Is there really a case for HRA benefit under the old tax regime?

The argument is that their flexi-pay benefits and work-related allowances such as leave travel allowance (LTA), car leases, fuel reimbursements, phone bills, meal cards, and gadget allowances all add up to a substantial deductible chunk. 

However, experts said it’s not worth the hassle.

“The benefit of reduced tax slab rates in the further incentivised new regime far outweighs the practical hassles of blocking funds and maintaining documentary evidence for claiming a combination of deductions in the old regime just to match the breakeven points,” said Mayank Mohanka, founder of TaxAaram India and a partner at S.M. Mohanka & Associates.

Also, most work-related benefits such as reimbursements and car leases are available under the new regime too, so the net impact should be seen by calculating the benefits under both regimes.

When HRA will save tax

HRA can save enough tax under the old regime under certain conditions. Foremost, the HRA should be a big chunk of the cost to company (CTC).

The HRA exemption that can be claimed is typically lower than the actual amount given in the CTC due to the manner in which it is calculated. Of the total rent paid, the exemption is available only for the least of the following three parameters: a) actual HRA received, b) 50% of basic salary, c) rent paid in excess of 10% of gross salary.

Unless the rent paid is substantially higher than the HRA granted, tax exemption on the full HRA cannot be claimed. So, don’t misread the HRA stated in the CTC as the absolute amount on which tax can be saved.

For salaries of less than ₹30 lakh, the basic is typically 15-30% of the gross salary. This makes the HRA component small as the allowance is typically 50% of the basic component. A small HRA component where the basic is lower at 15-25% of gross salary will hardly get enough exemption to cross the breakeven limit even after adding the ₹50,000 as standard deduction and ₹1.5 lakh as Section 80C deductions.

Let’s understand with an example. Mr A’s gross salary is ₹20 lakh, of which his basic is ₹5 lakh (25% of gross income) and HRA is ₹2.5 lakh (50% of basic). He needs deductions and exemptions of over ₹7.08 lakh for the old regime to be favourable.

Assuming his rent is high enough to get him full exemption of ₹2.5 lakh HRA, he needs additional deductions of at least ₹4.58 lakh to break even. Even after claiming the ₹50,000 standard deduction and ₹1.5 lakh under 80C, he won’t achieve the target.

It can be argued that the residual amount to break even can be claimed with LTA, National Pension System (NPS) contributions, car leases and other allowances like fuel reimbursements, and phone bills. But maximising deductions just to save tax can affect cash flows.

Will a scenario where the basic is 40-50% of gross salary enable those with smaller incomes to take advantage of HRA? Only if the individual pays very high rent.

Let’s go back to Mr A’s example. At 50% of gross income, Mr A’s basic would be ₹10 lakh and HRA ₹5 lakh. He needs to pay at least ₹50,000 monthly rent ( ₹6 lakh annually) to get full ₹5 lakh as exemption. Apart from this, he should claim deductions worth ₹38,000 to break even. It’s achievable, but at the risk of disrupting cash flows.

At ₹10 lakh basic, ₹2.4 lakh of his gross salary will go in EPF (employer’s and employee’s contributions combined) alone. There are mandatory components of variable pay and gratuity (4.8% of basic) too. Say, net of these components, his pre-tax income is ₹16.5 lakh. Tax-saving deduction alone would eat up about 43% of his income.

The only case this can work is in a double-income household paying high rent. One of the spouses can claim HRA on the full rent along with other deductions to benefit under the old regime without disrupting cash flows.

What about high earners?

For salaries of over ₹25 lakh, individuals need deductions of over ₹8 lakh to benefit in the old tax regime. In this case too, a big HRA component will make all the difference. Mint’s analysis shows that for salaries up to ₹50 lakh, taxpayers will need other big components of either a car lease or a home loan interest deduction of ₹2 lakh along with HRA to meaningfully save tax under the old regime.

Nitesh Buddhadev, founder of Nimit Consultancy, said for salaries above ₹50 lakh, HRA and LTA make up a big part of the gross pay.

“For those living in cities like Mumbai and Bengaluru, rent is quite high and claiming HRA will benefit them. In high-income ranges, an LTA of about ₹1-1.5 lakh is allowed. A family of four or five can now easily spend that much on flights for a domestic holiday,” he said.

However, Buddhadev added that in most cases, HRA and LTA will need to be complemented with car leases to reach the break-even limit. Smaller flexi-pay benefits such as meal cards, phone bills and conveyance expenses cannot make much difference on their own.

It should be noted that the car lease perquisite is available in the new regime as well and so are other flexi-pay benefits except LTA. Gautam Nayak, a partner at CNK & Associates LLP, said the benefits are available only for official work.

“Any allowance that you are getting for official work is exempt, including phone bills, food and beverage bills and conveyance bills. Phone should only be used for official purposes and conveyance too for actual official work only,” he said.

Food coupons are not exempted under the new regime as they are a form of personal allowance. However, food bills that are claimed as entertainment for clients, shown to be for official purposes, can be claimed in the new regime.

For those who invest in the NPS, the employer’s contribution (up to 14% of basic) is also exempt under the new regime. The employer’s 12% contribution to EPF too is exempt.

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So, taxpayers who don’t have substantial HRA to claim but have a car lease, invest in NPS and have other flexi-pay benefits should do the math to figure out whether forgoing HRA and claiming other components will save them more tax in the new regime over the old one (See graphics).

It might work in some cases as the top marginal tax slab of 30% has been increased to ₹24 lakh in the new regime. If these components combined bring the net income below this limit, your effective tax rate can decrease considerably.