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Published on:

April 14, 2025

Alankar Mishra

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Basics of GST

What is Special Allowance: Meaning, Example and Tax Exemption

Understanding Special Allowances and Taxes offered is crucial not only for effective payroll processes but also for effective tax planning. Special Allowances are one such component which can be essential in determining tax liability. Usually, this type of allowance comes with little to no justification and is left to be interpreted by the receiver.

In this comprehensive guide, we will walk you through what exactly a Special Allowance means, why it is given out, how it is taxed, and what benefits can employees get under the Income Tax Act of 1961.

‍What is a Special Allowance?

A Special Allowance covers a wide range of payments aside from the basic salary employees receive. Payments under this category are made for specific reasons, which may include performance, task completion and other expenses. The allowance is subject to flexibility therefore, the employer has the allowance to customize it as they see fit per organizational or position demands.

Applicable laws include, Section 17(1)(iv) and also Section 10(14) of the Income Tax Act regulates that type of payment.

Special Allowances can be:

Completely Taxable: These include allowances that are performance or discretionary compensation.

Partially or Fully Tax Exempt: Allows claimable when relating to travel, uniforms or research performed for work-related functions.

Why is Special Allowance Paid?

Employers incorporate in an employee’s compensation different allowances which can be classified into:

Remuneration for performance bonuses or productivity incentives.

Reimbursements for operating expenses, e.g. travel or research.

Allowable salaries under the tax relief system.

Expenses for other exceptional needs, such as travel to a remote location or uniform maintenance.

This flexibility encourages customized reimbursement strategies for the employer's purposes while allowing employees to claim tax deductions if there are any.

‍Types of Special Allowances

Special Allowances are categorized into two main types under the Income Tax Act:

1. Taxable Special Allowances

These are paid as additional compensation or incentive and do not qualify for exemption under Section 10(14). These are fully taxable under the head "Income from Salary".

Examples:

Performance Incentive.

Attendance Allowance.

Project Allowance.

Sales Bonus.

City Compensatory Allowance (in most cases).

2. Exempt Special Allowances (Under Section 10(14))

These are paid specifically to meet certain expenses incurred by the employee while performing official duties. They are either fully or partially exempt from income tax, subject to conditions and limits.

Section 10(14) is divided into:

a) Section 10(14)(i) – Allowances for official duties

Exempt to the extent of actual expenditure incurred

b) Section 10(14)(ii) – Personal allowances

Exempt up to specified limits, regardless of actual expenses

Popular Examples of Special Allowances and Tax Treatment

Type of Allowance	Purpose	Tax Treatment
Performance Allowance	Reward for achieving goals	Fully-taxable
Uniform Allowance	For maintaining an official dress code	Exempt to the extent of actual expenditure
Travelling Allowance	For official travel within the duty area	Exempt if used for official purposes
Research Allowance	Academic or professional research	Exempt to the extent of actual expenditure
Conveyance Allowance	Transport for work purposes	Exempt up to ₹1,600/month (non-disabled employee)
Helper Allowance	For engaging assistant at work	Exempt to the extent of actual expenditure
Children Education Allowance	Tuition support for children	Exempt up to ₹100/month per child (max 2)
Hostel Expenditure Allowance	Residential expenses of children	Exempt up to ₹300/month per child (max 2)

Real-life Example of Special Allowance Calculation

Let’s take a sample salary structure:

Basic Salary: ₹40,000.

House Rent Allowance (HRA): ₹15,000.

Special Allowance: ₹10,000.

Transport Allowance: ₹1,600.

Gross Salary: ₹66,600

In this example:

The ₹10,000 Special Allowance is fully taxable (assuming it's performance-based).

₹1,600 Transport Allowance is exempt (if not availing conveyance reimbursement)

So, ₹10,000 will be added to the taxable salary.

How to Claim Exemption on Special Allowances

To claim exemption under Section 10(14), the employee must:

Provide Proof of Expenses (if allowance is for official duty).

Submit Supporting Bills like travel bills, fuel receipts, uniforms, research material.

Ensure the allowance is not part of a prerequisite (like an employer-provided car).

Include the exemption in Form 12BB while filing income tax declaration

Special Allowance vs Other Salary Components

Component	Taxable?	Purpose
Basic Salary	Fully-taxable	Core salary
HRA	Partially exempt (Sec 10(13A))	Rent reimbursement
Dearness Allowance	Fully-taxable	Inflation adjustment
Special Allowance	Depends on nature (taxable/exempt)	Variable allowance or expense support
Bonus	Fully-taxable	Performance or festive bonus

Income Tax Sections Relevant to Special Allowance

Section 17(1)(iv): Defines "salary" to include all allowances, including special ones.

Section 10(14)(i): Exemption for special allowances granted for performing official duties (e.g., travel, research, uniform).

Section 10(14)(ii): Exemption for allowances to meet personal expenses (e.g., children's education, hostel expenses).

Rule 2BB of Income Tax Rules: Specifies the list and exemption limits for each allowance under Section 10(14).

Impact of Special Allowance on Taxable Income

Since most special allowances are fully taxable, they can increase your gross taxable salary. This may push you into a higher tax bracket if not planned for properly.

Hence, employers often restructure salary components to:

Maximize tax-exempt allowances.

Reduce the fully taxable portion.

Offer reimbursements instead of fixed special allowances (if eligible)

TDS on Special Allowance

Employers are required to deduct TDS (Tax Deducted at Source) on the full value of taxable special allowance. However, if part of the allowance is exempt and proper documentation is submitted, TDS will only apply to the taxable portion.

Employees must ensure accurate income declaration and submit supporting documents on time to HR/payroll teams.

GST on Special Allowance

There is no GST applicable on salary or any of its components, including special allowances, as they are part of an employer-employee relationship and not a supply of goods or services under GST.

How to Structure Salary to Maximize Exemption

Whether you are negotiating a salary or planning on compensation, here are tips to consider:

Change fixed special allowances into reimbursement expenses (travel, phone, internet).

Add in Section 10(14) allowances such as Research or Helper Allowances.

Get clarity on special allowances' purpose and taxability from HR.

Have proper bills and expense records for the exemptions claimed.

Conclusion

A Special Allowance is an important part of your salary which can increase your take-home pay or increase your taxes depending on how it is managed and used. Knowing the various types and their tax implications and exemptions under the Income Tax Act helps employees manage their finances more effectively.

Make sure to design special allowances in a manner that maximizes the value and minimizes the tax burden on your workforce. As an employer, this will greatly benefit your employees as well as your business.

Whether you are a salaried professional or an HR professional, understanding how special allowance works will greatly assist you in financial planning and payroll management.