Dearness Allowance: What Is It And How Is It Taxed?

The central government will likely implement a three-percentage-point increase in the dearness allowance (DA) for its more than one crore employees and pensioners. This adjustment would raise the existing DA from 42 per cent to 45 per cent, adhering to the agreed-upon formula.

The Union Cabinet is poised to decide following a proposal by the Finance Ministry’s expenditure department to increase the DA and assess its revenue impact. Subsequently, the proposal will be presented to the cabinet for approval.

In this context, it’s important to understand DA and how it is taxed:

What Is Dearness Allowance

The government disburses the DA to its workforce, including employees and pensioners, with the intention of mitigating the effects of inflation. The need for consistent augmentation of government employees' effective remuneration arises to counter the escalation of living costs. Although the government has introduced various measures to curb inflation rates, their efficacy has been only partial due to the market-driven fluctuations in prices.

Hence, it becomes imperative for the government to safeguard its employees from the adverse consequences of inflation. Recognizing that inflation's impact can differ based on an employee's geographical location, the DA is computed accordingly. Consequently, the DA fluctuates from one employee to another, contingent on their affiliation with the urban, semi-urban, or rural sectors.

Calculation Of Dearness Allowance

Given that the purpose of DA is to shield employees from the inflationary effects within a specific fiscal year, its computation occurs bi-annually, typically in January and July. The government revised the formula for calculating the dearness allowance in 2006. At present, the DA is computed based on the subsequent formula:

For Central Government Employees

DA per cent = [(Average of AICPI (Base Year 2001 = 100) for the last 12 months – 115.76)/115.76] x 100

For Public Sector Employees

DA per cent = [(Average of AICPI (Base Year 2001 = 100) for the last 3 months – 126.33)/126.33] x 100.

Here, AICPI means All-India Consumer Price Index.

Taxation Of Dearness Allowance

Says Archit Gupta, founder and CEO, Clear, a tax portal: “According to the most recent information, DA is subject to full taxation for salaried workers. In cases where an employee receives unfurnished rent-free accommodation, the portion of the salary up to which it contributes to the employee's retirement benefit salary is considered, provided all other requisite conditions are fulfilled. Under the Income Tax regulations in India, it is obligatory to distinctly indicate the dearness allowance component in the filed tax returns.”

Types Of Dearness Allowance

When it comes to calculation, DA is segmented into two distinct categories: Industrial DA and Variable DA.

Industrial Dearness Allowance (IDA) is applicable to public sector employees of the central government. The Industrial DA designated for public sector employees is reviewed every quarter, adjusting in response to fluctuations in the Consumer Price Index. This practice aims to counteract the effects of ascending inflation levels.

Variable Dearness Allowance (VDA) is relevant to Central Government employees. It undergoes revision biannually in accordance with the Consumer Price Index, acting as a countermeasure against the effects of escalating inflation.

The VDA is contingent on three distinct components, as detailed below:

Base Index: This remains constant over a specific duration.

Consumer Price Index: This influences VDA as it undergoes monthly fluctuations.

The fixed amount of Variable DA, as determined by the government, persists until any revision in the fundamental minimum wages by the government occurs.

Dearness Allowance For Pensioners

Pensioners, within this context, pertain to former central government employees who are entitled to receive either individual or family pensions from the government. Whenever a new salary structure is introduced by the Pay Commission, the corresponding adjustments are also applied to the pension of retired personnel. Similarly, modifications in the DA by a specific percentage result in corresponding revisions to the pensions of retired individuals.

During re-employment, pensioners are not eligible to receive DA except when re-employed under time scale or fixed pay conditions. However, in some cases, pensioners might be entitled to receive DA if re-employed, with the provision limited to their last drawn pay. Notably, DA is not disbursed to pensioners during their re-employment tenure in a foreign country. Nonetheless, pensioners residing abroad without being re-employed retain eligibility for receiving DA based on their pension.