Taxable, Non-taxable and Partially Taxable elements of salary

Taxable, partial taxable, non-taxable elements

As per the Payroll Processing in India, in addition to the basic salary, there are various other salary components such as taxable benefits offered by employers to employees. Moreover, these different components have different tax implications.

Under the IT Act of 1961 in Payroll Processing, taxable benefits can be broadly classified into two broad categories – recurring and ad hoc. Allowances and perquisites are part of these categories.  An allowance is usually the money paid to the employees for the expenses incurred by them as part of their work. Perquisites, on the other hand, are various other facilities provided by the employer to its employees.

Some allowances that come under ‘salaries’ are fully taxable, while others are partly taxable or fully exempt from tax liability. Periodically, companies also offer perks to their employees that may or may not have tax liabilities. Here is an attempt to understand the allowances or benefits which can be classified into three categories – fully taxable, partly taxable and tax-exempt.

Recommended Read: Payroll processing in India- A complete step by step guideline

Ad Hoc Components:

Adhoc components are salary components that are added to an employee for a given payroll month and are typically not paid as regular monthly components. Examples are – Joining bonus, Performance Bonus, Reimbursements, Leave Encashment at the end of a year, Penalty for late arrival etc.

Recurring Components:

Recurring Components are the fixed salary components irrespective of the performance of the employees like basic salary, HRA, DA etc.

Fully Taxable Components:

Basic

This is the base/first level of salary before making any deductions or additions. Most of the other components of salary are calculated as a percentage of basic. Basic salary is a fixed amount paid to employees by their employers in return for the work performed or the performance of professional duties by the former. Basic salary, therefore, does not include bonuses, benefits, or any other compensation from employers. Basic salary is always taxable and should not be more than 40% of the cost to the company. However, it should also not be kept too low since it will then result in a reduction in the other constituents of the salary.

Medical Allowance

Any allowance provided by the employer to meet the medical expenses of employees is fully taxable. Medical allowance is a fixed part of an employee’s monthly salary structure that gets paid irrespective of actual medical expenditure.

Conveyance Allowance

Also known as transport allowance, this is the allowance provided for commuting to and from work. It is usually provided when the company does not provide transport facilities like cabs or buses. This is completely taxable for the employee. Exemption from allowance is available to the extent of Rs. 1600 per month. However, in case of blind, deaf, dumb and handicapped employees the exemption limit is Rs. 3200. Any amount received in addition to the above limit is taxable.

Dearness Allowance

Dearness Allowance or DA is the allowance given by certain employers to their employees to compensate for an increase in the cost of living. The purpose of this allowance is to reduce the impact of rising inflation. It is usually paid in the form of a fixed percentage of basic salary. As per the Income Tax Act, the entire amount of DA received is taxable and has to be declared at the time of filing income tax returns. In October 2019, the DA of central government employees and pensioners was increased to 17% from the earlier 12% of basic salary.

D.A. Calculation for Central Government employees:

Dearness Allowance % = [Average of AICPI (Base Year 2001=100) for the past 12 months -115.76]/115.76*100

Here, AICPI means All India Consumer Price Index

D.A. Calculation for Central public sector employees:

Dearness Allowance % = [(Average of AICPI (Base Year 2001=100) for the past 3 months -126.33]/126.33*100

It is not mandatory for private sector companies to provide D.A to its employees. However, every government employee irrespective of his position or rank is entitled for D.A.

City Compensatory Allowance

CCA or City Compensatory Allowance is offered by companies to their employees to help them bear the high cost of living in metropolitan areas or large cities like Mumbai and Delhi.

Project Allowance

It is the type of allowance paid by the employer to the employees who are occupied with a particular project to make up for the costs caused due to their engagement in the project. Project allowance is typically a temporary allowance and completely taxable for the employees.

Overtime Allowance

As per the Indian Payroll Management, the overtime allowance is remunerated to the employees who work in the office past the ordinary working hours as mentioned in their KRA (Key Responsibility Area) contract.  Any overtime allowance provided by employers to employees is fully taxable.

Meal Allowance

The name already suggests the meaning of meal allowance. It is paid for the food requirements of the employees. It tends to be utilized for refreshments/meals/ tiffin services by the employees. As per the Indian Payroll Process, this allowance is fully taxable.

Partially Taxable Components:

House Rent Allowance (HRA)

House Rent Allowance is partially exempt from tax in Indian Payroll Processing. However, this exemption is applicable only for employees who live in rented accommodation. It becomes fully taxable if the employee resides in his/her own house. As per Section 10(13A) of the Income Tax Act, the exemption can be claimed by employees on house rent allowance (HRA) provided:

  • Actual HRA is received by the employee from the employer
  • Rent paid less 10% of (Basic +DA)
  • 40% of the basic salary for non-metros and 50% of basic salary for metro cities.

Leave Travel Allowance (LTA)

Leave travel allowance is the tax exemption provided on the amount incurred on the employee’s travel for a holiday with family. The employer decides the amount to be paid as LTA. This exemption comes with certain conditions. To begin with, it can be claimed only on the actual travel costs and not on hotel accommodation, local conveyance or other holiday-related costs. Only domestic travel is covered for exemption and is available for only two such holidays in a 4-year block.

Children Education Allowance

Children Education Allowance is the amount given by the employer for the educational expense of the children of the employees. Education allowance for children is tax-exempt up to Rs.100/- per month, which is Rs.1200/- per year. This exemption can be claimed for only two children. Hence the maximum that can be claimed is Rs.2400/- per year.

Hostel Expenditure Allowance

This is the allowance given by the employer for meeting the hostel accommodation expenses of the employee’s children, a maximum of Rs.300/- per month per child can be claimed as an exemption. This allowance is also limited to two children of the employee, limiting the tax-exempted amount to Rs.7200/- per year.

Non-Taxable/ Fully Tax-Exempt Components

In addition to the above-mentioned completely taxable or partially taxable allowances, there are certain other allowances that are fully exempt from tax. These allowances are usually paid to government employees. Examples of these allowances are:

Medical Insurance Premium

If the premium for medical insurance for the employee or his family members is borne by the company it is treated as a tax-free perquisite in the hands of the employee.

Phone and Internet bills

Reimbursement of telephone and Internet bills is tax-exempt. Though there is no set limit, it is set at the company’s discretion for reasonable usage. Bills have to be provided by the employee to claim this tax benefit.

Meal Coupons

Meal coupons like Sodexo are a popular tax saving perquisite offered by most employers in Indian Payroll Processing. These are tax-exempt, for a limit set at Rs.50 per meal. Assuming 22 working days and two meals per day during office hours, an amount of Rs.2200 per month is tax-free in the hands of the employee.

Books, periodicals, newspapers, and journals

Subscriptions to books, journals etc. which the employees may use to further their skills are also a tax-free perk that can be offered by the employer, provided the actual bills are submitted. Again, the limit here is set on the employer’s discretion.

Gadgets

Tablets, laptops, computers etc. provided by the company are considered as tax-free perks. They can be used for both professional and personal purposes.

Recreational and medical facilities

If the company provides medical facilities such as doctor check-ups then they are considered as tax-free. Similarly, membership to sports or health clubs or such facilities provided at the workplace are also fully exempt from income tax.

Gifts in kind

Gifts in kind, up to a maximum value of Rs.5000/- per year are not taxable in the hands of the employee.

Other Non-Taxable Allowances:

  • Allowances paid by the government to its employees located outside India
  • Allowances paid to the judges of Supreme Court and High Court
  • Allowances to Retired Chairman or Members of UPSC
  • Allowances paid by the UNO to its employees