m.
See also  Perquisites - Valuation of Motor Car / Other Vehicles [Rule 3(2)]

The actual rent paid by him is ₹10,000 p.m. for an accommodation at Noida till 31.12.2022. From 1.1.2023,  the rent was increased to ₹20,000 p.m. Compute the taxable HRA.

Solution :

    Period of 9 months 1.4.2022 to 31.12.2022   Period of  3 months  1.1.2023   to 31.3.2023
Actual HRA received   1,35,000   45,000 
Less: Exemption under section 10(13A)        
(i) Actual HRA received 1,35,000   45,000   
(ii) Rent paid – 10% of salary  of relevant period 50,625   46,875  
(a) 90,000 – (10% of 3,93,750)        
(b) 60,000 – (10% of 1,31,250)        
(iii) 40% of salary 1,57,500 50,625 52,500 45,000
    84,375   Nil

Taxable amount        :  Rs. 84,375 + Nil =  Rs. 84,375 

Exemption amount   :  ₹50,625 + ₹45,000 = ₹95,625 

Meaning of salary from 1.4.2022 to 31.12.2022 — ₹2,70,000 + 90,000 + 33,750 = ₹3,93,750 

Meaning of salary from 1.1.2023 to 31.3.2023 —₹90,000 + 30,000 + 11,250 = ₹1,31,250 

Example-3 : (Where there is a change in 2 factors e.g. salary and rent paid) 

Mr. X is employed with ABC Ltd. on a basic salary of ₹60,000 p.m. He is also entitled to a dearness  allowance of 20% of basic salary. 70% of the dearness allowance is included in salary for retirement benefits. The  company gives him HRA of ₹30,000 p.m. 

With effect from 1.1.2023, he receives an increment of ₹10,000 in his basic salary. 

During the previous year 2022-20, he has received arrears of salary pertaining to earlier years amounting to  ₹80,000. 

X was staying with his parents till 31.10.2022. From 1.11.2022, he takes an accommodation on rent in Delhi  and pays ₹25,000 p.m. as rent for the accommodation. 

Compute his gross salary for the assessment year 2023-24. 

Solution 

 
Basic Salary:    
60,000 x 9 5,40,000   
70,000 x 3 2,10,000 7,50,000 
Dearness allowance:     
20% of basic salary   1,50,000 
Arrears of salary   80,000 
Actual amount of house rent allowance received 3,60,000  
Less: Exemption under section 10(13A) 87,380 2,72,620
Gross Salary   12,52,620

Working Notes :

(1)       In the above question, there are two factors which have changed but calculation of HRA will be done in 3  parts, i.e.,

(i)        1.4.2022 to 31.10.2022 when he did not pay any rent

(ii)       1.11.2022 to 31.12.2022 — when he pays rent but no change in other factors 

(iii)      1.1.2023 to 31.3.2023 — when the salary has increased. 

(2)       Since no rent has been paid from 1.4.2022 to 31.10.2022, no exemption shall be available. 

(3)       For the period November and December 2022 exemption will be as under: 

   
(a) Actual HRA received (30,000 x 2) 60,000
(b) Rent paid – 10% of salary  
  [50,000 – 10% of (1,20,000 + 16,800)] i.e. [50,000 – 13,680] 36,320
(c) 50% of salary 68,400
  ₹36,320 will be exempt.  

(4)       For the period 1.1.2023 to 31.3.2023, exemption will be  minimum of the following 3 amounts: 

(a) Actual HRA received (30,000 x 3) 90,000
(b) Rent paid – 10% of salary  
  75,000 – 10% (2,10,000 + 29,400) i.e. 75,000 – 23,940 51,060
(c) 50% salary 1,19,700

Therefore, ₹51,060 will be exempt. 

The total exemption shall be Nil + 36,320 + 51,060 = 87,380. 

Problem 1:

Compute the exemption available under section 10(13A) in the following cases: 

Name of Employee A B C D E
Place of residence Delhi Noida Mumbai Patna Bangalore 
Salary p.m. 4,000 6,000 8,000 3,000 5,000 
H.R.A. p.m. 1,500 1,200 5,000 1,000 1,500 
Rent paid p.m. Nil 1,000 6,000 800 400

Ans.

Nil; B-4,800; C-48,000; D-6,000; E-Nil. [See Problem No. 4.13 of “Practical Approach to Income Tax”] 

Problem 2:

R is employed with XY Limited on a basic salary of ₹5,000 per month. He is also entitled to  dearness allowance @ 100% of basic salary, 50% of which is included in salary for as per terms of employment.  The company gives him HRA of ₹3,000 per month which was increased to ₹3,500 w.e.f. 1.1.2023. He also got an  increment of ₹500 in his basic salary w.e.f. 1.2.2023. Rent paid by him during the previous year 2022-20 is as  under: 

April and May, 2022 — Nil, as he stayed with his parents 

June to October, 2022 — ₹3,000 per month for an accommodation in Ghaziabad 

November, 2022 to March, 2023 – ₹4,000 per month for an accommodation in Delhi. 

