Section 16 Of The Income Tax Act: Deductions, Allowances And Benefits

When computing payable taxes from gross income, taxpayers can utilise various allowances and deductions to reduce their tax outgo. These allowances and deductions are mentioned under various sections of the Income Tax Act. One such section is Section 16 of the Income Tax Act. With this section, you can claim deductions and reduce the tax payable on your salary.

Read on to know about this section. 

Section 16 of IT Act – Tax Deduction on Salary Income

The following deductions are applicable under this section:

1. Standard deduction
2. Entertainment allowance
3. Tax on employment/professional tax

The following sections will show the various deductions under this section independently so that you can compute your tax savings.

Also read: Section 24 of the Income Tax act

Standard Deduction – Section 16 (i a)

Standard deduction comes under Section 16 (i a) and is a flat tax deduction allowed on salary income. The primary intent of this deduction was to replace allowances on transport and medical reimbursement of up to Rs. 19,200 and Rs. 15,000, respectively. 

In 2018’s budget, India’s finance minister allowed a standard tax deduction of Rs. 40,000 on gross salary. However, this was amended in the Interim Budget 2019. So, taxpayers can now claim the lower of the following amount for a tax deduction on their total salary:

• Total salary amount
• Rs. 50,000

Furthermore, you can claim this tax deduction regardless of your existing spending. 

Let us understand how this section works with an example:

Suppose Rahul earns a total salary of Rs. 50,000 in a financial year. In this situation, he will get a standard deduction on his entire salary. On the other hand, Vikas earns Rs. 5.5 lakh in a financial year. Here, he will be eligible to claim a standard deduction of Rs. 50,000. As a result, his taxable income will become Rs. 5 lakh.

The Benefit of Standard Deduction for Salaried Individuals

The Government of India introduced standard deduction on tax, intending to provide tax relief to salaried people. As mentioned earlier, the limit, which was previously set at Rs. 40,000 was raised to Rs. 50,000 in 2019. 

But does this amendment benefit salaried taxpayers more?

Previously, Section 16 of the Income Tax Act allowed reimbursements for medical expenses and conveyance. However, the deductions had a limit of:

• Medical allowance – Rs. 15,000 per year
• Transport expenses – Rs. 1,600 per month (i.e., Rs. 19,200 a year)

Therefore, the total amount that one could claim from their gross salary through such allowances was Rs. 34,200 (Rs. 15,000 + Rs. 19,200).

With this amendment, you get an extra tax benefit of Rs. 15,800 (i.e., Rs. 50,000 – Rs. 34,200).

Mentioned below is an example that will help you understand the process in detail.

Suppose your yearly salary is:

Basic pay	Rs. 6,00,000
Dearness Allowance	Rs. 2,00,000
EPF contributions	Rs. 25,000
PPF deposits	Rs. 50,000
Transport allowance	Rs. 19,200
Medical allowance	Rs. 15,000
Total Income	Rs. 8,00,000 (Rs. 6,00,000 + Rs. 2,00,000)
Gross Income	Rs. 7,25,000 – (Rs. 25,000 + Rs. 50,000)

Now, taking the previous standard deduction limit in mind, here is how your tax outgo will look:

Taxable income = Gross salary – transport and medical allowance (Rs. 7,25,000 – Rs. 34,200) = Rs. 6,90,800.

Tax outgo as per old tax regime:

Tax on income of up to Rs. 2,50,000 = Nothing.

Tax on income of between Rs. 2,50,000 and Rs. 5,00,000 at 5% rate = Rs. 12,500.

Tax on the remaining income at 20% rate = Rs. 38,160 (20% of Rs. 6,90,800 – Rs. 5,00,000).

Now, after the amendment in the standard deduction limit, your tax outgo will be:

Taxable income = Rs. 7,25,000 – Rs. 50,000 = Rs. 6,75,000.

Tax liability on income up to Rs. 2,50,000 = Nil.

Tax on income between Rs. Rs. 2,50,000 and Rs. 5,00,000 = Rs. 12,500.

Tax on the remaining income at 20% rate = Rs. 35,000 (20% of Rs. 6,75,000 – Rs. 5,00,000).

It is evident that under the new standard deduction limit, you can save substantial taxes. However, note that you will be able to obtain this deduction if you opt for the old tax regime.

Entertainment Allowances – Section 16 (ii)

If your employer pays you an entertainment allowance, then it is first added to your salary income, and after that, a deduction is provided considering a few criteria. The amount of deduction you can claim entirely depends on your employment nature. 

If you are employed with the Central or State Government, deduction on entertainment allowances under Section 16 of the Income Tax Act will be allowed to the lowest amount of:

• Rs. 5,000
• 20% of your basic salary
• Amount of entertainment allowance that you receive

Moreover, your salary must not include any other allowance or benefit to claim this deduction. Note that the authority calculates this deduction based on how much allowance you receive, rather than considering how much you spend on entertainment. 

For example, 

Basic salary	Rs. 50,000 a month (Rs. 6,00,000 a year)
Amount of entertainment allowance you get	Rs. 1,500 a month (Rs.18,000 a year)
Amount of entertainment allowance you use	Rs. 1,000 a month (Rs. 12,000 a year)

As per this example, here is your available deduction according to this section’s provisions:

• Flat deduction amount – Rs. 5,000
• 20% of basic salary – Rs. 1,20,000 (20% of Rs. 6,00,000)
• Allowance your receive – Rs. 18,000

Clearly, the lowest amount here is Rs. 5,000. So, you will be eligible for a tax deduction of Rs. 5,000.

Note: Even though you did not use the entire entertainment allowance, the amount that your employer paid will be considered for the final calculation of deductions.

Tax on Employment/Professional Tax – Section 16 (iii)

You can claim this deduction on tax on employment as per Section 16(iii) of the Income Tax Act. Here, the amount you pay as a tax on employment is allowed for a tax deduction. However, before proceeding, keep these pointers in mind:

1. You have to claim the deduction during the FY in which you paid professional tax to the government.
2. The tax that an employer pays for an employee is also eligible for deductions. Here, the said amount will be added to the total salary first. Later this amount will become applicable for deduction under Section 16 of the Income Tax Act.
3. There is no upper or lower deduction limit. The deduction entirely depends upon the amount of professional tax that one pays. However, you must know that the State Government cannot levy an annual professional tax of more than Rs. 2,500. 
4. The interest on professional tax and late fees are not applicable for deduction under this section.

Also read: Section 54F of the Income Tax Act

Final Word

If you are a salaried individual, a proper understanding of Section 16 of the Income Tax Act is crucial. Go through the above sections to lower your taxable income and, thus, your tax liability.

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