Tax rules in India are different and this depends on the income of an individual from salary and other sources. For most employees, filing income tax returns comes as a nightmare due to a lack of knowledge of the employee allowances they are paid by their employers. Thus, having a robust system that allows the employees in understanding the allowances they are entitled to, is very important for every employer.

What are employee allowances?

Simply put, employee allowances are the financial benefits that an employer gives to employees as compensation for certain expenses. These are specific expenses and the employees are paid the allowance over their fixed salaries.

For example, employees are paid conveyance allowance, which is paid to the employee to cover the expenses incurred during commute for office or official work. Thus, any kind of monetary benefit that you pay to your employee for meeting the expenses, above the salary paid is an allowance.

The allowances are added to the salary of the employee for the calculation of taxes under the Income Tax Act. For Income Tax, there are few allowances which are considered as income and are taxed. These are taxable allowances while some of the allowances are exempted from the income tax and non-taxable allowances.

There are partially taxed allowances as well, for which there are separate provisions and tax rules for calculating the amount to be taxed.

On the basis of tax treatment, allowances are categorized into three categories viz. Taxable allowance, partially taxable allowance and non-taxable allowances.

Taxable Allowances

Partially-taxable Allowances

Non-taxable Allowances

* Dearness allowance
* Entertainment allowance
* Overtime allowance
* City compensatory allowance
* Interim allowance
* Project allowance
* Tiffin/meals allowance
* Uniform allowance
* Cash allowance
* Non-practicing allowance
* Warden allowance
* Servant allowance

* HRA except when it qualified as exempt under Section 10
* Fixed medical allowance
* Conveyance allowance above Rs. 19,200 per annum under section 10 (14) (ii) of income tax act
* Special allowance - including children education allowance, children hostel allowances 
* Entertainment allowance deduction of 1/5 of salary or Rs. 5,000 whichever is less under section 16 (ii) of income tax act

* HRA upto 40% of basic salary (50% in case of employees staying in these 4 Indian metros - Delhi, Mumbai, Chennai and Bengaluru) subject to actual rent paid being more than HRA plus 10% of basic
* Conveyance allowance upto Rs. 1,600 per month or Rs. 19,200 per annum
* Payments to government employees posted abroad
* Allowance for UN employees
* Sumptuary allowance paid to judges of Supreme Court and High Courts
* Compensatory allowance paid to judges of Supreme Court and High Courts

1. Taxable Allowances

Taxable allowances are treated as part of the salary paid and are not exempted from taxation under any section of the Income Tax act. These are treated as part of income when the tax of an employee is calculated.

taxable allowances

a. Entertainment Allowance

This allowance is given to employees for the payments made by them towards their client’s hospitality. For example, if your employee pays for drinks, business outings, hotels and meals, meetings and other bills paid for the client, the employee is entitled to get entertainment allowance. This allowance is entirely taxable in the private sector companies.

The employees under government sector can claim an exemption under section 16 (ii) of the Income Tax Act by considering the amount whichever less of the following:
i. Entertainment allowance of Rs 5000 or
ii. 20% of the gross salary less allowances, perks, and other benefits.

b. Overtime Allowance

This is the allowance paid to the employees for working more than the designated working hours. This includes overtime for meeting the deadlines of the project or for any urgent assignment. This is completely taxable under the law.

c. Dearness Allowance

This allowance is paid to the employees for dealing with inflation and neutralize its impact on the cost of living. This allowance is given when an employee who migrates to another city for work and is a completely taxable allowance. Dearness allowance helps the employee to cope up with the rising prices and expenses arising due to moving to a new place. The sole purpose of this allowance is to lessen the effect of rising prices. The entire sum received as Dearness Allowance is to be declared while filing an income tax return.

dearness allowance

It is not mandatory for companies in the private sector to give Dearness Allowance to its employees. However, in the government sector, every employee is entitled to receive this allowance. Dearness Allowance also applies for pensioners of the government sector and they are also eligible to receive dearness allowance.

d. Meal or Food Allowance

As the name suggests, meal allowance is paid for the food for employees. Generally, refreshments, tiffin services and meals are considered part of it. This taxable allowance allows the employee to guilt-free order their food while at work.

e. City Compensatory Allowance

City Compensatory Allowance or CCA is the allowance that a company pays to its employees for compensating for the higher cost of living in the metro cities. This allowance is a good tool to retain and attract employees to cities where the cost of living is higher in comparison to the city they are working in or are willing to move.

You may like to read: Tax filing for your companies employees

2. Interim Allowances

This is again a fully taxable allowance and is paid by the employer in place of the final allowance, to the employee.

a. Cash Allowance

Cash Allowance paid by the employer in the form of holiday allowance, marriage allowance, or any other form, is fully taxable under the income tax laws.

b. Servant Allowance

If your employee is hiring a servant, he or she is entitled to a servant allowance which is again fully taxable under the IT Act.

c. Project Allowance

This allowance allows the employees to focus on the project as the company pays for the expenses related to the project.

d. Warden Allowance

This allowance is paid to the employees who work as wardens for an institution and is fully taxable.

e. Non-practicing allowance

When doctors or medical practitioners associate with laboratories, medical institutes or clinics, they receive a non-practicing allowance which is again fully taxable.

