Allowances are monetary benefits extended to employees over their regular pay scale. Such benefits cover all their expenses, and in addition, help employees manage their financial liabilities efficiently.
However, as per the Income Tax Act (ITA), some of these allowances bestowed on employees are taxable, while some are exempted completely or partially from tax liability. The section below highlights all the taxable and non-taxable allowances that are offered to employees.
What is an Allowance?
An allowance is a fixed amount of money extended to an organisation’s employees to help them sail through varied expenses. This fixed amount of money is given to these employees excluding their basic pay. Some examples of such allowances are conveyance allowances, overtime allowances, dearness allowances etc. The Income Tax Department of India takes these allowances as part of salary and levies tax on the same. However, there are certain allowances among such which are exempted from taxation.
What are the Taxable Allowances in India?
Taxable allowances are those that do not benefit from tax exemptions under the Income Tax Act. The following sections highlight such allowances.
- Overtime Allowance
Overtime allowances are rewarded to employees who have worked for a time span that is beyond their regular work hours, as stated in the job contract. For example, employees might have to work extra hours in cases of project deadlines or seasonal demand spikes. Such allowances offered by employers for working extra minutes are taxable.
- Dearness allowance
Dearness allowance (DA) is bestowed on employees who had to migrate to a new city for the job from the city where they live in. This allowance benefits employees with the cost of living adjustment, helping them tide over inflation and cope up with the different living expenses of a new city. As per the Income Tax Act, it is mandatory to declare the tax liability for dearness allowance and salary in the filed return.
- Entertainment allowance
Entertainment allowance is offered to employees of the private sector, enabling them to pay for hotel stays, client meetings, food, drinks etc. However, government employees are entitled to claim tax exemptions on this allowance under Section 16 (ii) of the Income Tax Act.
- Interim allowance
Employers of an organisation offer interim allowances to employees in place of final allowance. Such allowances are also taxable.
- City Compensatory allowance
City Compensatory Allowance (CCA) is generally given to employees who are living in urban centres in order to reimburse the inflated cost of living there. This benefit is also offered to employees to retain them in their city of workplace where the cost of living is comparatively higher than that of other cities.
- Non-practising allowance
Non-practicing allowances are provided to doctors who can show a certificate that shows that they are not employed in any self-practice. This benefit includes 20% of an individual’s basic salary and dearness allowance. In simple words, for physicians or doctors who are involved in any clinical centres of an institute or laboratories, such allowances provided to them are taxable under ITA.
- Warden allowance
Even warden allowance is subjected to taxation. Nevertheless, such allowances are given to the keeper or a warden of an institute to help them cope with living costs and manage their financial liabilities well.
- Cash allowance
Employers offering cash allowance in the form of bereavement allowance, marriage allowance or holiday allowance are also subjected to taxations.
What are the Non-taxable Allowances?
Here are some of the allowances that are not taxable, especially those which are extended to government judges, servants and UNO (United Nations Organisation) employees.
- Sumptuary allowances: These allowances are extended to judges of the High court and Supreme Court in addition to their salary and are exempted completely from taxation.
- Allowances offered to government servants abroad: Any allowance that is paid to a government servant for rendering their service outside India is also free from taxation.
- Compensatory allowances offered to judges: Such allowance that judges are bestowed with under Article 222 (2) of the Constitution of India is not taxable.
- Allowance paid to employees of UNO: The monetary benefit that UNO offers to their employees as per Section 2 of the United Nations Act is fully exempted from taxes.
What are the Partially Taxable Allowances in India?
Besides knowing fully-taxable allowances, salaried individuals should also have an idea regarding the following allowances that are partially taxable, as mentioned in the Income Tax Act.
- House Rent Allowance
HRA (House Rent Allowance) is one of the partially taxable monetary benefits offered to employees. In this allowance, employees receive financial support for their accommodation. Salaried individuals can claim tax deductions on HRA under Section 10 (13a) of the ITA..
- In metropolitan cities like Kolkata, Chennai, Mumbai etc., the actual rent that employees have to bear must be 50% of the basic salary. In case it is a non-metro city, the rent has to be 40% of the individual’s basic salary.
- Any amount that is excess to HRA after deduction has been claimed is entitled to taxation.
- Conveyance Allowance
Conveyance allowance is a financial benefit that is given out to employees as foot expenses that result from commuting to the workplace. Transport allowance/ conveyance allowance is another such allowance which is partially taxable.
It is extended by employers in order to help employees meet their expenses that incur from daily travel costs between their places of residence to the place where the employee works. For such allowance, salaried individuals can enjoy tax exemption of up to ₹1600 per month. If the amount paid is higher than ₹1600 is taxable as per the Income Tax Act.
- Medical Allowance
Such allowances are extended to employees to compensate for medical expenses incurred from treatment and diagnosis in case they or their family member needs medical attention. As per the Income Tax Act, employees are offered a tax exemption limit of Rs. 15000 on medical reimbursement. In case the reimbursement exceeds the exemption limit, the amount will be taxable.
To recapitulate, the overall salary package, known as CTC, mentions all sorts of allowances that will be offered to all salaried individuals. To make the most of such allowances, they must have a well-rounded idea regarding taxable and non-taxable allowances. It will help them keep track of their finances and the amount that goes into taxation.
Frequently Asked Questions:
Is project allowance taxable?
Yes, project allowances are taxable. These are monetary perks that employers extend to compensate for any project-related costs.
What is the difference between reimbursement and allowance?
Allowances are basically a part of an employee’s remuneration package that intends to compensate for varied expenses as a significant part of the employment services. For instance, the fuel cost is compensated under the conveyance allowance. These monetary benefits are extended to help employees carry out their regular professional duties without any monetary burden.
On the other hand, reimbursement is the money that the employer gives out to employees intending to compensate for their expenditures. These amounts are basically related to business expenditure and are not included in an employee’s salary, thereby are free from any sort of tax liability.
What is a prerequisite?
A prerequisite is a non-cash advantage that is rolled out to an employee. It is a benefit that employees can avail of based on their role and position in the particular enterprise. However, individuals must be aware that availing of a prerequisite has tax consequences.
Animesh Gupta is a Chartered Accountant by profession and a NISM certified Mutual Fund Expert. He has over 4+ years of experience working in the Financial Services Industry. In his role at Wintwealth, he is part of the Credit and Risk team and evaluates the risk of the bonds available on Wintwealth's platform.