Understanding Salary Allowances and Taxation Changes: Income Tax Act 2025 in 2026

From 1 April 2026, the Income Tax Act, 2025 will replace the Income Tax Act, 1961. This transition introduces two types of changes for salaried employees and their employers. The first change is structural; section numbers and form numbers have been updated. The second change is substantive; the exemption limits for allowances and the valuation rules for perquisites have been significantly revised after remaining unchanged for over two decades.

This post serves as a reference for HR professionals, payroll teams, Chartered Accountants, and employees who need to understand the changes in salary taxation from Tax Year 2026-27 onwards. While rates and core tax slabs remain unchanged, the framework for exempt allowances and valued perquisites has been updated.

It is important to note that these changes in allowance limits and perquisite valuations primarily affect employees opting for the old tax regime. Under the new tax regime, which remains the default from April 2026, most exemptions and allowances are not available. Employees should compute their tax liability under both regimes and choose accordingly.

Section Mapping: Salary Provisions Old vs New

Before diving into the specific changes, let's look at the essential section mapping for salary-related provisions. Every reference in payroll software, investment declarations, and TDS certificates must now use the new section numbers for Tax Year 2026-27 transactions.

Basis of charge (chargeability of salary):

Section 15 of the old Act is now Section 15 of the new Act. The number is unchanged, but the provision has been reworded.

Definition of salary:

Old Section 17(1) is now Section 16 of the new Act.

Definition of perquisite:

Old Section 17(2) is now Section 17(1) of the new Act.

Definition of profits in lieu of salary:

Old Section 17(3) is now Section 17(2) of the new Act.

Deductions from salary (standard deduction, professional tax, entertainment allowance):

Old Section 16 is now Section 19 of the new Act.

House Rent Allowance exemption:

Old Section 10(13A) read with Rule 2A is now Schedule III, Serial No. 11 of the new Act, as specified by Section 11.

Special allowances under Rule 2BB:

Old Section 10(14) read with Rule 2BB is now Schedule III, Serial No. 11 as read with new Rule 280.

Leave Travel Concession:

Old Section 10(5) is now Schedule III of the new Act.

TDS on salary:

Old Section 192 is now Section 392.

Form 12BB (investment declaration):

is now Form 124.

Form 16 (annual TDS certificate):

is now Form 130.

Form 24Q (quarterly return):

is now Form 138.

1. House Rent Allowance (HRA)

Old provision:

Section 10(13A) read with Rule 2A.

New provision:

Schedule III, Sr. No. 11, specified by Section 11 of the Income Tax Act, 2025.

The exemption formula remains unchanged. It is the least of three amounts: actual HRA received, rent paid minus 10% of salary, and 50% or 40% of salary depending on the city. However, the definition of metro cities has changed.

Previously, only four cities qualified for the 50% rate: Mumbai, Delhi, Kolkata, and Chennai. Now, four additional cities have been added: Hyderabad, Pune, Ahmedabad, and Bengaluru. Employees in these cities who were previously receiving only 40% of salary as the HRA exemption base now qualify for the 50% rate.

This change is significant for salaried employees in these cities, especially those in IT, manufacturing, and financial services.

2. Allowances Under Rule 280 (Previously Rule 2BB)

Old provision:

Section 10(14) read with Rule 2BB.

New provision:

Schedule III, Sr. No. 11 read with Rule 280 of the Income Tax Rules, 2026.

The specific allowance limits have been revised substantially. Here’s a comparison of the most commonly relevant allowances.

Children's Education Allowance

Old limit:

Rs. 100 per month per child, maximum of two children.

New limit:

Rs. 3,000 per month per child, maximum of two children.

This represents a 30x increase. The old limit had been unchanged since the 1960s and was practically irrelevant given current school fees. The new limit of Rs. 3,000 per month per child — Rs. 72,000 per year for two children — provides meaningful relief for employees with school-going children.

Children's Hostel Expenditure Allowance

Old limit:

Rs. 300 per month per child, maximum of two children.

New limit:

Rs. 9,000 per month per child, maximum of two children.

This is also a 30x increase. The revised limit of Rs. 9,000 per month per child — Rs. 2,16,000 per year for two children — offers significant tax relief for employees whose children reside in hostels for educational purposes.

Transport Allowance for Employees in Transport Systems

Old limit:

Lower of 70% of allowance or Rs. 10,000 per month.

New limit:

Lower of 70% of allowance or Rs. 25,000 per month.

