A special allowance is a sum of money that an organisation pays its employees for various reasons and to meet different purposes. This provision of a pre-determined and fixed sum of extra payment is found in all sorts of business entities: from enormous corporates to sole proprietorships.
Such allowances are calculated only on an employee’s basic salary. Any such payment over and above an employee’s pay may have both tax-exempt and taxable components, with exemptions depending on the grounds on which such an allowance has been granted.
Similar to other provisions like LTA and HRA, any special allowance is bound to vary widely depending on the position and performance of the employee plus the organisation’s financial health and existing employee benefit schemes.
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What is Special Allowance?
Special allowances, as mentioned, vary widely across companies. Some companies simply pay it as a ‘bonus’ amount to highlight their appreciation of an employee’s superior work quality. Other companies, however, can pay a special allowance based on the principles of ‘employment of profit’.
The latter category is mentioned in detail in the Income Tax Act of 1962.
In instances of an allowance paid in recognition of outstanding performance, the amount is usually tax-exempt subject to the maximum incurred expenses.
Other companies feature special allowance in salary slips. After all existing overheads- including conveyance and dearness allowances, LTA and HRA, among others, are extinguished, the remaining amount is treated as a unique allowance.
This sum does not come under the purview of any overheads. In other words, after an employee’s CTC is calculated under a wide range of overheads and all sums are accounted for, any remaining amount is considered a special allowance.
There are various legal aspects which govern these grants. For example –
- Any such stipend or advance that is set aside by an employer and paid for a specific expense is exempted from Income Tax under Section 17 (2) of the IT Act, 1961. However, this sum must be paid within the employment period when the employee is active in his or her allotted duties.
It is also an illustration of the differences between an allowance and a perquisite.
- A company may compensate its high-achieving employees with better salaries, stock options and the like. Should the company or the employer wish, it can also arrange for a special allowance that allows their prized employees to maintain their standards of living.
In both these scenarios, no Income Tax is levied on allowances paid.
Allowances and Taxation Systems
Only those allowances or grants are taxable which are not expressly mentioned under any IT Act exemptions. Most exemptions are covered under Section 10(14) of the IT Act 1961.
Furthermore, there are specific conditions where extraordinary allowances will not be taxable; these are mentioned under the following IT sections. They are –
- Exemptions will only kick in if an allowance is not a perquisite. It is an essential differentiation that only permanent employees receive.
- Only those advances will be exempt when it is paid exclusively and wholly for superior office performance and occupying an office of profit.
- Any extraordinary payments of a personal nature or angle are not tax-exempt.
- Finally, there is no upper limit to an allowance as per the law.
There are also a handful of tax laws that apply to the following scenarios –
- No tax can be levied on any advances or payments to the Honourable Justices of the HCs and the Supreme Court.
- If a company’s special allowance also includes HRA, partial tax exemption is available under Section 10(13A).
- Any other allowance, city compensatory allowance, for instance, is never exempt from taxation.
In the last caveat, the laws of Dearness Allowance or DA come in automatically as different cities have varying living costs.
Special Allowance and its Categories
There are several types of special advances and allowances, and they can either be personal or official. Note that all allowances have to be paid each month and they will be taxed under their corresponding IT sections.
Here are several categories of such extraordinary allowances for personal purposes:
|Grounds for allowance||Exemptions|
|Children’s education||The maximum exemption limit is Rs. 100 per child for a 2-child family. Excess amount is taxable.|
|Hostel allowance||Maximum limit is Rs. 300 per child for 2 children in a family. Any excess amount is taxable.|
|Transport||Rs. 1600 a month/ Rs. 3200 a month for handicapped employees. The rest or excess is taxable.|
|Outstation||This is usually paid by India’s rail, water and roadways. 70% of the total amount received is exempt.|
|Island duties||A maximum sum of Rs. 3250 a month is tax-free if Armed Forces personnel are stationed in Lakshadweep or the Andaman & Nicobar islands|
|Professional or official allowances|
|Travelling Allowance (TA)||No Income Tax except on savings|
|Research or academic allowance||-do-|
In March 2019, the Supreme Court amended rules on the dual provisions of Provident Funds (PF) in India. According to the new rules, all employers must now treat their employees’ basic pay and the special allowance as one unit, and the Provident Fund has to be paid on this total amount.
In India, with minimal Social Security norms in place, especially in the private sector, such a decision is a welcome one. While it may negatively affect an individual’s take-home salary every month, the corpus at the end of that individual’s service life will act as a retirement fund.
There is some speculation that more reforms may be heralded in once the FY 2021-2022 starts.