The maximum amount of House Rent Allowances (H.R.A.) permitted to be enjoyed by an employee tax-free is up to 50% of the salary in the metros namely Delhi, Kolkata, Mumbai and Chennai and 40% in other cities.
If you notice carefully, there is a clause of “up to” and not flat. This was quite interesting to me when I figured that out. Why not keep it flat? The following is the reason. The government wants some amount of money to be paid by the employee from his pocket which does comes back to exchequer. According to 2A section of the Income Tax Act, the employee has to bear a minimum of 10% of the salary as Rent so that he can get the full benefit of 50% or 40% depending on where he is located.
To make things clear, consider:
Ramu gets Rs. 1000 as salary and he stays in Bangalore. Now for him to get the complete 40% of the salary as Tax Free he has to take a house for rent for a minimum of Rs. 500.
Confused?? Ramu to make his 40% of income tax free he has to ensure that clause 2A is met, i.e. 10% of the salary, Rs.100 has to be paid in excess than that of 40% of salary. Since his salary is Rs. 1000, he can get tax rebate of up to Rs. 400. In order to get Rs. 400 tax rebate he has to rent a house for Rs. 500 (Rs. 400 + 10% of Rs. 1000).
You might be thinking it is strange but that is how the government provides the tax break. Government ensures that you spend money either by paying your tax or by paying your land lord and not keeping it to yourself.
Just to keep in mind, Government sucks money from you if you are employee. It ensures that you pay the big fat fellow money before laying your hands. By the application of the Income Tax Act 2A, you can save up to 50% of your salary if you reside in any of the metros or 40% if you reside in other cities. Condition is you have to spend 10% extra.