An allowance is a fixed monthly amount paid by an employer to an employee to meet a particular expense (whether or not the expense is actually incurred).
Allowances are classified by the basis of exemption:
### A. Spending-Based Exemption (exempt = lower of allowance received or amount actually spent)
Applicable when the allowance is granted to meet specific official duties.
Travelling Allowance
Daily Allowance
Conveyance Allowance
Helper Allowance (for office work)
Academic / Research Allowance
Uniform Allowance
> Unspent portion is taxable.
### B. Limit-Based Exemption (fixed monetary cap)
Allowance
Maximum Exemption
Children Education Allowance
₹100 p.m. per child (max 2 children)
Children Hostel Allowance
₹300 p.m. per child (max 2 children)
Tribal Area Allowance
₹200 p.m.
Underground Allowance (mine workers)
₹800 p.m.
Transport Allowance
₹3,200 p.m. (only for handicapped employee)
Transport business employee Allowance
70% of allowance, max ₹10,000 p.m.
### C. Formula-Based Exemption – House Rent Allowance (HRA) [Section 10(13A)]
Exemption = Lower of the following three:
1. Actual HRA received
2. Rent paid minus 10% of Salary
3. 50% of Salary (Mumbai, Delhi, Kolkata, Chennai) or 40% of Salary (other cities)
Salary for HRA = Basic + DA (forming part) + CT (commission on turnover only)
Compute monthly if any component (salary/HRA/rent/city) changes during the year, then sum the monthly exemptions.
### D. Allowance with Deduction – Entertainment Allowance [Section 16(ii)]
Only Government employees are eligible. Deduction = lower of:
Actual EA received
1/5 × Basic Salary
₹5,000
> EA is fully added in Gross Salary first, then claimed as a deduction u/s 16(ii).
### E. Fully Taxable Allowances (no exemption)
Dearness Allowance – DA (forming part) and Normal DA – both fully taxable.
Medical Allowance
Telephone / Servant / City Compensatory / Project / any allowance not specifically exempted.
Worked example
### Example 1
Children Education Allowance: Mr. X gets ₹400 p.m. per child for 3 children. → Exempt = ₹100 × 12 × 2 = ₹2,400. Taxable = 400×12×3 − 2,400 = ₹14,400 − 2,400 = ₹12,000.
### Example 2
Transport Allowance: Mr. Y (non-handicapped) gets ₹2,000 p.m. transport allowance. → No exemption – fully taxable ₹24,000.
### Example 3
HRA: Basic ₹40,000 p.m., DA(forming part) ₹10,000 p.m., HRA ₹20,000 p.m., rent paid in Mumbai ₹18,000 p.m. for full year. Salary p.m. = 50,000. (i) HRA = 2,40,000; (ii) Rent − 10% Salary = 13,000 × 12 = 1,56,000; (iii) 50% × 50,000 × 12 = 3,00,000. Exempt = ₹1,56,000. Taxable HRA = ₹84,000.
### Example 4
Entertainment Allowance: Govt. employee with Basic ₹3,00,000 p.a. and EA ₹6,000 p.a. → Deduction u/s 16(ii) = lower of (6,000; 60,000; 5,000) = ₹5,000.
⚠️ Common exam mistakes
Allowing Transport Allowance exemption of ₹1,600/₹3,200 to all employees – only handicapped employees enjoy this.
Computing HRA for the whole year in one go when rent/salary/city changed – exemption must be calculated month-wise.
Including non-turnover commission while computing 'Salary' for HRA – only CT is included.
Granting Entertainment Allowance deduction to private-sector employees – it is for government employees only.
Treating Medical/Telephone allowances as exempt – they are 100% taxable.
Bare-Act text Section 10(13A); Section 10(14); Rule 2BB · Income-tax Act, 1961 · click to expand
Section 10(13A) – any special allowance specifically granted to an assessee by his employer to meet expenditure actually incurred on payment of rent in respect of residential accommodation occupied by the assessee, to such extent as may be prescribed, having regard to the area or place in which such accommodation is situated and other relevant considerations. Section 10(14) – any such special allowance or benefit, not being in the nature of a perquisite, specifically granted to meet expenses wholly, necessarily and exclusively incurred in the performance of duties, to the extent to which such expenses are actually incurred for that purpose.