What are the different types of allowances and how they are taxed under income tax in India?

The different types of allowances are :

Different types of allowances and their taxability

Dearness allowance :

Dearness allowance is the most popular allowance being given to employees these days. It is determined on the basis of rising prices of com­modities in general. The amount is taxable. However, it is not included in salary for pensionary benefits. If the terms of employment so provide, it may be included in salary for pension or provident fund contribution too. In that case for all practical pur­poses generally basic salary will include dearness allowance. Sometimes the dearness allowance is converted into dearness pay which will then certainly be included for pen­sionary benefits.

City compensatory allowance :

City compensatory allowance is paid generally to compensate higher cost of living in certain big cities. It is also taxable.

House rent allowance [10(13A) and rule 2A] :

This sort of relief is granted by the employer to the employee in order to compensate him in the matter of higher rent prevailing in big cities. The allowance is excluded in computing total income within the limit prescribed by rule 2A. In other words, the excess of house rent allowance received over the excludible limit is to be included.

The excludible limit will be least of the following:

(a) The actual amount of such allowance received by the assessee in respect of the relevant period; or

(b) Excess of actual rent paid by assessee in respect of residential accommodation occupied by him over one-tenth of the amount of salary due to the assessee in respect of the relevant period; or

(c)  An amount equal to one-half of the amount of salary due to the assessee in respect of the relevant period where such accommodation is situated Bom­bay, Calcutta, Delhi or Madras.

and another where such accommodation is situated at any other place, two-fifths of the salary due to the assessee in respect of the relevant period is the excludable limit.

Foreign allowance [10(7)] :

This allowance is paid by the Government of India to its citizen employees for being posted outside the country and it is not included in total income. It is completely tax-free.

Travelling allowance :

Travelling allowance paid to the employees and spent or them on official duties is not taxed. If however some allowance remains unspent, it is put to tax.

Conveyance allowance :

This is the amount given by the employer for meeting conveyance expenses of the employee. This is not taxed on the general presumption that the amount must have been spent by the employee on conveyance used for official purposes. In case there remains some unspent amount, it is taxed. It is important to note that where the conveyance is owned by the employee himself, the allowance is neither taxed nor the assessee allowed any deduction on account of the wear and tear of the conveyance used in discharge of his official duties.

Specific allowance :

Any allowance given to the employee for meeting specific expenses is not taxed and does not form part of his total income, provided the amount has been spent.