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The financial benefits given to employees by their employers over and above their regular salary are called allowances. Some allowances that come under the head ‘salaries’ are fully taxable, while others are partly taxable or fully exempt from tax liability.
Allowance can be described as a fixed amount of money given by the employer to the employee to compensate for certain specific type of expense. The allowance is given over and above the salary paid to the employee. For example – Some companies give the benefit of overtime to employees if they stay back in office or work beyond the normal working hours to finish a seasonal demand or specific project. Apart from overtime, there are other allowances provided to salaried employees. The Income Tax Department considers allowances as part of the salary and is subject to tax, although there are some allowances which get tax benefits as per the exemptions mentioned in different sections of the Income Tax Act. Going by their tax treatment, the allowances are categorised differently - taxable, non-taxable and partially taxable.
Read on to know more about the various allowances that fall under different categories.
Allowances which are considered as part of the employee’s salary and do not get the benefit of partial or full exemption under a section of the Income Tax are called Taxable allowances. Let’s look at some of the popular allowances that fall under this category.
Entertainment allowance is the fund given to an employee by the company to pay for client meetings, drinks, food, hotel stay, etc. Entertainment allowance is fully taxable for employees working in the private sector. Government employees are allowed to claim exemption on entertainment allowance as per section 16 (ii) but have a limit of the following i) 20% of gross salary (excluding all other allowance, benefits, and perks), ii) Actual entertainment allowance and iii) INR 5000.
The overtime allowance is rewarded to the employees who work or stay back in office beyond the normal working hours as mentioned in their job contract. Such situations can happen due to seasonal demand or project deadlines. The overtime allowance received by the employee from the employer is fully taxable.
Dearness allowance is paid to employees who migrate from the city of their residence to another for job purpose. The allowance helps them to deal with inflation related expenses and difference in cost of living for employees living in different towns and cities.
As the name suggests the meal allowance is paid for food requirements of the employees. It can be used for refreshment/meals/ tiffin services by the employees. This allowance is completely taxable as per the Income Tax Act.
City Compensatory Allowance is provided by the company to its employees to reimburse the high cost of living in major cities like Mumbai. The allowance is also used to retain employees working in places where the cost of living is higher compared to other working locations.
The interim allowance is given by the employer to the employee in lieu of a final allowance. The interim allowance is completely taxable.
When employers give a cash allowance to the employee like a marriage allowance, holiday allowance etc., it is fully taxable
Allowance which is provided to the employee for hiring a servant is also fully taxable in the hands of the employee.
When an employer gives allowance to the employee to carry out the project-related expenses it is called project allowance. Project allowance is also fully taxable.
Warden allowance is paid to the employee who works as a warden or keeper in an institute. This allowance is also subject to tax.
When a doctor who is attached to various laboratories, clinics or medical institutes receives any non-practicing allowance then it is also completely taxable.
The allowances given to an employee which form a part of their salary but are fully exempted from tax are called non-taxable allowance. Below is the list of allowances which form part of non-taxable allowances.
When servants of Indian Government travel abroad for assignments they receive an allowance to carry out their expenditure in another country. These allowances are exempted from tax liability.
The allowances received by UNO employees are free from tax liability.
Judges of High court and Supreme Court get allowances which are free from exempt from tax. These allowances are known as sumptuary allowances.
The compensatory allowances received by Judges of High Court and Supreme court are also exempted from tax as per Income Tax Act.
The allowances which are partially exempted from tax to a certain limit are called partially taxable allowances, as per the sections specified in the Income Tax Act. Some examples of partially taxable allowances are mentioned below.
The allowance which is paid to the employee by the employer for commuting to work from his/her residence is called conveyance allowance. The allowance is exempt from tax to the limit of INR 1600 per month. Any amount paid greater than INR 1600 will be taxable as per the Income Tax Act.
House rent allowance is paid to the employee by the employer to compensate the accommodation expenses. If the employee does not live in a rented place and owns his own house or lives with parents then this allowance is fully taxable. The deduction can be claimed by employees on house rent allowance as per section 10 (13a) provided:
The actual HRA is received by the employee from the employer
In metro cities like Mumbai, Bangalore, Chennai or Delhi actual rent paid should be 50% of the basic salary. In the case of employee living in non-metros, it should be 40% of basic salary.
Any excess amount received as HRA after claiming the deduction is fully taxable.
This is the allowance paid to the employee to cover his/her medical expenses along with the medical expenses of the close family members. The tax-exempt on this allowance is limited to the extent of INR 15,000 and any additional amount beyond this is completely taxable.
The special allowance is offered to the employee for the performance of duty falling under Section 14(i). This allowance is partially taxable and does not fall within the category of a prerequisite.
Allowances are primarily part of an employee’s salary package that help cover the expenses that he or she may incur as part of the employment services. For example – If an employee has a sales role profile then he/she may be required to travel a lot on daily basis to meet different clients. The expense on transportation such as fuel cost will be compensated by the employer as transport allowances. Likewise, there are many other allowances that are given to the employees for their benefits to carry out their employment regularly without much hassle. Allowances are categorised into three parts Non- taxable allowances, partially taxable allowances and taxable allowances.
Reimbursement: Reimbursement is an amount that the employer compensates to the employee for expenditure. Reimbursements are related to the business expenses and it does not add any benefit to the employee’s salary income. Thus, there is no tax liability incurred on reimbursements.
What is a perquisite?
The benefits received by a salaried employee over and above their wages or salary are termed as perquisites. Depending on the nature, perquisites can be taxable or non-taxable. Uniform allowance is an example of perquisite and is exempt up to the limit as described under section 10(14) of Income Tax Act.
If the employer reimburses all the expenses related to children’s education and grocery, will these be included in my income?
Yes, this reimbursement is considered as perquisites and need to be valued as per the rules and regulations.
If I receive arrears of my salary, is that taxable?
Yes, arrears of a salary are taxable. However, considering the years it relates to, one can avail for lowered incidence tax under section 89 of the Income Tax Act.
Will leave encashment be treated under taxable income from salary?
Yes, if the leave encasement is received while the person is in service, it will be taxable. However, for government employees, leave encasement received after retirement is exempt in their hands. The leave encashment is subject to exempt from tax as per the limit prescribed under the Income Tax Act.