What is Special Allowance: Taxation, Calculation and Exemption Limit
A special allowance is a sum of money provided by an organization to its employees for various reasons and objectives. This fixed, additional payment is common across all types of business entities, from large corporations to sole proprietorships.
These allowances are typically based on an employee's basic salary. Payments made in addition to the salary can have both tax-exempt and taxable components, depending on the purpose of the allowance.
Allowances like LTA (Leave Travel Allowance) and HRA (House Rent Allowance) can vary significantly based on factors such as the employee's position, performance, the organization's financial health, and existing employee benefit programs.
In this blog, we will explore what special allowances are, how they are taxed and exempted under both old and new tax regimes, the different categories of special allowances, and provide an example to show how these allowances are calculated in a salary.
What is a Special Allowance?
Special allowances differ widely across companies. Some organizations provide these allowances as a 'bonus' to reward exceptional work quality, while others base them on the principle of 'employment of profit,' as detailed in the Income Tax Act of 1962.
When an allowance is given in recognition of outstanding performance, it is often tax-exempt up to the maximum incurred expenses.
In some cases, companies include special allowances in salary slips. After covering all other components like conveyance, dearness allowance, LTA, and HRA, any remaining amount is classified as a special allowance. This amount does not fall under any other overheads. Essentially, once an employee's CTC (Cost to Company) is calculated and all sums are accounted for, the leftover amount is considered a special allowance.
Several legal aspects govern these grants:
- Any stipend or advance set aside by an employer for a specific expense is exempt from Income Tax under Section 17(2) of the IT Act, 1961, provided it is paid during the employment period when the employee is active in their duties. This also highlights the distinction between an allowance and a perquisite.
- Companies may compensate high-achieving employees with better salaries, stock options, and other benefits. If desired, the employer can also provide allowances to help their valued employees maintain their standard of living. In these cases, no Income Tax is levied on the allowances paid.
Allowances and Taxation Systems
Only those allowances or grants that are not explicitly mentioned under any exemptions in the IT Act are taxable. Most exemptions are covered under Section 10(14) of the IT Act, 1961.
Certain conditions allow specific allowances to be non-taxable under the following Income Tax Sections:
- Exemptions apply only if an allowance is not classified as a perquisite, which is a distinction that applies solely to permanent employees.
- Advances are exempt only when paid exclusively and entirely for superior office performance and occupying an office of profit.
- Personal or extraordinary payments are not tax-exempt.
- There is no legal upper limit on allowances.
Specific tax laws apply to certain scenarios:
- No tax is levied on advances or payments to the Honorable Justices of the High Courts and the Supreme Court.
- If a company's special allowance includes HRA, partial tax exemption is available under Section 10(13A).
- Other allowances, such as city compensatory allowance, are never exempt from taxation.
- Dearness Allowance (DA) laws vary as different cities have different living costs.
Special Allowance and its Categories
There are various types of special advances and allowances, classified as either personal or official. All allowances must be paid monthly and are taxed according to their respective Income Tax Act Sections:
| Personal Allowance Category | Exemption in Old Tax Regime | Exemption in New Tax Regime |
| Children's Education Allowance | Up to ₹100/month per child (for two children); any amount over this is taxable | New tax regime doesn't provide an exemption, the entire income is taxable |
| Underground Allowance | Up to ₹800/month for those working in underground mines; any amount over this is taxable | New tax regime doesn't provide an exemption, the entire income is taxable |
| Hostel Allowance | Up to ₹300/month per child (for two children); any amount over this is taxable | New tax regime doesn't provide an exemption, the entire income is taxable |
| Tribal Area Allowance | Up to ₹200/month for those living in certain hilly or scheduled areas; any amount over this is taxable | New tax regime doesn't provide an exemption, the entire income is taxable |
Transport Allowance (commuting between residence and place of duty) | Up to ₹1600/month; Up to ₹3200/month for handicapped employees | Only actual expenses are exempt; Up to ₹3200/month for handicapped employees |
| Island Duty Allowance | Up to ₹3250/month for armed forces in Lakshadweep and Andaman & Nicobar Islands | New tax regime doesn't provide an exemption, the entire income is taxable |
| Outstation Allowance | 70% of the amount received is exempt for rail, water, and roadway employees | New tax regime doesn't provide an exemption, the entire income is taxable |
| Travelling Allowance | Actual travel expenses are tax-free | Actual travel expenses are tax-free |
| Daily Allowance | Actual daily expenses during official tours are tax-free | Actual daily expenses during official duty are tax-free |
| Research/Academic Allowance | Actual expenses for research and training are tax-free | New tax regime doesn't provide an exemption, the entire income is taxable |
| Conveyance Allowance | Actual conveyance expenses for work are tax-free | Actual conveyance expenses for work are tax-free |
| Uniform Allowance | Actual expenses for buying and maintaining a uniform are tax-free | New tax regime doesn't provide an exemption, the entire income is taxable |
| Helper Allowance | Actual expenses for hiring help for work are tax-free | New tax regime doesn't provide an exemption, the entire income is taxable |
New Provident Fund Regulations for Special Allowance
The Supreme Court has revised the rules regarding Provident Funds (PF) in India. Employers must now consider employees' basic pay and special allowance as a single unit for PF contributions. This change, while reducing the monthly take-home salary, ensures a larger retirement fund by the end of the service period, which is particularly beneficial given the limited social security provisions in the private sector in India.
Special Allowance Calculation in Salary
The calculation of special allowances in salary varies based on gross income and company policies. Here's a special allowance example to illustrate this calculation.
Aman's basic salary is ₹62,000. He receives a transport allowance of ₹1600 per month. Since the maximum exemption for transport allowance is ₹1600/month, it is fully exempt from tax.
Taxable amount for Aman:
- Basic salary: ₹62,000 per month
- Taxation on transport allowance: ₹0
Conclusion
Special allowances are an essential part of the compensation provided by employers, supplementing the basic salary. The taxability of these allowances depends on specific conditions.
According to income tax regulations, special compensatory allowance exemptions are available under various scenarios. Therefore, understanding the tax implications is crucial for compliance with income tax laws.
FAQs
What is special allowance in salary?
Special allowances are additional fixed amounts added to an employee's basic salary for various purposes, with portions that can be tax-exempt or taxable. These allowances vary based on the employee's role, performance, and the company's financial health. Specific conditions determine the tax exemptions applicable to these allowances.
What are the special allowances under section 10(14)?
Under Section 10(14), certain allowances are partially tax-exempt. For instance, the education allowance allows up to ₹100 per month per child to be tax-free. Additionally, a hostel allowance for children's hostel fees is tax-free up to ₹300 per month per child.
Is special allowance counted in gratuity?
When calculating gratuity, only the Basic salary and Dearness Allowance (DA) are included. Other components, such as special allowances, are not considered in the gratuity calculation.
Can special allowance be higher than basic salary?
Typically, the special allowance is lower than the basic salary.
Can I claim an exemption on special allowance under the new regime?
Under the new tax regime, most special allowance exemptions have been eliminated, including those for HRA, LTA, and Section 10(14) allowances. However, certain exemptions under Section 10, such as for voluntary retirement, gratuity, and leave encashment, are still available.