In today’s world, the needs of an individual are constantly and rapidly increasing. For a better standard of life, better facilities are also required. A human’s needs are never fully satisfied and an individual’s salary is never fully sufficient. In order to achieve good output and earn higher profits, it is necessary for a company to look after its employees and place them in a good position. Just the salary is not enough for the employees to fulfill their daily expenses. The employers offer the employees with various benefit packages or a variety of perks depending upon the nature of the company. Therefore the companies provide its employees with some additional benefits along with the salary also known as allowances for their convenience. These allowances are given to the employees in exchange for the services rendered by them.
Meaning of Allowance
Allowance is a fixed amount of financial or monetary benefit offered by the employer to its employee to meet the required expenditures over and above the basic salary. Allowances are pre-determined and are given irrespective of the actual expenditure.
For example – The company provides the employees with some additional benefits like overtime allowance if they work for extra working hours. The company can also give a travel allowance if the employer is travelling from home to the workplace. There are many such examples for which allowances can be provided to employers.
Companies provide the allowances as a part of the salary of the employer and are taxable except for those which are specifically exempted from the Income Tax Act.
Types of Allowances
Depending upon the application of tax treatment, the allowances can be bifurcated into three segments:-
- Taxable Allowances
- Non – Taxable Allowances
- Partially – Taxable Allowances
1. Taxable Allowances
Allowances which are treated as a part of the salary and which are not either fully or partially exempted under any sections or provisions of the Income Tax Act are called taxable allowances.
There are many different types of taxable allowances. Some of the major ones are as follows:-
i. Dearness Allowance
To neutralize the impact of inflation, an allowance is given to the public sector and government employees and pensioners called a dearness allowance. Dearness allowance is fully taxable with salary and according to the Income Tax Act it becomes mandatory to declare the tax liability for dearness allowance along with the salary in the filed return.
Due to constant changes in prices in the market, it becomes necessary for the government to protect the employees from the impact of inflation. It thus aids the employees in adjusting the cost of living and copes up with the increasing prices.
The dearness allowance is calculated on the basis of the location of the employee, thus it varies according to the impact of inflation in every location. The dearness allowance varies from employee to employee depending upon their location – urban, semi-urban and rural sector.
ii. Entertainment Allowance
Entertainment allowance is the allowance paid to the employees for the purpose of hospitality services such as hotel, client meetings, drinks, business outings and many more. Entertainment allowances are fully taxable for private-sector employees. According to section 16(ii), the government employees can claim an exemption on this tax up to certain limit as follows –
- 20% of gross salary (excluding all other allowance, perks and benefits),
- Actual entertainment allowance and
- Rs 5,000.
iii. Overtime Allowance
The overtime allowance is given to those employees who work more than the working hours which are agreed in the contract between the employer and the employee. The employees may work for extra hours if they are assigned with urgent tasks or project deadlines. The overtime allowance received by the employee is fully taxable.
iv. City Compensatory Allowance
The city compensatory allowance is given by the company to the employees to afford the high cost of living in major or metropolitan cities where the standard of living is higher than the national average. This allowance is also paid to retain the employees in the towns and cities where the company is situated rather than employees working in other locations.
This allowance is calculated as per the discretion of the employee and is not related to the regular pay. According to section 10(14) of the Income Tax Act, this allowance is completely taxable and is added to the income of the employee for taxation purposes. There is no maximum or minimum limit on this allowance.
v. Cash Allowance
Cash allowance is paid by the employer to the employee to cover the incidentals and other expenditure like marriage allowances, holiday allowances, etc. Cash allowances are fully taxable.
2. Non – Taxable Allowances
The allowances which are paid to the employees by employers forming a part of the salary but are fully exempted from taxes are called non – taxable allowances. Such allowances are mostly paid to the government employees.
The lists of non – taxable allowances are as follows:-
- Allowances paid by the governments to its employees located abroad.
- Allowances paid to the UNO employees.
- Allowances paid to the judges of Supreme Court and High Court. These are also called sumptuary allowances.
- Allowances paid to the Retired Chairman or Members of UPSC.
- Compensatory allowances paid to the judges of Supreme Court and High Court.
3. Partially Taxable Allowances
Allowances that can be exempted from tax up to a certain limit as per mentioned in the Income Tax Act are called as partially taxable allowances. Only some part of these allowances is taxable.
Some of the partially taxable allowances are as follows:-
i. House Rent Allowances
House rent allowance is the allowance that is provided by the company to the employee for the purpose of accommodation. This allowance is applicable only if the employee is living in a rented house. If the employee is living in her own house i.e. without paying the rent then this allowance is fully taxable. This allowance helps the employee with tax benefits towards the payment of accommodation. The amount of the allowance to be paid totally depends upon the employer and various criteria like the salary and city of residence.
According to section 10(13A), the employee can claim an exemption on the house rent to the extent of whichever is least among the following-
- The actual rent that is paid should be less than 10% of the basic salary.
- If the employee is staying in a metro city then 50% of the basic salary and 40% if the employee is living in a non-metro city.
- The actual amount received as the House Rent Allowance from the employer.
ii. Conveyance Allowance
The Conveyance Allowance also known as the Transport Allowance is paid to the employees to compensate the travel cost incurred while commuting from the residence to the workplace and vice–versa.
Conveyance allowance is only given to the employee if there is no transportation facility provided by the employer. If the employer provides the employee with a transport facility then there is no need for a conveyance allowance.
According to section 10(14)(ii) of the Income Tax Act and Rule 2BB of Income Tax Rules, the Conveyance allowance is given an exemption of up to Rs.19,200 per annum or Rs.1,600 per month.
Special Exemption Cases-
- For the blind or orthopedically handicapped individuals, the exemption limit is Rs.3200 per month.
- UPSC members do not have to pay tax on conveyance allowance as per Section 10(45) of the Income Tax Act.
iii. Special Allowances
According to section 14(i), allowances that are paid to the employee for the performance of duty are called as special allowances. Examples of such allowance are the children’s education allowance or the children hostel allowance wherein the amount is paid by the employer for the education or for the hostel expenses of the employee’s children. In case of children education allowance, the exemption is available to the extent of Rupees 100 per month per child for maximum of 2 children and Rs 300 per month per child for a maximum of 2 children in case of the children hostel allowance. If the amount exceeds the limit in both the allowances then it is taxable.
iv. Special Compensatory Allowance (Hilly Areas)
The special allowance is paid to the employees living or working in hilly areas or at high altitudes. The amount exempted under income tax depends on the location and other factors. The exemption varies from Rs. 300 per month to Rs. 7000 per month. For example, in the case of employees in the Siachen area of Jammu and Kashmir, exemption of Rs. 7,000/- is available.
v. Underground Allowance
Underground allowance is paid to the employee working in an uncongenial, unnatural climate in the underground. Exemption from this allowance is available to the extent of Rs. 800 per month. Any amount received in excess of the limit prescribed is chargeable under the applicable income tax slab.
Thus these are the different types of allowances provided to the employees by the employers. The employees are an asset to the company so it ensures that the employees work in a proficient manner. If one has to reduce his tax liability he should consider the salary structure and adjust the allowances accordingly.
This Article is Authored by Rutuja Dhotre, 4th Year BA.LLB Student at ILS Law College, Pune