What is dearness allowance?

What is Dearness Allowance

Dearness allowance refers to a fixed percentage of basic salary that is given to employees to offset the impact of inflation. It is a common component in most salary structures. Both central government and public sector employees have this component in their salaries. For private sectors, companies aren’t bound by law to provide it, but some companies still opt to offer a percentage of the basic salary as dearness allowance.

The concept of dearness allowance was first introduced during the Second World War to adjust the rising food costs, but now it is used to match the continuous rise in the cost of living.

Dearness allowance is an integral part of take-home salary, and it differs according to the 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?

Dearness allowance 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

Types of dearness allowance

There are two types of dearness allowance:

  1. Industrial Dearness Allowance:

    The type of dearness allowance is applicable for public sector employees. The rate of IDA gets revised every quarter based on the changes in consumer price index (CPI).

  2. Variable Dearness Allowance:

    The type of dearness allowance which is applicable for both central government and public sector employees. The rate of VDA gets revised every semi-annually depending on the changes in CPI.

Role of pay commission in Dearness Allowance calculation

The pay commission has to examine the different elements that construct an employee’s final salary. Dearness allowance is one of the most important factors considered by the Pay Commission, when it frames its reports. The pay commissions’ responsibility is to take into account every factor that helps determine salaries, including the periodic updating and revising of factors used to calculate dearness allowance.

Dearness allowance under Income Tax

According to the Income Tax Act, 1961, dearness allowance received by employees are fully taxable. Employees are required to mention the dearness allowance component separately when filing tax returns.

What is dearness allowance merger?

As the cost-of-living increases with time, so does dearness allowance. The calculation of DA is revised every financial year for eligible employees. After a constant revision in calculations every year, dearness allowance can reach an amount that is 50% of basic salary because of the adequate escalation effect. In this case, dearness allowance and basic salary merge after crossing the 50% of basic threshold. This is known as a dearness allowance merger.

Difference between DA and HRA.

Employees are often confused between the DA and HRA but the two make up for different salary components. The main differences between them have been outlined below:

Dearness Allowances:

  1. Public sector and central government employees are entitled to it by law.
  2. There are no tax exemptions for dearness allowance.
  3. Dearness allowance is calculated as the percentage of the basic salary.
  4. The calculation rates are dependent on inflation and the rising cost of living.

House Rent Allowances:

  1. Central government, public sector, and private sector employees are entitled to it.
  2. HRA is taxable unless an employee is living in rented accommodation, in which case it is exempted from taxes.
  3. HRA amount is fixed as it does not depend on variables like CPI.

Dearness Allowance – FAQs

Is dearness allowance the same as house rent allowance?

No, dearness allowance and house rent allowance are different components of salary. Dearness allowance is given to meet the impact of rising inflation, while HRA is given for paying for rental accommodations.

Is dearness allowance taxable?

Yes, dearness allowance is categorized under income and hence fully taxable.

Who will get dearness allowance?

All central government and private sector employees are liable to receive dearness allowance. At times, organizational policies for private sector comapanies also allow their employees to receive DA as a salary component.

What happens if dearness allowance reaches 50 percent?

Upon reaching 50% of basic salary, dearness allowance is merged with basic salary. This is called dearness allowance merger.

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