House Rent Allowance (HRA) is an integral part of salary packages in India, providing attractive tax benefits to employees who live in rented accommodations. This blog explores HRA in detail, discussing its computation, HRA tax exemption rules, eligibility, and how it affects the overall taxable income. It is a must-read for employees looking to optimize their HRA, as well as employers keen on designing competitive salary packages.

Introduction: What is HRA in Salary?

House Rent Allowance (HRA) is a fundamental part of an employee’s salary which is allocated specifically for the purpose of housing rent. Knowing What is HRA in salary is very important, as HRA forms a part of an employee’s final pay and is also used in determining tax liability. 

In India, HRA is exempt from tax income tax based on Section 10(13A) Income Tax Act, subject to certain conditions. HRA becomes an important tool for tax planning particularly for salaried individuals living in rented accommodation.

The idea behind HRA is to bring some relief to those employees who rent a home instead of owning one. As an employee benefit, HRA enables one to save on taxes on a certain portion of their income and helps lighten up their tax burden.

Understanding House Rent Allowance (HRA)

HRA is an allowance paid to employees by their employer as a part of their salary package to meet the expenditure of a rental house. It is most useful for employees living in rented apartments as it can reduce taxable income. The total amount an employee will get as HRA depends on several factors such as salary drawn by the employee, the city in which they live, and the rent they pay. The exact amount of HRA received can be fully or partially exempted from tax.

For example, you get a higher exemption of HRA if your residence is in a metro city such as Mumbai or Delhi as compared to a non-metro city because the expenditure in a metro city is usually higher.

HRA is a benefit not only in terms of finance but also in terms of retaining employees. Companies use HRA to lure employees, especially in urban areas where the housing cost is high. The higher the HRA, the better the salary package for a person, whether he is a prospective or an existing employee.

How to Calculate HRA in Salary

Calculating HRA is not a simple task. It depends on the basic salaries of the employee, the city of residence, and the actual rent paid by the employee. Here are the steps on how to calculate HRA in salary:

1. Find the Basic Salary: The first step is to determine the basic salary of the employee because HRA is normally calculated as the HRA percentage of basic salary. It forms the core of an employee’s salary package, which does not include other allowances and benefits.
2. Place of residence: The place where an employee resides plays a deciding role in the calculation of HRA. Employees who live in metro cities like Mumbai, Delhi, Chennai, Kolkata, Pune, Bangalore, Hyderabad, Ahmedabad, Nagpur, etc., are entitled to a higher HRA tax exemption as they are forced to pay a higher rent due to the higher cost of living in these cities compared to non-metro cities like Lucknow, Bhopal and Indore.
3. Rent Paid: Actual rent paid by the employee is taken into consideration. Calculations of exemption are based on the exact rent paid by the employee. This means that if the rent paid is less than 10% of the basic salary, then the HRA tax exemption will practically be nil.
4. Calculate the HRA Received: The next step would be to calculate the actual HRA received from the employer. This is generally a predetermined percentage of the basic pay but the company may have its own policy in this regard.
5. Comparing Components: Lastly, compare the following three components – the HRA received, which is 50% (for metro cities) or 40% (for non-metro cities) of the basic salary, known as the HRA percentage of basic salary, and the rent paid minus 10% of the basic salary. The lower of these three components shall be the exempted amount.

HRA Calculation Formula

Your HRA exemption is calculated by taking the lowest of three different numbers. Here is how to calculate HRA in salary using the HRA calculation formula.

