Taxation · Salaries

Allowances and Their Taxability under Salaries for CA Inter

Updated 4 October 2026 · Fact-checked

An allowance is a fixed money amount an employer pays on top of salary for a stated purpose. Under the Income-tax Act, 2025 it is taxable salary unless a specific exemption applies. Sort each allowance as fully taxable, partly exempt (such as HRA, limited to the least of three amounts) or fully exempt, then add the taxable part.

Understand Allowances and Their Taxability

An allowance is a fixed amount of money paid to an employee, over and above basic salary, to meet some expense or condition of work. House rent, transport, children's education and city living costs are common examples. The starting rule is simple: every allowance is part of salary and is taxable.

The law then gives exemptions for some allowances. This gives you three buckets. Fully taxable: no exemption at all, for example dearness allowance, city compensatory allowance, overtime allowance, tiffin allowance, fixed medical allowance and a general special allowance. Partly exempt: exempt up to a limit, for example house rent allowance (HRA), children education allowance and hostel allowance. Exempt to the extent spent: allowances given to meet official expenses, such as travelling, daily, conveyance and helper allowance, where the exemption is only the amount actually spent for duty.

Do not mix up an allowance with a perquisite. An allowance is cash handed over to the employee, who may spend it as they like. A perquisite is a benefit or facility given in kind or at the employer's cost, such as a rent-free house or a company car. Allowances are taxed on the amount received (less any exemption). Perquisites are taxed on a valuation under the valuation rules.

The regime matters. Most personal exemptions, including HRA and children education allowance, are available only if the employee is under the old regime. Under the default new regime, these are not available, so such allowances are taxed in full. A few allowances meant for official duty, and the transport allowance for certain disabled employees, remain exempt. Always read the question for the regime. If it is silent, use the one the question implies, and state your assumption.

For numbers: the exempt limits for children education and hostel allowance, and the list of cities that qualify for the higher HRA percentage, come from the rules made under the Income-tax Act, 2025. Use the figures given in the question or in your current ICAI study material for tax year 2026-27.

Key rules to remember

HRA exempt amount (old regime): Exempt HRA = Least of: (a) actual HRA received; (b) rent paid − 10% of salary; (c) 50% of salary if the house is in a specified metro city, otherwise 40% of salary; Work out each figure for the same period (full year or the months of rent paid). Salary for this purpose means basic salary plus dearness allowance that forms part of retirement benefits, plus commission based as a fixed percentage of turnover. Do not add other allowances.
Taxable HRA: Taxable HRA = HRA received − Exempt HRA; If no rent is paid, nothing is exempt and the whole HRA is taxable. If (b) is negative, the exemption is nil.
Allowance for official duty: Exempt = Lower of amount received and amount actually spent for duty; Taxable = excess, if any; Applies to travelling, daily, conveyance, helper, research and uniform allowances. Keep proof of actual expenditure in mind: the question must give the amount spent.
Children education and hostel allowance: Exempt = Limit per child per month × number of children (maximum two children) × months, restricted to the amount received; Old regime only. The limit per child per month is stated in the question or ICAI material for the year. Hostel allowance has its own separate limit and the same two-child cap per employee.
Transport allowance: Ordinary employee: fully taxable. Certain disabled employees: exempt up to the monthly limit in the rules; The disabled-employee exemption is for specified disabilities and is also available under the new regime. Transport allowance given to meet official conveyance cost is covered by the official duty rule instead.
Fully taxable allowances: Dearness, city compensatory, overtime, tiffin, fixed medical, general special allowance = 100% taxable; Add the full amount received to salary income.

How to solve Allowances and Their Taxability questions

Use this order for any question that lists several allowances. It keeps your working clean and earns step marks.

1Note the regime. If the new regime applies, personal exemptions such as HRA and children education allowance are not available, so those allowances are taxed in full.
2List every allowance with the annual amount received. Convert monthly figures to annual and watch for changes during the year.
3Classify each allowance: fully taxable, partly exempt (HRA, children education, hostel), or exempt to the extent spent on official duty.
4For HRA, find salary (basic + DA that forms part of retirement benefits + commission on turnover), months of rent paid and the city. Compute the three amounts and take the least.
5Apply the limit or the actual-spend test to the other allowances and find the taxable part of each.
6Add the taxable parts to basic salary, taxable perquisites and other salary items.
7Write a short line for each allowance showing amount received, exempt part and taxable part. Then give the final total.

Quickest way: Three-bucket sort and the HRA least-of-three

When to use it: Use it when the question has a long list of allowances and you have limited time, especially in the MCQ section.

MCQ: if the allowance is a plain cash allowance with no official-duty link (special, city compensatory, overtime, tiffin), the answer is fully taxable. Eliminate options that exempt it.
MCQ: for HRA, first check whether any rent is paid. No rent means the whole HRA is taxable. Then compute the three amounts and pick the smallest.
MCQ: if the option shows an exemption larger than the allowance received, it is wrong. Exemption can never exceed the amount received.
Written: draw a three-column mini-table in your answer (Received, Exempt, Taxable). The examiner can award step marks even if one figure is wrong.
Written: show the three HRA limbs as (a), (b) and (c) on separate lines, then state which is the least. Never write only the final figure.
Written: state the regime assumption in one line at the start.

