Sunday, April 17, 2011

Understanding Indian Salary Slip - Importance of HRA

House Rent Allowance

This is also very interesting component of CTC. As name suggest its allowance to pay rent for rented house. So what if you are not staying in rented house? What benefit you get if you are staying in rented house? Find all answers below.

This component is completely paid in the monthly salary. This is basically tax saving component. If you are staying in rented house then you can claim the rent amount and thus you save some income tax. Though this is bit complex calculation, find below simplified with example.

HRA exemption (monthly) is calculated as minimum of below 3 items.

  1. HRA Received in Salary
  2. 40% Basic salary
  3. Total HRA claimed – 10% Basic salary

So for example

Basic salary: 15000
HRA: 5000

Rent paid every month: 8000

As per point No 1) total HRA received per month in salary: 5000

As per point No 2) 40% of Basic salary: 6000

As per point No 3) (Total HRA Claim - Rent paid every month) 8000 – 1500(10% Basic Salary): 6500

So HRA exemption will be 5000. So every month 5000 will be deducted from Taxable income. It means you don’t pay any tax on HRA you receive every month in salary.

Those who stay in their home do not get any tax benefit on HRA. But if you have taken home loan to purchase your home then you can save lots of tax. Look for my next posting on Tax saving tips where this point will be explained.

As we understood from above paragraphs that we can really save some Tax from HRA. What is the exact Tax benefit for the people who stay on rented house compared to people who leave in their own house? Find below the answer.

For example Taxable income for people who stay in their own house for the financial year is 5,20,000.

As per the 2011 Income tax rule, Income tax paid is:

(As per 2011 Income Tax Rule, there is no tax for salary below 1,60,000)

1,60,001 to 5,00,00 income tax rate is 10%: (500000 – 160000)*0.1 (10%) = 34000
5,00,001 to 8,00,000 income tax rate is 20%: (5,20,000 -5,00,000)*0.2(20%) = 4000

Total income tax is 38000.

For the people who stay in rented house and claim 5000 HRA (per month) for Tax exemption, the taxable income for the financial year will be:

5,20,000 – 60,000 (5000*12 months) = 4,60,000

As per the 2011 Income tax rule, Income tax paid is:

(As per 2011 Income Tax Rule, there is no tax for salary below 1,60,000)

1,60,001 to 5,00,00 income tax rate is 10%: (460000 – 160000)*0.1 (10%) = 30000

Total income tax is 30000.

So the saving due HRA component for people staying in rented house as compared to people staying in own house will be:

38000 – 30000 = 8000.

I hope HRA component is simplified and easy to understand for many of you.

Sunday, April 10, 2011

Understanding Indian Salary Slip - Importance of Basic salary

Many of us have surprised seeing first salary being so different than mentioned in CTC (Cost to the Company). Many of us have felt shocked and may be cheated. Even I too felt the same when I saw my first in-hand salary. But after understanding every section of CTC in detail, I learnt that in-hand salary was as expected. Being in industry for almost decade in India, I still find many young colleagues feel bemused while understanding salary slip and comparing against CTC. So I decided to share my experience with you all in simplified way so that you all know what exactly you are getting in-hand salary. All basic components of CTC along with some financial myth behind it and Tax saving tips are described in separate post.

Basic Salary

It is the most important component of your CTC. This decides the Provident Fund (Savings for Future) component of your salary. Usually employer contributes 12% of the basic salary in to PF and also similar contribution done by employer. That is also one of the reason that you see your in-hand salary is less that what you see in CTC. And to be very frank this is really very good investment for future. PF Money stays with the government statutory body and currently rate of interest for PF is 9.5%. This is really very good return on your investment looking at volatile financial market.

What I mean by above paragraph? Have a look at below example calculation.

Example CTC Figure:

Basic Salary:   15000

Employer’s contribution towards PF (12% of Basic Salary): 1800

Employee’s contribution is never mentioned in CTC. So you will say below figures in your salary slip.

Basic Salary: 15000

PF Contribution (12% of Basic Salary): 1800

So it means what you get in-hand basic salary is 13200. So your in-hand salary is reduced by an amount of 1800. But this amount is saved for your future. This is compulsory saving directed by government.

Many companies keep the basic salary as low as possible, while this is compulsory amount, contributed for PF, from both employee and employer. By keeping Basic salary component small, many companies keep to contribution to PF small at the same time keep the in-hand salary high for employee.

The amount saved under PF by employee is also claimed under section 80C to save the Income Tax.