1. Actual HRA Received
2. 50% of Basic Salary (in metro cities) or 40% of Basic Salary (in non-metro cities)
3. Actual Rent Paid minus 10% of Basic Salary

Example Calculation:

Please follow the below-mentioned example to understand this well:

Employee Details:

Basic Salary: ₹50,000 per month

HRA Received: ₹20,000 per month

Actual Rent Paid: ₹15,000 per month

City of Residence: Non-metro city

Step-by-Step Calculation:

1. Actual HRA Received:

   – ₹20,000

2. HRA percentage of basic salary: 

   – Since it’s a non-metro city: 40% of Basic Salary

   – Calculation: 40% of ₹50,000 = ₹20,000

3. Rent Paid minus 10% of Basic Salary:

   – Calculation: ₹15,000 (Rent Paid) – ₹5,000 (10% of ₹50,000) =  ₹10,000

Determining the Exempted HRA:

Compare the three amounts calculated above:

1. ₹20,000
2. ₹20,000
3. ₹10,000

HRA Amount Exempted: ₹10,000 (the minimum among the three)

Taxable HRA Amount:

Total HRA Received: ₹20,000

Exempted HRA: ₹10,000

Taxable HRA: ₹20,000 – ₹10,000 = ₹10,000

So, in this case, the employee can claim ₹10,000 per month as an HRA exemption. The rest of ₹10,000 will be added to his taxable income.

HRA Percentage of Basic Salary

The HRA percentage of basic salary depends on the city of residence of an employee. For the metro cities, it is generally 50% of the basic salary while for non-metro cities, it is 40%. This percentage is decided by the employer and is specified in the salary structure given to the employee. It is important to be familiar with the HRA percentage of basic salary as it directly affects the HRA calculation and the HRA tax exemption that can be claimed.

For example, an employee with a basic salary of ₹60,000 living in a metro city will have an HRA component of ₹30,000 (50% of ₹60,000). The same employee staying in a non-metro city will have an HRA component of ₹24,000 (40% of ₹60,000). Hence, understanding the HRA percentage along with the salary package is of utmost importance.

How to Calculate HRA Tax Exemption

To figure out how to calculate HRA tax exemption, you have to consider the rules defined in the Income Tax Act 1961. The minimum of the below-mentioned quantum would be the exemption:

1. HRA received
2. 50% of the basic salary for metro cities (40% for non-metro cities)
3. Rent paid minus 10% of basic salary

This calculation determines the amount that can be claimed as tax exemption, and this amount is deducted from the taxable salary which in turn reduces the tax payable. It is to be noted that HRA tax exemption is allowed only if the employee is residing in a rented house and paying rent. If an employee lives in his own house, he is not eligible for exemption.

Illustrative Table of HRA Calculation

Factors Affecting HRA Calculation

Several factors can influence the calculation of HRA, including:

1. City of Residence: As mentioned above, the city of residence is an important factor in deciding HRA exemptions since the cost of living in metro cities is higher than in tier II cities.
2. Basic Salary: It is the basic salary that provides the base for the HRA calculation. A higher basic salary typically means a higher component of HRA. However, the tax benefit is not the entire HRA received but only a part of it, depending on other aspects like the rent paid and the place of living. 
3. Rent Paid: The actual rent the employee pays directly impacts the exemption amount.

If the rent paid is less, the HRA tax exemption will also be less. If the rent is high, it can result in a higher exemption, but it must be more than 10% of your basic salary.

4. Employer’s Policy: The employer’s policy is also an important factor for HRA calculation. Some employers may give you a fixed HRA component, while others may use certain criteria to calculate the HRA component. You need to understand your employer’s HRA policy to make the most of the tax benefits.

How HRA Affects Your Taxable Income

The most important reason HRA is an essential part of a salary structure is that it can lower your taxable income. This is because when you claim an HRA exemption, the amount of HRA you get reduces the taxable income. In this section, we will discuss how HRA decreases your taxable income and in what circumstances HRA can be claimed.

For instance, if an employee has a taxable income of ₹10,00,000 and an HRA of ₹2,00,000, of which the exemption is ₹1,50,000, then only the balance of ₹50,000 will be added to his taxable income. He will benefit from tax savings, especially if his tax rate is in the higher bracket.

