Tax on HRA deductions

It depends on the city and the rental being paid

Financial advisors are often quizzed about how an employee House Rent Allowance (HRA) works. Typically, an employee gets a certain amount of HRA. But often he either owns a flat or is about to buy one. So, he is concerned whether on account of the ownership, he may lose the HRA deduction that he is entitled to. The concern could also be the other way round: Since he is receiving HRA, he may not be eligible for home loan deductions. Let's check if these fears are justified.

HRA is basically an allowance, part of your taxable salary. It is not mandatory for the employer to give you HRA. But, if your employer gives you HRA, you will get it irrespective of whether you own a house or pay rent. Like your salary, you will receive it monthly.

However, the law also provides that if the employee satisfies certain conditions, a deduction will be provided from the HRA received and only the balance amount would be subject to tax. This deduction depends on the city you live in and the amount of rent you pay.

Let us first see how already owning a house is related to getting HRA. The two are not connected. HRA and home loan provisions are two different issues under the Income Tax Act (ITA) and one does not influence the other. So, you may own a flat or any number of flats, either in the same city you work in or anywhere else in India or abroad. It won't influence the HRA deduction you are entitled to. Conversely, whatever your HRA, your home loan deductions on the equated monthly instalments (EMIs) for the house you've bought or intend to buy would not be affected.

Calculate deduction
Let's move on to understanding your eligible HRA deduction and how to calculate it. The first condition is that you have to be paying rent. That is what the allowance is meant for. It is not necessary that you pay rent to only a landlord. You could live in your parents' house and pay rent to them. If so, you're eligible for HRA deduction. Only, in this case, the rent received will be taxable for your parents; if their total income is below the taxable limit, the entire transaction would be tax-free. The basic exemption limit for a senior citizen is Rs 2,40,000 a year. Split between both your parents, the total amount of rent could be as much as Rs 4,80,000 (Rs 2,40,000 multiplied by 2) without tax incidence. So, you get your HRA deduction, they don't pay any tax and everyone wins.

The same structure cannot be adopted in the case of your spouse as the relationship between husband and wife cannot be commercial. Husband and wife are supposed to live together under the same roof; they cannot charge rent from each other.

Where you live also influences HRA deductions. In a metro city, you would be eligible for a deduction of up to half your salary (basic plus dearness allowance, if applicable). Else, the limit is upto 40 per cent.

So, HRA deductions could mean any of the following:

* Actual HRA received

* 50 per cent of salary for employees living in metros and 40 per cent otherwise

* Excess of the rent paid over 10 per cent of salary.

Illustration
For example, Ashish earns a basic salary of Rs 60,000 per month. He pay monthly rent of Rs 25,000 for an apartment in Mumbai. The actual HRA he gets is Rs 20,000. Vikram's HRA deduction will be the least of the following three figures:

* Actual HRA received, that is, Rs 20,000

* Half of the salary, that is, Rs 30,000

* Excess rent paid over 10 per cent of the salary, that is, Rs 25,000 minus Rs 6,000 which is Rs 19,000

Therefore, the HRA deduction for Ashish would be Rs 19,000 and so, the taxable component of HRA would be Rs 20,000 (HRA received) less Rs 19,000 (HRA deduction) which comes to Rs 1,000.

Finally, do maintain the rent receipts or a copy of the lease agreement. These serve as a proof of having paid the rent.

The writer is Director, Wonderland Consultants