When employees join a company, their salary structure includes various allowances. One of the most common types of allowances is the dearness allowance, which is paid to most employees. Let’s examine what this type of allowance is, how it is calculated, and how it affects an employee’s pay. 

What is dearness allowance?

What is Dearness Allowance

A fixed percentage of basic salary given to all types of central government and public sector employees to balance the inflation impact is known as dearness allowance. It was first brought into action during the Second World War to adjust the food cost, but now it is used to match the continuous growth in the cost of living. It is an integral part of take-home salary, and it differs with the types of location. As we know, the living costs in urban areas are higher, so companies provide more dearness allowance in cities but if you are working in rural or semi-rural areas, the amount will be less.   

How to calculate dearness allowance?

It is calculated two times in every financial year during January and July. The formulas for central government and public sector employees are different:

For central government employees:

DA= {(Average of the AICPI (Base year -2001 = 100) for the last 12 months -115.76)/115.76}x100

For public sector employees:

DA= {(Average of the AICPI (Base year -2001 = 100) for the last 3 months -126.33)/126.33}x100

Here, AICPI = All India Consumer Price Index

Different types of dearness allowance

There are two types of dearness allowance:

  1. Industrial Dearness Allowance: The type of dearness allowance which is applicable for public sector employees is known as industrial dearness allowance. The rate of IDA gets revised every quarter based on the changes in CPI.
  2. Variable Dearness Allowance: The type of dearness allowance which is applicable for central government and public sector employees is known as variable dearness allowance. The rate of VDA gets revised every semi-annually depending on the changes in CPI.

Role of pay commission in DA calculation

The pay commission has to examine the different elements that construct an employee’s final salary. Consequently, dearness allowances are considered by the Pay Commission when it articulates its subsequent reports. Pay commissions’ responsibility is to consider every factor that helps determine salaries, including the periodic updating and revising of the multiplication factor used to calculate DA.

DA under Income Tax

According to the Income Tax Act, 1961, DA received by employees are fully taxable.  If an employee is provided with rent-free accommodations by the employer, and the employee does not pay for the utilities or furnishings, then the portion of the dearness allowance that represents retirement benefits would be included in the employee’s salary. Employees must state their tax liability concerning their dearness allowance when filing their return. 

What is the dearness allowance merger?

As the cost-of-living increases with time, so is the dearness allowance. The calculation of DA is revised every financial year for eligible employees. After a constant enhancement in the calculation every year, it now covers 50% of the basic salary because of the adequate escalation effect. In this case, when DA and basic salary merge after crossing the 50% is known as a dearness allowance merger. It results by providing a hike in employee pay 

Difference between DA and HRA.

The employees are often confused between the DA and HRA; that’s why we have articulated the main difference between these terms to make it more transparent and easier:

Dearness Allowances:

  1. Public sector and central government employees are entitled.
  2. No exemptions from tax.
  3. It is calculated as the percentage of basic salary.
  4. It increases with the inflammation of the cost of living.

House Rent Allowances:

  1. Central government, public sector, and private sector employees are entitled.
  2. Specific tax exemptions.
  3. House Rent Allowances is not calculated as the percentage of basic salary.
  4. It is an element of an employee’s salary for accommodation.

Wrapping up

It plays an important role in public sector employees and you must remember that Dearness allowance and living costs are interdependent on each other. For calculating the accurate amount of salary for every employee, you can use a payroll software that can automate the calculation as well as reduce the human errors.

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