Eligibility Criteria for HRA Exemption

For an employee to be eligible for HRA tax exemption, he or she has to fulfill the following conditions as per the Income Tax Department:

1. Salaried Employee: The employee must be a salaried employee who is receiving the HRA as part of his salary
2. Living in Rented Accommodation: The employee has to live in rented accommodation and he/she has to provide house rent payment proof, like a rent receipt or a rental agreement.
3. Rent Exceeds 10% of Basic Salary: The rental paid should exceed 10% of the basic salary to get the benefit of the exemption. If rent is less than 10%, HRA tax exemption could be minimal or nil.
4. HRA included in Salary: HRA should be a component of the salary package for the employee. If an employer does not offer HRA, the employee will not be eligible for this exemption.

If all these conditions are satisfied, the employee is eligible for HRA exemption under Section 10(13A) of the Income Tax Act.

Also Read: HRA Compliance Checklist 

How to Claim HRA Exemption

An employee can claim an HRA exemption quite easily as long as all the necessary documentation is available. Here is a step-by-step guideline on how to claim HRA tax exemption.

1. Gather the rent receipts from the landlord. These should include the landlord’s name, address, PAN, and the rent amount paid to them. 
2. The landlord provides the rented apartment to the employee with a lease agreement, which lists the rented housing conditions. This is another proof of the renting contract and is often required by the enterprise when the employee fills in the tax declaration. 
3. The rent receipts and the lease agreement should be sent to the employer as a part of the tax declaration process. Employers generally collect this evidence at the start of the financial year or during the tax assessment year to calculate the taxable income of the employee.
4. Your employer will issue a Form 16 at the end of the financial year. This form, a summary of your income, deductions, and taxes paid, is essential for filing your income tax returns. Verify that the HRA tax exemption has been properly reflected in Form 16.

If the rent is ₹1,00,000 per annum and above, the PAN of the landlord must be provided. In the absence of the same, the HRA exemption might be denied.

Importance of HRA in Salary Structure

The HRA plays an important role in an employee’s salary structure, especially for those living in rented properties. It aids them in meeting their living expenses and also provides significant tax deductions.

Since rent constitutes a significant portion of most employees’ monthly expenses, particularly those residing in metro cities, exemption in HRA boosts their take-home pay. Employees in the higher tax brackets enjoy maximum tax savings.

Besides, if employees know how HRA works, they can make better housing choices. For example, if they know that renting has a greater impact on HRA exemption, they might decide to rent, which will reduce their tax burden the most.

Difference Between HRA and Rent-Free Accommodation (RFA)

The key difference between the two schemes, HRA and RFA, is that the former is a perk of the salary meant to reimburse the expenses related to rent. The latter is accommodation the employer provides to the employee free of cost.

HRA: The employee is provided with a rent allowance, and a part of this is not taxed.

RFA: The employer provides housing, and the value of this benefit is added to the employee’s taxable income. The value of such a benefit could be reduced by a standard deduction based on the employee’s salary and city of residence.

Common Mistakes to Avoid When Claiming HRA

While claiming HRA may seem straightforward, there are several common mistakes that employees should avoid to ensure they maximize their tax benefits:

1. Not Submitting Rent Receipts: Without these documents, the entire HRA amount could be added to the taxable income, and the employee might end up paying more tax than necessary.
2. Wrong Exemption Calculation: One of the frequent mistakes employees commit is not correctly computing the HRA-exempt amount using the HRA percentage of basic salary. They either forget to deduct 10% of the basic salary or ignore the 50%/40% rule for metro/non-metro cities. 
3. Cash Payments for Rent Without Receipt: While paying cash for rent is not uncommon, not keeping a record of the cost of your rent means that you won’t be able to claim the HRA tax exemption. In case of cash payments, take a detailed receipt from your landlord.
4. Excessive Rent Claims: Some employees may be tempted to inflate rent expenses to increase their exemption in HRA. This can backfire when the tax authorities demand proof of rent payments.
5. Not Updating the Employer About Changes in Rent: If an employee moves into a new rental property or if the rent changes significantly, the employee must inform the employer and submit new rent receipts. Without the new information, the employer will calculate the tax based on outdated rent information.