Compute his gross salary for assessment year 2023-24. 

Ans.

₹1,32,650.

1.2. Prescribed Allowances which are Exempt to a certain extent [Section 10(14)]

Are of the following two types:

(i) Special allowances for performance of official duties:

These allowances are not in the nature of a perquisite within the meaning of section 17(2) and are specifically granted to meet expenses wholly, necessarily and exclusively incurred in the performance of duties of an office or employment of profit. These allowances will be exempt to the extent such expenses arc actually incurred for that purpose. [Section 10(14)(i)].

(ii) Allowances to meet personal expenses:

These allowances are granted to the employee to meet his personal expenses either at the place where the duties of his office or employment of profit arc ordinarily performed by him or at the place where he ordinarily resides. These allowances are exempt to the extent prescribed. [Section I0(14)(ii)].

1.2.1.     Special allowances which are exempt to the extent of actual amount received or the amount spent for the performance of the duties of an office or employment of profit, whichever is less

[Following allowances (except which are notified by CBDT, see Notification No. 38/2020 below), shall not be exempt if the employee opts to be taxed under section 115BAC]

These allowances are:

See also  Award or Reward [Section 10(17A)]
(a) Travelling allowance:

Any allowance granted to meet the cost of travel on tour or on transfer of duty. “Allowance granted to meet the cost of travel on transfer” includes any sum paid in connection with transfer, packing and transportation of personal effects on such transfer.

(b) Daily allowance:

Any allowance, whether granted on tour or for the period of journey in connection with transfer, to meet the ordinary daily charges incurred by an employee on account of absence from his normal place of duty;

(c) Conveyance allowance:

Any allowance granted to meet the expenditure incurred on conveyance in performance of duties of an office or employment of profit, provided that free conveyance is not provided by the employer. Expenditure incurred on journey from residence to office and back to residence shall not be treated as expenditure incurred on conveyance in performance of official duties;

(d) Helper allowance:

Any allowance, by whatever name called, granted to meet the expenditure incurred on a helper where such helper is engaged for the performance of the duties of an office or employment of profit;

(e) Academic allowance:

Any allowance, by whatever name called, granted for encouraging academic, research and training pursuits in educational and research institutions;

(f) Uniform allowance:

Any allowance, by whatever name called, granted to meet the expenditure incurred on the purchase or maintenance of uniform for wear during the performance of the duties of an office or employment of profit.

The above allowances shall be exempt to the extent of minimum of the following:

(1)     Actual allowance received.

(2)     Actual amount spent for the purposes of duties of office or employment.

1.2.2.  Allowances to meet Personal Expenses

[Following allowances (except which are notified by CBDT, see Notification No. 3 8/2020 below), shall not be exempt if the employee opts to be taxed under section 115BAC]

These allowances can be of the following two types:

(1)     Allowances which are exempt to the extent of amount received or the limit specified, whichever is less (2)     Allowance which is exempt to the extent of certain percentage of amount received
(1) Allowances which are exempt to the extent of amount received or the limit specified, ‘whichever is less:

 

(a) Children Education Allowance:

Exempt upto actual amount received per child or Rs. 100 p.m. per child upto a maximum of 2 children, whichever is less.

(b) Hostel Expenditure Allowance:

Exempt upto actual amount received per child or Rs. 300 p.m. per child upto a maximum of 2 children, whichever is less.

(c) Tribal Area, Scheduled Area/Agency Area Allowance:

Exempt upto actual amount received or Rs.200 per month, whichever is less.

(d) Special Compensatory Hilly Area Allowance or High Altitude Allowance etc.:

Exemption varies from Rs. 300 to Rs. 7,000 per month.

(e) Border Area, Remote Area Allowance, Disturbed Area Allowance, etc.:

(as per given later): Exemption varies from Rs. 200 p.m. to Rs. 1,300 p.m.

(f) Compensatory Field Area Allowance:

Exempt to the extent of Rs. 2,600 p.m.

(g) Compensatory, Modified Field Area Allowance:

Exempt to the extent of Rs. 1,000 p.m.

(h) Counter Insurgency Allowance granted to members of armed forces:

Exempt to the extent of Rs. 3,900 p.m.

(i) Transport Allowance given to certain disabled employees:

Any transport allowance granted to an employee who is blind or deaf and dumb or orthopedically handicapped with disability of lower extremities, to meet his expenditure for the purpose of commuting between the place of his residence and the place of his duty, to the extent of Rs. 3,200 p.m.

