Allowances under Income Tax Act: Meaning, Types, and Fully Taxable Allowances Explained
If you’re a salaried individual in India, chances are that your monthly pay includes more than just a basic salary. Among the major components is something called “allowance” — a term we see in salary slips, yet don’t fully understand from a taxation point of view.
In this article, we’ll break down the meaning of allowances, how many kinds exist, and go into detail about allowances that are fully taxable under the Income Tax Act, 1961. Whether you’re a student, a taxpayer, or a financial professional, this guide is for you.
What is an Allowance?
An allowance is a fixed amount of money paid regularly by an employer to an employee to cover specific expenses related to the employee’s job responsibilities or personal circumstances. It is over and above the basic salary and is either taxable, partially exempt, or fully exempt depending on its type.
Examples: House Rent Allowance (HRA), Dearness Allowance (DA), Transport Allowance, etc.
These are governed under Section 17(1) of the Income Tax Act, which includes all monetary payments from the employer to the employee as part of “salary.”
Types of Allowances under Income Tax Law
Allowances under the Income Tax Act are broadly categorized into three types:
1. Fully Taxable Allowances
These allowances are 100% taxable and are added to your gross income under the head “Salaries.”
2. Partially Exempt Allowances
These allowances have a specific limit of exemption, and anything above that limit is taxable. Examples include House Rent Allowance (HRA) and Transport Allowance for disabled employees.
3. Fully Exempt Allowances
These are completely tax-free. Examples include foreign allowance for government employees posted abroad, and allowances received by UNO employees.
In this article, our main focus is on the fully taxable allowances.
Fully Taxable Allowances under Income Tax Act
Let’s now dive into the major allowances that are fully taxable, regardless of the nature of the job or the income level.
1. Dearness Allowance (DA)
- Purpose: To offset the effect of inflation.
- Applicability: Central and state government employees, public sector, and sometimes private sector.
- Taxability: 100% taxable. It is also included in salary for calculating retirement benefits like pension and gratuity.
2. Overtime Allowance
- Purpose: Compensation for extra working hours beyond normal duty.
- Taxability: Fully taxable, even if paid on an hourly basis or irregularly.
3. City Compensatory Allowance (CCA)
- Purpose: Given to employees posted in metro cities to cope with higher living costs.
- Taxability: Entire amount is taxable, regardless of city.
4. Lunch / Tiffin / Meal Allowance
- Purpose: To cover daily meals or food expenses at the workplace.
- Taxability: Entire amount is taxable unless it is provided in kind (like free food at workplace up to ₹50 per meal).
5. Servant Allowance
- Purpose: To hire domestic help.
- Taxability: Fully taxable in the hands of the employee.
6. Project Allowance
- Purpose: Paid to employees working on specific projects.
- Taxability: Entire project allowance is considered part of taxable income.
7. Warden / Proctor Allowance
- Purpose: Given to academic staff performing extra duties like hostel supervision.
- Taxability: Fully taxable as part of salary income.
8. Non-Practicing Allowance (NPA)
- Purpose: Medical professionals in government jobs who are not allowed to practice privately receive this.
- Taxability: Fully taxable and included for retirement benefit calculations.
9. Other Fully Taxable Allowances
These include:
- Holiday Allowance
- Entertainment Allowance (for private employees)
- Cash Allowance
- Marriage Allowance
- Family Allowance
All these fall under the fully taxable category.
Legal Provision under the Income Tax Act
All these allowances are covered under Section 17(1) of the Income Tax Act, 1961. This section defines “salary” to include wages, annuity or pension, gratuity, fees, commissions, perquisites or profits in lieu of salary, advance salary, and allowances.
There is no separate section for taxable allowances — they are treated as part of salary and taxed under the respective income slab rates applicable to the individual.
Real-Life Example
Let’s consider Mr. Ankit, a software engineer in Bengaluru. He receives the following monthly allowances:
| Allowance | Amount (₹) | Taxability |
|---|---|---|
| Dearness Allowance | 10,000 | Fully taxable |
| Lunch Allowance | 2,000 | Fully taxable |
| House Rent Allowance | 15,000 | Partially exempt |
| City Compensatory Allowance | 5,000 | Fully taxable |
Only the HRA may qualify for exemption under Section 10(13A), while all other allowances are fully taxable and added to his gross income.
Why It’s Important to Know This?
Understanding which allowances are taxable helps you:
- Avoid underreporting of income
- Estimate your actual tax liability
- Make better salary negotiations
- Claim deductions only where applicable
Key Takeaways
- Allowances are monetary benefits given by employers to employees over and above salary.
- There are three types: fully taxable, partially exempt, and fully exempt.
- Some of the most common fully taxable allowances include:
- Dearness Allowance
- City Compensatory Allowance
- Overtime Allowance
- Meal Allowance
- Servant and Project Allowance
Mnemonic :
Mnemonic to Remember Fully Taxable Allowances: “DOLPHINS Can’t Hide”
| Letter | Allowance | Taxability |
|---|---|---|
| D | Dearness Allowance | Full |
| O | Overtime Allowance | Full |
| L | Lunch / Meal Allowance | Full |
| P | Project Allowance | Full |
| H | Holiday / Warden Allowance | Full |
| I | Incentive / Entertainment | Full |
| N | Non-Practicing Allowance | Full |
| S | Servant Allowance | Full |
| C | City Compensatory Allowance | Full |
| H | House-keeping / Family | Full |
