The 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. These allowances are generally taxable and are to be included in gross salary unless a specific exemption is provided in respect of such allowance. For the purpose of tax treatment, we divide these allowances into 3 categories:
I. Fully taxable cash allowances
II. Partially exempt cash allowances
III. Fully exempt cash allowances
I. FULLY TAXABLE ALLOWANCES
This category includes all the allowances, which are fully taxable. So, if an allowance is not partially exempt or fully exempt, it gets included in this category.
The main allowances under this category are enumerated below:
(i) Dearness Allowance and Dearness Pay
As is clear by its name, this allowance is paid to compensate the employee against the rise in the price level in the economy. Although it is a compensatory allowance against high prices, the whole of it is taxable. When a part of Dearness Allowance is converted into Dearness Pay, it becomes part of the basic salary for the grant of retirement benefits and is assumed to be given under the terms of employment.
(ii) City Compensatory Allowance
This allowance is paid to employees who are posted in big cities. The purpose is to compensate for the high cost of living in cities like Delhi, Mumbai etc. However, it is fully taxable.
(iii) Tiffin / Lunch Allowance
It is fully taxable. It is given for lunch to the employees.
(iv) Non-practicing Allowance
This is normally given to those professionals (like medical doctors, chartered accountants etc.) who are in government service and are banned from doing private practice. It is to compensate them for this ban. It is fully taxable.
(v) Warden or Proctor Allowance
These allowances are given in educational institutions for working as a Warden of the hostel or as a Proctor in the institution. They are fully taxable.
(vi) Deputation Allowance
When an employee is sent from his permanent place of service to some place or institute on deputation for a temporary period, he is given this allowance. It is fully taxable.
(vii) 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. It is fully taxable.
(viii) Fixed Medical Allowance
Medical allowance is fully taxable even if some expenditure has actually been incurred for medical treatment of employee or family.
(ix) Servant Allowance
It is fully taxable whether or not servants have been employed by the employee.
(x) Other allowances
There may be several other allowances like family allowance, project allowance, marriage allowance, education allowance, and holiday allowance etc. which are not covered under a specifically exempt category, so are fully taxable.
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II. PARTIALLY EXEMPT ALLOWANCES
This category includes allowances which are exempt up to a certain limit. For certain allowances, an exemption is dependent on an amount of allowance spent for the purpose for which it was received and for other allowances, there is a fixed limit of exemption.
(i) House Rent Allowance (H.R.A.)
An allowance granted to a person by his employer to meet expenditure incurred on payment of rent in respect of residential accommodation occupied by him is exempt from tax to the extent of least of the following three amounts:
a) House Rent Allowance actually received by the assessee
b) Excess of rent paid by the assessee over 10% of salary due to him
c) An amount equal to 50% of salary due to assessee (If accommodation is situated in Mumbai, Kolkata, Delhi, Chennai) ‘Or’ an amount equal to 40% of salary (if accommodation is situated in any other place).
The salary for this purpose includes Basic Salary, Dearness Allowance (if it forms part of salary for the purpose of retirement benefits) and Commission based on fixed percentage of turnover achieved by the employee.
The exemption of HRA depends upon the following factors:
(1) Basic Salary
(2) Rent paid
(3) Place of residence
(4) HRA received
If an employee is living in his own house and receiving HRA, it will be fully taxable.
(ii) Entertainment Allowance
This allowance is first included in gross salary under allowances and then deduction is given to only central and state government employees under Section 16 (ii).
(iii) Special Allowances for meeting official expenditure
Certain allowances are given to the employees to meet expenses incurred exclusively in performance of official duties and hence are exempt to the extent actually incurred for the purpose for which it is given. These include travelling allowance, daily allowance, conveyance allowance, helper allowance, research allowance and uniform allowance.
(iv) Special Allowances to meet personal expenses
There are certain allowances given to the employees for specific personal purposes and the amount of exemption is fixed i.e. not dependent on actual expenditure incurred in this regard. These allowances include:
a) Children Education Allowance
This allowance is exempt to the extent of Rs.100 per month per child for a maximum of 2 children (grandchildren are not considered).
b) Children Hostel Allowance
Any allowance granted to an employee to meet the hostel expenditure on his child is exempt to the extent of Rs.300 per month per child for maximum of 2 children.
c) Transport Allowance
This allowance is generally given to government employees to compensate the cost incurred in commuting between place of residence and place of work. An amount upto Rs.800 per month paid is exempt. However, in case of blind and orthopedically handicapped persons, it is exempt up to Rs. 1,600 p.m.
d) Out of station allowance
An allowance granted to an employee working in a transport system to meet his personal expenses in performance of his duty in the course of running of such transport from one place to another is exempt upto 70% of such allowance or Rs.6,000 per month, whichever is less.
III. FULLY EXEMPT ALLOWANCES
(i) Foreign allowance is usually paid by the government to its employees being an Indian citizen posted out of India for rendering services abroad. It is fully exempt from tax.
(ii) Allowance to High Court and Supreme Court Judges of whatever nature are exempt from tax.
(iii) Allowances from UNO organization to its employees are fully exempt from tax.
