An allowance is a financial benefit of a fixed amount of money provided by an employer to meet a particular type of expenditure over and above regular salary. Allowances are regarded as part of the salary and are taxable, except for those under exemptions under various sections of the Income Tax Act. Based on the tax structure, these allowances can be categorized into three groups – Taxable, Non-taxable and Partially taxable.
Taxable allowances are treated as a part of salary and are not exempted under any sections of Income Tax. They include –
- Dearness allowance–It is paid to public sector employees and pensioners as a cost of living adjustment to neutralize the impact of inflation and difference in cost of living for employees living in different cities and towns.
- Entertainment allowance – It is the amount of money given to an employee to make payments for the hospitality of their customers for drinks, meals, business outings, client meetings, hotels, etc. Though this allowance is taxable for all private-sector employees, government employees can, however, claim an exemption on this tax.
- Overtime allowance – This allowance is given to employees who tend to work more than the operational hours decided by the company. It can be due to meeting deadlines for the firm’s urgent assignments and project. Any Overtime Allowance received by the employees is taxable.
- City compensatory allowance – CCA is offered to employees to compensate for a relatively high cost of living in metropolitan cities. This is used to incentivize to retain employees in towns and cities where the cost of living is higher compared to employees working in other locations.
- Interim allowance – Interim allowance is a provisional allowance provided by the employer instead of final allowance.
- Project allowance–This is provided by the employer allowance to liquidate a project’s expenses and it is completely taxable.
- Tiffin/meals allowance–This taxable Meal allowance is paid for meals/refreshments/tiffin services to their employees.
- Cash allowance – Cash allowance is given for expenditure such as marriage, holiday, etc. and it is fully taxable.
- Non-practicing allowance – When a medical doctor is associated with clinics of various laboratories or hospitals, any nonpracticing allowance paid to them is taxable.
- Warden allowance–It is for any employee who is working as a warden/keeper in any institute. This allowance is considered as taxable.
- Servant allowance–It includes allowance provided to employees for employing the services of a servant, wardens, keepers, gardener, etc. such allowance is always taxable.
Partially Taxable Allowances –
Partially taxable allowances are exempted from tax to a certain limit, as specified in the income tax rules & regulations. These include –
- House Rent Allowance– This allowance is provided to the employees by a company to help them in cope with their accommodation expenses. But, if an individual doesn’t live in the rented space provided, this allowance will be fully taxable. Employees can claim as much as 50% of the basic salary for those residing in Metro cities and 40% of basic salary for people living in non-metros
- Fixed medical allowance – This allowance is paid by an employer when the employee or any of his family members require prolonged medical treatment. However, if the medical treatment expense exceeds a specified amount, then it becomes taxable.
- Special allowance includes children education allowance, children hostel allowances, etc. A special allowance is paid to an employee for the performance of a duty. This allowance does not fall within the category of a perquisite and is partially taxable
- Conveyance allowance is paid to employees for commuting to their workplace from home every day. The allowance is exempted up to Rs. 1,600 only, any amount more than that will be taxable as per the income tax act.
- Entertainment allowance has a deduction of 1/5 of salary or Rs. 5,000 whichever is less under section 16 (ii) of the income tax act.
Non Taxable Allowances–
Non-taxable allowances are a part of an individual’s salary which is fully exempted from taxes. The list of allowances that are totally non –taxable are –
- Payments to government employees posted abroad.
- Employees serving in the United Nations Organisation.
- Allowance paid to judges of Supreme Court and High Courts also called Sumptuary allowance
- Also, the Compensatory allowance paid to judges of Supreme Court and High Courts