What is HRA and How is it Calculated?

House Rent Allowance or HRA is a vital component of the salary slips of employees. Basically, it refers to the amount paid by the employers to their employees – as a part of their salaries – to help them meet accommodation costs.

Apart from helping the employees to meet expenses incurred on their rented house, the HRA also enables tax saving options on their savings. Tax exemptions on HRA are regulated under the provisions of Section 10 (13A) under the Income Tax Act of 1961. 

Who is Eligible to Claim Tax Deductions on HRA?

Salaried individuals can claim a portion of their HRA as tax deduction under section 10 (13A) of the Income Tax Act. They need to meet the following eligibility criteria for that:

• They need to be salaried individuals. Tax deductions on HRA are not available for self-employed individuals
  
• They should be receiving the House Rent Allowance (HRA) from their employer as a part of their salary
  
• They should be living in a rented house. Tax deductions on HRA are not available for employees living in self-owned houses
  
• They should actually be paying monthly rent for their house. In other words, rent receipts of their homes should be issued in their names only

How is HRA Calculated?

Primarily, the House Rent Allowance of an employee is calculated on the basis of their salary. However, some other factors are also taken into consideration, which includes:

• The city in which the employee is living
  
• HRA percentage offered by the employer
  
• House rent being paid by the employee
  

If an employee is living in a metropolitan city, they are entitled to receive an HRA equivalent to 50% of their salary. On the other hand, if an employee is residing in a non-metropolitan city, their HRA should be equivalent to 40% of their salary.

Here, the salary is defined as the sum of basic salary, dearness allowance, and any other commissions or incentives an employee is entitled to receive. In case an employee doesn’t get any dearness allowance or incentives, their HRA is equivalent to 40 to 50 per cent of their basic salary.

However, in all probability, the HRA which can be claimed as tax savings should be the lowest of the following three provisions:

• The actual amount paid as HRA by the employer
  
• The actual rent of the employee’s house minus 10% of their basic salary
  
• 50% of the salary (if the employee is living in a metropolitan city) or 40% of the salary (if the employee is living in a non-metropolitan city)
  

To understand the calculation of the HRA in a better manner, let’s take the example of Mr Verma, who is residing in a rented flat in Mumbai and pays ₹10,000 per month as the rent of his house. Below is how the monthly salary slip of Mr Verma looks like:

Now, let’s calculate the eligible HRA for tax savings based on the above information:

1. The actual amount received as HRA from the employer is ₹ (13000 x 12) or ₹1,56,000
2. The actual rent of his house minus 10% of his salary is ₹ (10000 x 12 – 36000) or ₹84,000
   
3. 50% of his basic salary (as he lives in a metro) is ₹1,80,000

Based on the above calculation, the amount that Mr Verma can claim as tax exemption on HRA will be the minimum of three, i.e., ₹84,000.

Conclusion

The major benefit of receiving HRA from your employer is that it acts as the best tax-saving option and helps you reduce your tax outgo. To lower your taxable income further, you can also invest in the best tax-saving plans, such as life insurance and ULIPs.

The income tax is levied on all earning individuals who fall under a taxable income bracket. The income tax is paid to the Government of India and is charged annually. However, there are several tax deductions and exemptions that you can claim to lower your tax liability. The Income Tax Calculator helps you ascertain your tax output for a financial year based on your taxable income. This can help you plan well and save tax using the tax-saving deductions and exemptions, if possible.