HRA Exemption rules

HRA Exemption rules

There are 3 types of allowances in Income tax

• Taxable allowances
• Partially taxable allowances
• Fully exempt allowances

What is HRA?

It is a partially taxable allowance paid to an employee by the employer if the employee is living in a residential flat or a house on rent. The HRA forms part of the salary structure and some part of the HRA is exempted u/s 10(13A) of the Income Tax Act.

How much of HRA is exempted?

The HRA exempt is the minimum of

• Actual HRA received
• If living in metro cities, then 50 percent of salary otherwise 40 percent salary.
• Difference of Actual rent paid and 10 percent of annual salary

The salary for the purposes of HRA would include 

• Basic Dearness Allowance only when the terms of employment so provide to include DA as part of salary or for retirement benefits 
• Commission received on the basis of turnover if any.

An Example

Mr Ram draws a basic monthly salary of Rs 25000 with a monthly DA of 5000. He receives House Rent Allowance of Rs 10000 but pays Rs 9000 as rent for an accommodation in Delhi.

Here, the HRA exempt is least of:

•     Actual HRA received (10000*12)= Rs 120000
•     Since Delhi is a metro city, 50 percent of 360000 that is Rs 180000
•     Rent paid – 10 percent of salary (108000-18000)= Rs 90000

Hence HRA that can be availed would be Rs 120000.

Now you do not pay any rent during the year but receive HRA, you would not be allowed claim HRA benefit as the rent paid by you is 0.

A point to note

If the rent that you pay to your landlord exceeds Rs 1 lakh annually, you need to report the PAN of your landlord to your employer if you want to be eligible for exemption. Also you must submit proper rent receipts and agreements to your employer.

Analysis of income tax case of Meena Vaswani, Mumbai vs Acit(26) in 2017

Meena Vaswani, a female Chartered Accountant working for a hotel company was living with her husband in a 700 sq feet flat for which she had taken a house loan and was paying interest on it. She used to claim deduction u/s 80C for repayment of principal amount of house loan and also u/s 24(b) for loss on house property due to interest on loan paid. Her mother was staying nearby (5 minute walk distance) in a 400 sq feet flat. This is the background of the case. 

Now comes the interesting part. She was offered HRA by her employer. This HRA was being paid to her own mother!
  
You must have clearly understood the issue of the case. She was claiming HRA exemption by paying rent to her own mother. Well you know that you cannot claim HRA if you are paying rent on your own house. 

What did she tell in her defence?

She stated that her mother is aged and she used to stay with her to take care of her at the same time giving her rent for staying with her. Also she did not enter into any agreement formally as she found no reason why she must do so with her own mother. She produced rent receipts too as evidence for income tax purposes. Also she paid rent in cash.

But the Appellate tribunal was not satisfied as there was no formal agreement between the two. Also there wasn't any evidence of any cash withdrawals from the bank for the said purpose. A whooping amount of Rs 31500 was paid as rent monthly for a 400 sq feet flat and that also to her own ailing mother whose accommodation was only a 5 minute away from her own house!

Due to the absence of any documentary evidence mainly the formal rent agreement, the case was in favour of the Assessing Officer. Hence, she could not claim any HRA exemption.

And yes, you read a loophole in the taxation act. You can pay rent to your parents and save tax provided you enter into a rent agreement formally with them and pay them through cheques in their bank accounts. It is not always necessary to pay them directly in banks but you can pay through cash through provided you have the necessary evidence to demonstrate to your assessing officer if any issue arises. Otherwise you wont get any exemption.

There was another case regarding payment of rent to his own wife. (Bajrang Prasad Ramdharani versus ACIT (2013) )
To know more about the case click here

So always maintain robust documentation to avoid any further issues.

An example of how to save tax by paying tax to your parents 

Mr Ram lives in Siliguri, West Bengal with his parents. His office is in located in the outskirts of Siliguri. His employer pays HRA to the employees working there. So if Mr Ram wants to take a local bus to travel to his office but still wants HRA exemption, can he do so?

After the analysis of the case explained above, it is quite sure that this loophole can be used to our benefit. To claim HRA, he must produce adequate documentation to the employer at the time of deduction of TDS to claim exemption on HRA. He has to enter into a rent agreement with his father/mother ensuring that rent is paid monthly /annually as the case may be through banking channels in order to avoid any further issues.

Now how much tax is he saving through this?

Lets say Mr Ram earns a Basic salary of Rs 40000 monthly. He gets a taxable allowance of Rs 10000/month along with an HRA of Rs 25000/month.

HRA exempt is the least of:

• Actual HRA received= Rs 300000
• 40% of Salary= Rs 192000
• Rent-10% of Salary= Rs 36000

Basic salary	480000
Taxable allowance	120000
Taxable HRA	108000
Taxable salary	708000
Tax on salary	54100
Add: Education cess 4%	2164
Total tax payable	56264

Lets assume you pay your rent to your mother who is a housewife and has no other income other than the rent you will be paying to her. This will be taxed as House property income in her income tax return.

House property income of mother	360000
Less: Property taxes paid	3000
Less: Standard deduction u/s 24(b) @ 30%	107100
Taxable income	249900

It can be clearly seen how the rental income is earned in your own family at the same time claiming hra exemption.

This is how you can save tax on your salary!!