House Rent Allowance exemption

An employer often pays House Rent Allowance, HRA, on top of basic salary. It is not automatically tax-free just because it is labelled a housing allowance.

The Income Tax Act exempts only part of it, worked out from a three-way comparison, and only for someone who has actually chosen the old tax regime.

The exemption is the least of:

1. HRA actually received.
2. Rent paid, minus 10% of salary.
3. 50% of salary, if the residential house is in Bombay, Calcutta, Delhi or Madras; 40% of salary anywhere else.

Whatever is left over, HRA received minus the exemption, is added to taxable salary.

The rule assumes rent is actually being paid; someone living rent-free, such as in a parent's own house with no rent agreement, has nothing to claim against. And the whole computation is not available under the new tax regime, which does away with this exemption entirely.

Illustrative figures. Ms Fernandes works in Mumbai, earning a salary of Rs 8,00,000 a year for this purpose, receives HRA of Rs 2,40,000 a year, and actually pays rent of Rs 3,00,000 a year.

1. HRA received                       = Rs 2,40,000
2. Rent paid - 10% of salary          = 3,00,000 - 80,000 = Rs 2,20,000
3. 50% of salary (metro)              = Rs 4,00,000

Exemption = least of the three = Rs 2,20,000
Taxable HRA = 2,40,000 - 2,20,000 = Rs 20,000

Had Ms Fernandes chosen the new tax regime instead, none of this arithmetic would matter — the entire Rs 2,40,000 of HRA would simply be added to her taxable salary, with no exemption available at all.

Chapter 7 (Concepts of Taxation), the salary exemptions table in section 7.6.1, states this three-way test immediately below the gratuity exemption, and flags HRA as "not allowed" under the new regime. Expect a computation question with a given salary, HRA and rent figure, and a conceptual question on the regime under which HRA can be claimed at all.

• The exemption is the least of three figures, not the largest or an average of them — a common shortcut error.
• HRA has no exemption at all under the new tax regime, regardless of the underlying rent paid.
• The metro list is specifically Bombay, Calcutta, Delhi and Madras — any other city, however large, uses the 40% figure, not 50%.
• "Salary" for this formula generally means basic salary plus dearness allowance where it counts towards retirement benefits, not the full gross pay packet.