(j) Underground Allowance:

Any underground allowance granted to an employee who is working in uncongenial, unnatural climate in underground mines shall be exempt to the extent of Rs. 800 p.m.

(k) High Altitude (uncongenial climate) Allowance:

Given to the member of the armed forces for altitude of 9000 ft. to 15000 ft. Rs. 1,060 p.m. and for altitude above 15000 ft Rs.1,600 p.m.

(l) Special compensatory highly active field area allowance granted to members of armed forces:

Exempt to the extent of Rs. 4,200 p.m.

(m) Island (Duty) Allowance:

Given to the member of the armed forces in the Andaman & Nicobar and Lakshadweep Group of Islands exempt to the extent of Rs. 3,250 p.m.

(1)       Assessee claiming exemption of allowance mentioned under clauses (f) and (g) above shall not be entitled to the exemption in respect of allowance referred to under clause (e) above.

(2)       Assessee claiming exemption in respect of the allowance mentioned under clause (h) above shall not be entitled to the exemption in respect of disturbed area allowance mentioned under clause (e) above.

(3)       It may be noted that allowances mentioned in para above are exempt to the extent of amount received or the limit specified, whichever is less. Actual expenditure in this case has no relevance.

(4)       If the employee receives such allowances in excess of the amount exempt above, the excess if any received by the employee shall be taxable in his hands.

(2) Allowance which is exempt to the extent of certain percentage of amount received

Allowance allowed to transport employees working in any transport system

[This allowance, shall not be exempt if the employee opts to be taxed under section 115BAC]:

If any fixed allowance is given by the employer to the employee who is working in any transport system, to meet his personal expenditure during his duty performed in the course of running of such transport from one place to another, the amount of exemption shall be 70% of such allowance or Rs. 10,000 p.m., whichever is less.

Exemption will be allowed to the transport employees only when they are not in receipt of daily allowance. If they are in receipt of daily allowance, they can claim exemption as per above described.

Employees opts to be Taxed under Section 115BAC (i.e. new Regime), he shall be entitled to Exemption of the following Four Allowances only.

(i)      any allowance granted to meet the cost of travel on tour or on transfer;

(ii)     any allowance, whether granted on tour or for the period of journey in connection with transfer, to meet the ordinary daily charges incurred by an employee on account of absence from his normal place of duty;

(iii)    any allowance granted to meet the expenditure incurred on conveyance in performance of duties of an office or employment of profit:

Provided that free conveyance is not provided by the employer;

(iv)    Transport allowance upto Rs. 3,200 p.m. granted to an employee, who is blind or deaf and dumb or orthopedically handicapped with disability of lower extremities, to meet his expenditure for the purpose of commuting between the place of his residence and the place of his duty.

Further, the exemption provided in respect of free food and non-alcoholic beverage provided by such employer through paid voucher shall not apply to an employee, being an assessee, who has exercised option under section 115BAC (5).

EXAMPLE -1 :

R is in receipt of the following allowances from his employer during the previous year 2021-22:

  1. Conveyance allowance 600 p.m. He spends Rs. 5,000 during the previous year for official purposes.
  2. Transport allowance Rs. 2,200 p.m. for commuting from residence to office and back. He spends Rs. 1,400 p.m. during the year.
  3. Uniform allowance Rs. 5,000 p.a. He spends Rs. 4,000 on the purchase and maintenance of uniform.
  4. Education and Hostel Expenditure allowance Rs. 450 per month per child for 3 children.
  5. Personal assistant allowance Rs. 2,000 p.m. He engaged the personal assistant for official work and paid him salary of Rs.1,500 p.m. for 9 months. Personal assistant spends 60% of his time for official work of R.

Compute how much of the above allowances are taxable, if R:

(a)      does not opt to be taxed under section 115BAC

(b)     opts to be taxed under section 115BAC

Solution :

Computation of taxable allowances

S.N. Particular   Does not opt to be taxed u/s 115BAC Opts to be taxed u/s 115BAC
1. Conveyance allowance (600 x 12) 7,200
Less: Exempt to the extent spent for official purposes 5,000 2,200 2,200
2. Transport allowance (2,200 x 12) 26,400
Less: Exempt Nil 26,400 26,400
3. Uniform allowance 5,000
Less: Exempt to the extent spent for purchase and maintenance of uniform 4,000 1,000 5,000
4. Education allowance (450 x 3 x 2) 16,200
  Less: Exempt [(100 + 300 = 400) x 2 x 12] 9,600 6,600 16,200
5. Personal assistance allowance (Helper Allowance ) ( 2,000 x 12) 24,000    
  Less : Exempt to the extent spent for official purposes (1,500 x 9=13,500 x 60/100) 8,100 15,900 24,000
  Total Taxable Allowance to be included in Gross Salary   52,100 73,800

1.3. Entertainment Allowance

This deduction is allowed only to a Government employee. Non-Government employees shall not be eligible for any deduction on account of any entertainment allowance received by them.