Common mistakes in Allowances and Their Taxability

Taking salary for HRA as total of all pay components, including special allowance and bonus.
The word salary feels like gross pay.
Fix: For HRA, salary is only basic, DA that forms part of retirement benefits, and commission fixed as a percentage of turnover. Leave out all other allowances, bonus and perquisites.
Using 50% for any city and 40% for small towns without checking the specified city list.
Students memorise metro as big city.
Fix: Use 50% only for the cities specified in the rules or in the question. Read the city carefully and use 40% for every other place.
Claiming HRA, children education or hostel allowance exemption under the new regime.
Students forget the regime check before starting.
Fix: Look at the regime first. Under the new regime these allowances are fully taxable.
Treating a perquisite as an allowance, or the reverse, for example taxing a rent-free house as HRA.
Both relate to housing and look similar.
Fix: Ask whether cash was paid (allowance) or a benefit provided (perquisite). Cash goes through exemption rules here; a facility goes through valuation rules.
Applying the child limit to every child instead of capping the count at two children per employee.
Students ignore the two-child cap.
Fix: Count a maximum of two children per employee for children education allowance, and separately a maximum of two children per employee for hostel allowance.
Giving exemption for official-duty allowances without comparing with the amount actually spent.
Students assume the full allowance is exempt because it is for duty.
Fix: Exempt amount is the lower of received and spent. Tax the excess.

Worked examples

Example 1

Mr Arun, an employee in Delhi (a metro city), is under the old regime. He gets basic salary ₹25,000 per month, dearness allowance ₹5,000 per month (forms part of retirement benefits) and HRA ₹15,000 per month. He pays rent of ₹14,000 per month for all 12 months. Compute the taxable HRA for the year.

Show the solution

Salary for HRA = basic + DA = ₹25,000 + ₹5,000 = ₹30,000 per month. Annual salary = ₹30,000 × 12 = ₹3,60,000.
HRA received = ₹15,000 × 12 = ₹1,80,000. This is limb (a).
Rent paid = ₹14,000 × 12 = ₹1,68,000. Less 10% of salary = ₹36,000. Limb (b) = ₹1,68,000 − ₹36,000 = ₹1,32,000.
Delhi is a metro city, so 50% of salary = ₹1,80,000. This is limb (c).
Exempt HRA = least of ₹1,80,000, ₹1,32,000 and ₹1,80,000 = ₹1,32,000.
Taxable HRA = ₹1,80,000 − ₹1,32,000 = ₹48,000.

Answer: Exempt HRA is ₹1,32,000 and taxable HRA is ₹48,000, which is added to salary income.

Example 2

Ms Rita is under the old regime. During the year she receives: transport allowance ₹2,000 per month (she is not disabled); children education allowance ₹3,000 per month for two children; a travelling allowance of ₹50,000 for official tours, of which she spent ₹42,000 on the tours; and a special allowance of ₹5,000 per month, not linked to any duty. Assume the exempt limit for children education allowance is ₹100 per child per month. Compute the taxable amount of these allowances.

Show the solution

Transport allowance: not disabled and not for official duty, so fully taxable. ₹2,000 × 12 = ₹24,000.
Children education allowance: received ₹3,000 × 12 = ₹36,000. Exempt = ₹100 × 2 children × 12 months = ₹2,400. Taxable = ₹36,000 − ₹2,400 = ₹33,600.
Travelling allowance for official tours: exempt is the lower of ₹50,000 received and ₹42,000 spent = ₹42,000. Taxable = ₹50,000 − ₹42,000 = ₹8,000.
Special allowance: fully taxable. ₹5,000 × 12 = ₹60,000.
Total taxable = ₹24,000 + ₹33,600 + ₹8,000 + ₹60,000 = ₹1,25,600.

Answer: The taxable amount of the allowances is ₹1,25,600.

Exam tips

Write the regime in the first line of your answer. It decides whether HRA and children education exemptions are even available.
Show the HRA three limbs separately and name the least. Step marks sit on each limb.
In MCQs, check the city, the months of rent paid and what is included in salary before calculating. The traps are usually here.
If a question gives the exempt limit for children education or hostel allowance, use it as given. Do not substitute a limit from memory.
Be ready to separate allowance from perquisite in short theory questions, with one example of each.

Practice questions from Salaries

Allowances and Their Taxability in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CS ExecutiveAllowances and Their Taxability

Allowances and Their Taxability: frequently asked questions

What is the difference between an allowance and a perquisite?

An allowance is a fixed cash amount paid to the employee, who can spend it freely. A perquisite is a benefit or facility given by the employer, such as a rent-free house or car. An allowance is taxed on the amount received less any exemption, while a perquisite is taxed on its valuation.

How do I calculate HRA exemption under the Income-tax Act, 2025?

Take the least of three amounts: actual HRA received, rent paid less 10% of salary, and 50% or 40% of salary depending on the city. The rest of the HRA is taxable. This is available only under the old regime, and only if the employee actually pays rent.

Is HRA exempt under the new tax regime?

No. The HRA exemption is available only under the old regime. Under the new regime the full HRA is added to salary income.

Which allowances are fully taxable?

Dearness allowance, city compensatory allowance, overtime allowance, tiffin allowance, fixed medical allowance and a general special allowance are fully taxable. Transport allowance for an ordinary employee is also fully taxable. Always check whether the question links an allowance to official duty.