Tax-saving components of your CTC

After two years of hard work, Atul Agnihotri got a much-deserved raise and a promotion. He was so overjoyed that he threw a party. There, a friend asked him about his increased Cost to Company (CTC). When Atul detailed his CTC break-up, the friend pointed out that the raise, in effect, was hardly a raise. That is because the increment had increased his tax liability. This meant that the tax would, in effect, eat up much of the raise. Atul was shocked. The friend then explained that certain components of his CTC could help save taxes, too. 

Atul is not an exception. Many employees rejoice when their CTC increases, but rarely pay attention to the various components. It is important to know how to save tax and increase your take-home pay. Each component invites a different tax treatment. Let us understand these components in detail.

Related: Dummy’s guide to Form 16

Components of CTC

Basic Pay: This is the primary component of your CTC, also called ‘Basic Salary’. It makes up a major part of your CTC. The basic pay is fully taxable in the tax slab in which your income falls. The higher the basic pay, the higher your tax liability.

Allowances: If you study your CTC, you will find a mention of ‘Allowances’ and a limit against it. Your employer offers various allowances, some of which are tax-free. Popular tax-free allowances include the following:

1. House Rent Allowance (HRA): The taxes on HRA are applicable if you live in a rented house. According to prevalent tax laws, the amount of HRA exempted must be lower than:

• The actual HRA received 
• 50% of your basic pay if you live in a metro city; otherwise, 40% of your basic pay
• (Rent paid) – (10% of basic pay)

Related: What you must know about HRA to ensure it is not rejected

Standard Deduction: Until a few years ago salaried individuals could claim a conveyance allowance up to Rs 19,200 and medical reimbursement up to Rs 15,000. However since 2018, the Standard Deduction has been re-introduced in lieu of these allowances. As of Financial Year (FY) 2020-21, an individual can claim up to Rs 50,000 under the said expense head and save up to Rs 5,800 on their tax liability.

Leave Travel Allowance (LTA): LTA allows your employer to cover your travelling expenses when on leave from work. LTA is exempt from tax under Section 10(5). At the most, an employee can claim it twice in a block of four continuous years. However, remember that LTA covers only domestic travel, and you must submit actual bills to claim this exemption.

Children’s education and hostel allowance: The school/ college tuition fee of up to two children can be claimed as a deduction under Section 80C subject to the upper limit of Rs 1.5 lakh offered under the Section. Note that only the tuition fee (no other cost of educating) of a full time course from an accredited body is eligible for the deduction.

Related: Should you stick to the old tax regime or move to the new one?

You can claim a deduction on the boarding expenses of your ward too. The limit of exemption is Rs. 100 per month for two children. For hostel allowance, your children should be staying in a hostel. Here, the allowance exempted from tax is Rs. 300 per month for two children.

Perquisites: Perquisites are some fringe benefits that employers offer. These are usually taxable, but some are tax-exempt.

• Taxable pre-requisites: This includes rent free accommodation, supply of gas, water and electricity, employee professional tax, reimbursement of medical expense, and salary of servant. Fringe benefits provided to employees such as free meals, gifts above Rs. 5000, club and gym facilities etc. are also part of this.
• Tax exempted perquisites: Travel allowance, computer or laptop provided by companies for official use, refreshments given during working hours, medical aid provision, use of health club or sports club (if any), telephone facilities, interest fee salary loan, contribution to provident fund, free medical and recreational facilities, etc. 

If the employer reimburses personal expenses on a credit card, the same is taxable as perquisites in the hands of the employee. However if the expenses are documented to have been for official purpose only then the reimbursements are not taxable.

Some lesser-known perquisites offered to employees that are taxable include:

• Company owned car used by an employee
• Education facilities provided to an employee’s children
• Accommodation facilities and domestic help 

Contributions: These are tax-free payments your employer makes towards your social security schemes. Some popular tax-free contributions include:

• Employee Provident Fund (EPF): Both, you and your employer contribute towards the EPF scheme. Your contribution can be claimed as a deduction under section 80C, when filing tax returns. The limit for claiming exemptions is 12% of your basic pay and dearness allowance.
• Employee State Insurance Corporation (ESIC): If your monthly gross income is below Rs. 21,000, your employer will contribute 3.25% of it towards ESIC. This scheme provides insurance coverage. Your employer’s contribution is part of your CTC, and is tax-free.
• National Pension Scheme (NPS) contributions: Your employer’s contribution towards the NPS is exempt from tax up to 10% of your basic salary and daily allowance.

Related: Understanding your savings account

Understanding how these CTC components work, can be a big help on how to save tax. So, the next time you negotiate your CTC, do not make the same mistake Atul made. Keep an eye out for the tax-free components. You can also talk to a financial expert to help you negotiate a CTC that ensures you optimum benefits. 

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or insurance or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.