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HRA: An effective tax planning tool

kunal 
on 22 January 2015

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Introduction

According to Section 14 of Income Tax Act, 1961, the income of a person is classified under various defined heads of income. Thus, for the purpose of computation of total income, the income is first categorized under the heads of income and then charged to Income Tax in accordance with the provisions and rules as specified in the Income Tax Act.

The five heads of income according to section 14 for computation of income tax in India are as follows:

1. Income from Salary

2. Income from House Property

3. Income from Profits and Gains of Business or Profession

4. Income from Capital Gains

5. Income From Other Sources

The remuneration which an individual receives for services rendered by him under a contract of employment shall be chargeable to income tax under the head ‘Income from Salary’. Income under this head is chargeable only if an employer-employee relationship exists between the payer and payee. According to section 17 of Income Tax Act, 1961, salary includes basic salary or wages, advance salary, Fees, commission, pension, annuity, perquisites, gratuity, annual bonus, income from Provident Fund, Leave Encashment, Allowances and awards.

It is under this head “Income from Salaries”, HRA becomes taxable as a component of salary. HRA is an important tax planning tool which many people tend to ignore due to lack of knowledge on how to calculation the same. Claiming HRA exemption carefully can help reduce one’s tax burden significantly.

What is House Rent Allowance

House rent allowance or “HRA” as we generally call it, is an allowance received by people in employment as a component of their salary from their employers. HRA is paid to the employee with the purpose to meet the expenses of the rented stay of the employee. The Income tax allows deduction of HRA granted to the assessee by his employer to meet the expenditure incurred on payment of rent in respect of the residential accommodation occupied by the assessee. Section 10(13) of the Income tax act, 1961 and Rule 2A of Income tax rules deals with the exemption on HRA. It is to be noted that entire HRA is not deductible. HRA exemption is available to a certain extent and remaining allowance is subject to income tax.

In order to claim the benefit of HRA, an employee has to stay in a rented accommodation and pay rent for it and should be in receipt of HRA from his employer. The employee should actually pay the rent. The rented premises should not be owned by the employee or any of his family members i.e. the premises should be a rented one.

How to calculate the exemption under HRA

The rented premises must not be owned by the assessee. In case one stays in an own house, nothing is deductible and the entire amount of HRA received is subject to tax at slab rates. As long as the rented house is not owned by the assessee, the exemption of HRA will be available up to the minimum of the following three options in the assessment year:

1. Actual house rent allowance received from your employer

2. Actual house rent paid by you less 10% of your basic salary

3. 50% of your basic salary if you live in a metro or 40% of your basic salary if you live in a non-metro

This minimum of above is allowed as income tax exemption on house rent allowance while computing income under the head salaries.

Salary for the purpose of calculating the exemption means Basic Salary which includes dearness allowance if the terms of employment provide for it, and commission based on a fixed percentage of turnover achieved by the employee. The deduction will be available only for the period during which the rented house is occupied by the employee and not for any period after that.

Illustration

Basic Salary: Rs. 30,000 per month or Rs. 360,000 per year

HRA received: Rs. 10,000 per month or Rs. 120,000 per year

Rent paid: Rs. 8,000 per month or Rs. 96,000 per year (Residing in Delhi)

HRA exemption shall be computed as below:-

Least of the following three is exempt:

1. Actual HRA received from employer: Rs. 120,000

2. Rent paid – 10% of Basic Salary: Rs. 96,000 – (Rs. 360,000*10%): Rs. 60,000

3. 50% of Basic Salary: (Rs. 360,000 *50%): Rs. 180,000

Least of above: Rs. 60,000

Hence, out of total HRA received by the employee of Rs. 120,000, HRA shall be exempt to the extent of Rs. 60,000 and balance Rs. 60,000 shall be taxable.

For specific queries please drop a mail to info@caksc.in


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