Streamline Your Rent Payments and HRA Claims with EnKash

Whether you’re paying rent to your landlord, or submitting a claim to your employer for HRA exemption, EnKash becomes your companion at every step to ensure your rent expense is managed professionally. 

As an employee, if you want to automate rent payments, track your rental payments, ensure timely transfers, and generate tax-compliant rent receipts to claim HRA tax exemption, then EnKash offers the best solution across mobile, web, and email.

Furthermore, EnKash keeps track of your business’s cash flows and spending patterns so that you can make better financial decisions. If you have multiple rental properties, EnKash can help you manage your tenants and rents in one simple app. Or if you have to make multiple rental payments every month, EnKash helps you streamline the process to save you time and money.

Also Read: Importance of Expense Management 

Conclusion

Knowing “what is HRA in salary” and how to compute it can help both employees and employers not only plan their housing expenditures well but also take the maximum benefit of HRA in terms of tax exemptions. 

By following the guidelines provided in this article, employees can ensure they are availing themselves of the maximum benefit of tax exemption and thus modulate their taxable income. Whether it is about planning your finances or structuring your employee salaries, HRA has a major role to play in your tax planning.

Understanding the complexities of exemptions in HRA is useful for employers as well. Knowing how to structure salary packages to offer employees a healthy HRA component can help them attract and retain top talent. 

FAQs
What is HRA in salary, and why is it important?

House Rent Allowance (HRA) is a component of salary provided to an employee to meet his rental costs. It helps its employees bear their housing expenses. On the other hand, it provides tax benefits to the employee and decreases his taxable income.

Can HRA be claimed if I own a house but still pay rent?

Yes, you can claim HRA even if you own a house as long as you are staying in rented accommodation due to a transferable job/posting or other reasons.

What happens if I don’t submit rent receipts to my employer?

If you don’t submit receipts for rent paid, your employer will add the entire HRA amount to your taxable income. That would increase your tax liability. However, you can still claim the exemption in HRA while filing for income tax returns by providing proof of rent payments.

If I live in a rented house owned by a spouse, is it covered by HRA exemption?

You cannot claim exemption in HRA if you pay rent to your spouse. The Income Tax Department does not recognize such transactions as legitimate rental agreements since the relationship between spouses is interdependent, and thus, the amount paid is not actual rent.

Can I claim HRA if my landlord doesn’t have a PAN?

If your yearly rent is more than ₹1,00,000, you have to provide the PAN of the landlord.  If the landlord doesn’t have a PAN, you need to obtain a declaration from them stating that they don’t have one. You must keep this declaration for your tax records.

What should I do if my rent is paid in cash?

If you pay rent in cash, you should ensure that your landlord provides you with a receipt with information such as the name of the landlord, address and PAN – if any, and the period for which rent is paid. Cash payments are likely to be looked at with suspicion, so it is important to maintain records.

How does the ‘metro’ vs. ‘non-metro’ distinction impact my HRA exemption?

The distinction between metro and non-metro cities impacts the HRA calculation as metro city residents are eligible for a higher tax exemption (50% of basic salary) compared to non-metro city residents (40% of basic salary). This HRA percentage of basic salary distinction recognizes the higher cost of living in metro cities like Mumbai, Delhi, Chennai, and Kolkata.

Can I claim an HRA exemption if I live in a furnished rental?

A tax exemption in HRA is possible if you live in a furnished rental. If the cost of furnishing is included in the rent agreement, the entire rent is exempt from tax as long as you pay monthly and the landlord gives you a receipt.

Is it possible to claim HRA along with the Section 80GG deduction?

No, you can’t claim both HRA and Section 80GG together. The latter is for the taxpayer who does not get HRA as part of his salary. Under 80GG, the rent paid is separately deductible under specific conditions.

How can I maximize my HRA tax benefits?

You need to calculate the HRA exemption correctly by considering all the relevant factors, such as the rent paid, the basic salary, and the city in which you reside. You must have the proper documentation, such as the rent receipts and the rental agreements. You could seek the advice of a tax consultant to look at various tax-saving strategies that are suitable for you.