In case of entertainment allowance, the assessee is not entitled to any exemption but he is entitled to a deduction under section 16(ii) from gross salary. Therefore, the entire entertainment allowance received by any employee is added in computation of the gross salary. The Government employee is, then, entitled to deduction from gross salary under section 16(ii) on account of such entertainment allowance to the extent of Minimum of the following 3 limits.

(i)      Actual entertainment allowance received during the previous year.

(ii)     20% of his salary exclusive of any allowance, benefit or other perquisite.

(iii)    Rs. 5,000.

Note. – If an employee opts to be taxed under section 115BAC, the above deduction of entertainment allowance shall not be allowed.

1.       For purpose of deduction in respect of entertainment allowance, the actual amount spent towards entertainment expenses is irrelevant. Even if the Government employee spends the entire amount of entertainment allowance or even an amount greater than the entertainment allowance received is spent on entertainment for official purposes, the deduction shall be minimum of the above 3 limits.

2.       Amount actually spent out of entertainment allowance is irrelevant for claiming deduction.

3.       Sumptuary allowance has to be treated as an entertainment allowance.

Example-1:

X, an employee of the Central Government, gets ₹30,000 p.m. as basic salary and is  entitled to ₹1,500 p.m. as entertainment allowance. Compute the deduction under section 16(ii) from gross salary  in respect of entertainment allowance. 

Solution :

 
Basic Salary   3,60,000 
Entertainment Allowance   18,000 
Gross Salary   3,78,000 
Less: Standard deduction 50,000   
Deduction under section 16(ii) 5,000 55,000 
    3,23,000 
Deduction under section 16(ii) shall be allowed to the extent of the minimum of the following 3 amounts: 

(i)      Actual entertainment allowance i.e. ₹1,500 u 12 = ₹18,000. 

(ii)     20% of salary, i.e., 20% of ₹3,60,000 = ₹72,000 

(iii)    ₹5,000 

Therefore the deduction will be of ₹5,000. 

Example-2:

R is employed as a pilot in Air India. He is in receipt of the following during the previous  year 2022-23: 

1. Basic salary ₹50,000 p.m.
2. Bonus 2 months of basic salary
3. Entertainment allowance ₹11,500 p.m.
4. Uniform allowance ₹1,200 p.m.
He has spent ₹8,000 for purchase and maintenance of uniform for official  purposes.  
5. He has been given ₹6,000 p.m. as allowance to meet personal expenses during the performance of his duties  in the transport
Compute his income under the head salary for the assessment year 2023-24.

Solution :

Computation of gross salary of R 

Particulars
Basic salary (₹50,000 × 12)   6,00,000 
Bonus (₹50,000 × 2)   1,00,000 
Entertainment allowance (₹1,500 × 12)   18,000 
Uniform allowance (₹1,200 × 12) 14,400  
Less: Amount spent for purchase and maintenance of uniform 8,000 6,400
Transport allowance to meet personal expenses (₹6,000 × 12) 72,000  
Less: Exempt 70% of the allowance or ₹10,000 p.m. 50,400 21,600 
whichever is less    
Gross salary   7,46,000
Less: Standard deduction 50,000  
Less: Deduction Entertainment allowance Nil 50,000
Income under the head salary   6,96,000
Entertainment allowance shall not allowed as a deduction as R is not a government employee.

1.4. Allowances which are Exempt in case of Certain Persons

(i) Allowances to a citizen of india, who is a Government employee, rendering services outside India. [Section 10(7)]

(ii) Allowances to High Court judges under section 22A(2) of the High Court Judges (Conditions of Service) Act, 1954.

(iii) Sumptuary allowance given to High Court and the Supreme Court judges. Sumptuary allowances are in the nature of entertainment allowance.

(iv) Allowance received by an employee of United Nations Organisation (UNO) from his employer.

1.5. Allowances which are Fully Taxable

All other allowances excepting those discussed in preceding paras, are fully taxable. Some of such allowances arc enumerated as under:

1. Dearness Allowance (DA) 2. City Compensatory Allowance (CCA) 3. Medical Allowance

Fully taxable, irrespective of whether any amount has been spent on medical treatment or not

4. Lunch Allowance/ tiffin allowance 5. Overtime Allowance 6. Non-practising Allowance
7. Family Allowance 8. Warden Allowance 9. Servant Allowance

Note.—If the employee opts to be taxed under section 115BAC, besides the above allowances, the following allowances shall also be fully taxable:

(i)      Leave travel concession/allowance

(ii)     House rent allowance

(iii)      Notified/specified allowances except which are notified to be exempt by CBDT.

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