Employees are often confused about their pay structure. They find it difficult to understand the salary components, which becomes an issue, especially during appraisal and job change. They start questioning how the allowance is calculated and why a certain amount is provided as an allowance.
What is Allowance in salary?
An allowance is an amount of money that generally is provided to employees by employers. It is a compensation package, added to the basic salary, covering specific expenses. The amount of allowances is variable mainly depending on the employer’s policies and the nature of the job.
It is provided on a recurring basis and its main purpose is to cover essential expenses like transportation, food, education, and day-to-day expenses.
Organizations plan to offer allowances in various ways like monthly, quarterly, or yearly. It may be paid directly to the employee’s salary account or organization pay through any third-party payment gateway app.
1. How to Calculate Allowances in Salary?
Calculating allowances in salary ensures various components and factors, like basic salary, CTC, net income, gross income, etc. However, A framework can easily be provided for calculating allowances by using a mathematical formula. Keep in mind that this is a simplified example and may not cover all possible scenarios.
Basic Salary(BS) = Gross PAY – Total Allowance
Total Allowance (TA)= House Rent Allowances (HRA)+ Dearness Allowances(DA) + Travel Allowances(TA) + Other Allowances (OA)
2. What are the types of allowance with examples?
According to section 17 of the Income Tax Act 1960, there are three types of allowances applicable to both private-sector and public-sector employees. Some allowances are for exemption and some are partly taxable.
- Taxable Allowance
- Non-taxable Allowance
- Partially taxable allowances
➔ Taxable Allowance
A taxable allowance is a financial benefit provided to employees as a part of the compensation packages by their employer.
With respect to section 17 of the Income Tax Act of 1960, the allowance provides employees with additional financial support for specific expenses or needs while also generating tax revenue for the government, as these allowances are subject to taxation according to applicable laws and regulations. The tax treatment of allowances can vary depending on the country’s tax laws and regulations.
In many countries, including India, the taxability of allowances is determined based on specific rules and conditions. Here are some common examples of taxable allowances:
▸ Dearness allowances
An allowance for a periodic adjustment to the salaries and pensions of employees and retirees in many countries, primarily in the public sector is known as the Dearness Allowance. It is intended to mitigate the impact of inflation and rising living costs on the real income of individuals.
DA is calculated as a percentage of the basic salary or pension and is revised periodically, often on a yearly basis, based on changes in the Consumer Price Index (CPI) or other inflation indicators.
This adjustment ensures that employees and retirees maintain their purchasing power in the face of increasing prices for essential goods and services. DA is an essential component of compensation packages for government employees and serves to keep their income aligned with the changing economic conditions.
▸ Special Allowances
Besides the HRA, Employers pay employees for the special allowance as well. This type of allowance depends on the employer’s decision. They can just pay the bonus, showing their appreciation for job quality, or pay as a specific allowance with the concept of employee job quality and their dedication.
Following are the allowances that are within the Specials allowance.
- Conveyance Allowance
Conveyance allowance, which is provided to cover transportation expenses related to the employee’s job, is generally taxable.
- Education Allowance
Educational Allowance is a type of priority given to employees for the education of their children, such as tuition fees or hostel fees, and is typically taxable and self-career upbuildment as well.
- Medical Allowance
Allowances provided for medical expenses are also included in the taxable allowance.
- Holiday Allowance
If an employee receives an allowance specifically for taking holidays or vacations, it is generally taxable.
- Overtime Allowance
Additional compensation paid to employees for working overtime or weekends is generally taxable.
- Travel Allowance
This type of allowance provides to make up the travel expenses related to work, such as daily commuting or travel between office locations, which may be taxable.
➔ Non-Taxable Allowances
Non-taxable allowances are the second type of allowance that is paid to employees by employers. It is not related to the Income Tax Act 1960.
It provides the employee’s financial support for specific expenses or needs without subjecting the allowance to income tax, helping to reduce the financial burden on employees and promoting certain activities or behaviors, such as education, housing, or transportation, that benefit both the employee and the organization.
Organisation can ensure the limitation of the nontaxable allowance and can be granted for specific purposes depending on the tax laws in a particular region or country. Here are some common examples of non-taxable allowances
▸ Uniform Allowance
Some employers provide employees with allowances to purchase or maintain uniforms required for their jobs. In many jurisdictions, these allowances are not considered taxable income.
▸ Transportation Allowance
Along with the HRA, Some employers provide transportation allowances to cover the cost of commuting to work. Depending on the country’s tax laws, these allowances may be non-taxable up to a certain limit.
▸ Disability Allowance
Disability allowances or payments made to employees due to work-related injuries or disabilities are typically non-taxable.
▸ Gifts and Awards
Non-cash gifts or awards provided by employers for special occasions (e.g., holidays or work anniversaries) may be non-taxable if they meet specific criteria.
▸ Other Non-Taxable Allowances
- Allowance that is paid to Indian employees who work for the company from outside of India.
- Allowance that is paid to the employees of the Supreme Court or High Court.
- Allowance that is provided to ex-employees of Members of UPSC
- Allowances that are paid by the UNO to its employees.
➔ Partial Taxable Amount
A “partial taxable allowance” is an allowance or payment provided by an employer to an employee that is only partially subject to taxation. This means that while a portion of the allowance is considered taxable income and must be reported on the employee’s income tax return, another portion may be tax-free or subject to special tax treatment.
Common examples of partial taxable allowances include:
▸ Education Allowance
Often employers provide the education allowances to help employees cover the costs of their children’s education. These allowances must have certain limitations so that employees can’t cross the requirement lists.
▸ Meals and Lodging Allowance
The employees can get allowances for meals and lodging in some special circumstances like when they are away on business trips. These allowances can be non-taxable if they meet specific criteria set by tax authorities.
▸ House Rent Allowance (HRA)
The act of house rent allowance(HRA) is a benefit that employees receive every month from their employers. It helps employees with their accommodation expenses. Providing HRA partially is mandatory for every organization for HRA under section 10 (13A) of the Income Tax Act 1960.
There are certain conditions as well for applying the HRA. Those are,
1. The employees who are applying for HRA must be salaried or self-employed individuals.
2. They must live in rented houses, cause HRA is not made for the person living in their own house.
3. Employees have to provide the accommodation proof to the employers.