3. Partially Taxable Allowances

Partly taxable allowances are those allowance which is not fully taxed and can be exempted from taxation only up to a certain limit according to the provisions of the Income Tax Act.

a. Conveyance Allowance

It is the allowance given to the employees for the expenses incurring out of the daily commute to the workplace. You pay this allowance to the employee for commuting to office everyday simply.

conveyance allowance

If the allowance paid is Rs 1600, then it is not taxed and if the allowance exceeds Rs 1600, then the amount exceeding Rs 1600 will be taxed as per the provisions of the Income Tax Act. However, blind, dumb, deaf or handicapped employees are entitled to get an exemption from taxation up to Rs 3200 for conveyance allowance.

b. Allowance in case of a Transport Company

The allowance paid to the employees of a transport company for the expenses incurred during duty or during running from one place to another in transport is known as transport allowance. This allowance is partially exempted on the basis of the lowest sum out of the following:

i. 70% of the allowance
ii. Rs 10,000 pm

Any amount received above the said limit is taxable. This exemption is not applicable in the case of DA received by the employees.

c. House Rent Allowance

This allowance is one of the important allowances which is paid to the employees to cope up with the expenses of their accommodation in case of rented accommodation. If the employee lives in his/her own houses then they are not eligible for this allowance to be exempted from tax. Deduction under section 10 (13A) can be claimed by the employee for the exemption of tax.

The deduction allowed, are on the basis of the following:
i. Actual House Rent Allowance received by the employee
ii. Actual rent should be 50% of the basic salary for employees living in metro cities
iii. For non-metro cities, the actual rent should be 40% of the basic salary
iv. Excess rent paid in a year over 10% of the annual base salary

For example, if you want to calculate the HRA for your employee who has a basic salary of Rs 100000, receives DA of Rs 10000, HRA Rs 30,000 and pays rent of Rs 30,000 and lives in a non-metro city.

Then the exemption of HRA will be the lowest of the following:
i. HRA received i.e. Rs 30,000
ii. 40% of the salary (100,000+10,000) i.e. Rs 44,000
iii. Rent paid less 10% of the basic salary {30,000- (110,000*10%)} i.e. Rs 19,000
iv. Now the HRA exemption will be Rs 19,000 and the taxable HRA will be Rs 11,000

d. Medical Allowance

Medical Allowance is paid by the employer for the treatment of family members or when prolonged treatment is required. This is again a partly exempted allowance as the amount exceeding the limit of Rs 15000 will be taxed under the provision of the Income Tax Act.

medical allowance india

e. Special Allowances

This allowance is paid to employees for duty under section 14(i). This allowance is partially taxable and does not fall within the perquisite category.

f. Children Education Allowance

This allowance is given by the employer for the education of the children of their employees. The exemption limit of children education allowance is limited to Rs 100 per month per child for a maximum of two children. Any allowance received above this is taxable under the law.

g. Hostel Expenditure Allowance

This allowance is paid to employees towards the hostel expenses of their children. Rs 300 per child per month is exempted for the maximum of two children as per the Income Tax laws. The amount exceeding this limit is taxed.

4. Non-Taxable Allowance

These are those allowance which is part of the salary paid to employees but is exempted from taxation.

a. Allowances paid to Government Employees Abroad

This allowance is paid to government employees who travel abroad for assignments or work. This allowance is paid to compensate for the expenses incurred during the foreign travel and is fully exempted from tax.

b. Allowance to UNO employees

This allowance is paid to UNO employees and is not taxed.

c. Allowances to Judges of High Court and Supreme Court

Judges of the Supreme Court and High Court are entitled to get allowances that are exempted from taxation. This allowance is also known as a sumptuary allowance.

d. Compensatory Allowance

The compensatory allowance is received by judges if the Supreme Court and High court. These allowances are exempted from taxation.

Difference between employee expense reimbursement and employee allowances

Though there seems to be confusion between allowance and reimbursement for you as an employer. The simplest definition and difference are stated below

difference between employee allowances and reimbursements

What is an Employee Allowance?

Allowance is the amount of monetary advantage that is included in the salary that you pay to your employees to cover the additional costs incurred by them and to cover the inflation, while they are employed with your company. Allowances can be covering the costs of travelling or recurring expenses that arise regularly or for services that are required and even for the extra work that your employee dos for you. This is the sum that you pay to your employees regularly to meet the expenses.

Tax implications on allowances:

Allowances are part of income and are thus categorized in three categories fully taxable allowances, partially taxable allowances and non-taxable allowances

What are Employee Reimbursements?

Reimbursements are the money that you pay back to the employee which they paid for or during official work. These are not part of a travel allowance or any other allowances but are of a specific nature. Generally, petty cash is used to pay reimbursements to employees and these are considered as business expenses and not expenses of employees, which is why these are paid back to the employee after producing the required proof of the expenses.
For example, Medical expenses reimbursement, business expenses reimbursement like business travel, education, business supplies, and tools, etc.

You might want to read: Employee expense reimbursements 101

Tax implications on reimbursements:

Reimbursements are filed under perquisites while filing an income tax return and not taxed. The taxability of reimbursements depends on your reimbursement arrangement as a company. The Indian Revenue System (IRS) has two types of plans: Accountable Plan and Non-accountable plan.

  • Accountable Plan: Under this plan, the business reimbursements made by your company is not considered as wage and thus it is not taxable
  • Non-accountable plan: Under this plan, the reimbursements made by you is considered as supplementary wage and are taxable. In these expenses which were not business, expenses are reimbursed to the employee and are thus taxed.

In Conclusion

Thus, here is the complete list of the taxable and the non-taxable allowances possible for an employee, which can be weighed and structured as a part of your employees’ salary so as to give them a maximum tax rebate. You need to consider the tax implications of all allowances and reimbursement options to figure out the best possible structure which suits the needs of your organization and then plan accordingly.

Help your employees plan their tax by digitizing their tax benefits and manage disbursements with ease.

 

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