This applies to employees working in transport systems (railways, airlines, shipping, road transport) who do not receive a daily allowance.

Transport Allowance for Employees with Disabilities

Old limit:

Rs. 3,200 per month (flat, for blind, deaf, dumb, or orthopedically handicapped employees).

New limit:

Rs. 15,000 per month plus DA for metro cities, Rs. 8,000 per month plus DA for other cities.

The introduction of a city-based distinction and DA linkage reflects a more realistic approach to the commuting costs faced by employees with disabilities.

Underground Allowance

Old limit:

Rs. 800 per month (for employees working in underground mines).

New limit:

15% of basic pay.

This shift ensures the allowance scales with salary levels, making it relevant for senior mining sector employees who previously received no meaningful benefit from the flat amount.

3. Perquisite Valuation Changes

Old provision:

Section 17(2) read with Rules.

New provision:

Section 17(1) of the Income Tax Act, 2025 read with revised Rules under the Income Tax Rules, 2026.

The perquisite valuation rules have been significantly revised. Here are the key changes.

Motor Car Perquisite Valuation

The monthly taxable values for company-provided cars used for both official and personal purposes have been revised significantly.

Where running and maintenance expenses are borne by the employer:

For vehicles with engine capacity up to 1.6 liters, the old taxable value was Rs. 1,800 per month. The new taxable value is Rs. 5,000 per month.

For vehicles with engine capacity exceeding 1.6 liters, the old taxable value was Rs. 2,400 per month. The new taxable value is Rs. 7,000 per month.

If a chauffeur is provided, the additional taxable value increases from Rs. 900 per month to Rs. 3,000 per month.

Where running and maintenance expenses are borne by the employee:

For vehicles up to 1.6 liters, the old taxable value was Rs. 600 per month. The new taxable value is Rs. 2,000 per month.

For vehicles exceeding 1.6 liters, the old taxable value was Rs. 900 per month. The new taxable value is Rs. 3,000 per month. The chauffeur addition remains at Rs. 3,000 per month.

Note:

These fixed monthly values represent the taxable perquisite — the amount added to the employee's salary for tax computation. A higher valuation does not necessarily mean more tax; it simply means the notional benefit is now assessed at a more realistic rate.

Food and Beverage Perquisite

Old limit:

Free food and non-alcoholic beverages provided during working hours, or through paid vouchers usable only at eating joints, were exempt up to Rs. 50 per meal.

New limit:

Rs. 200 per meal.

The Rs. 50 limit had been unchanged for over two decades and was disconnected from actual meal costs. The revised Rs. 200 per meal limit is a practical update that makes employer-provided meal vouchers genuinely useful.

Gift, Vouchers, and Tokens

Old limit:

Gifts, vouchers, or tokens from the employer up to Rs. 5,000 in aggregate per year were not taxed as perquisites.

New limit:

Rs. 15,000 in aggregate per year.

Any gifts received above this threshold are taxed at actual cost or face value. The 3x increase in this limit means that festival gifts, occasion vouchers, and performance tokens of reasonable value can now be provided by employers without creating a perquisite tax burden for the employee.

Interest-Free or Concessional Loans

Old limit:

No taxable perquisite if the aggregate loan amount does not exceed Rs. 20,000.

New limit:

No taxable perquisite if the aggregate loan amount does not exceed Rs. 2,00,000.

This is a 10x increase in the small loan exemption threshold. The method of valuation for loans above this threshold remains unchanged — the taxable value is calculated as interest at the SBI rate applied to the maximum outstanding monthly balance, minus any interest actually paid by the employee. Loans for specified medical treatments under Rule 18 continue to be exempt regardless of amount.

Employer-Provided Education for Employee's Children

Old limit:

Rs. 1,000 per month per member.

New limit:

Rs. 3,000 per month per member.

The perquisite is taxable only if the cost of education per household member exceeds Rs. 3,000 per month. Below this threshold, no perquisite value is assigned.

Non-Monetary Perquisites for Lower-Income Employees

Old limit:

Employees with salary income up to Rs. 50,000 were exempt from tax on non-monetary perquisites such as medical facilities.

New limit:

The threshold has been increased to salary income up to Rs. 4,00,000.

This substantial expansion brings a much larger section of the salaried workforce within the exemption.

Medical Facilities Abroad

Old provision:

The exemption for travel costs (for patient and one attendant) to seek medical treatment abroad was restricted to employees with a Gross Total Income of Rs. 2 lakhs or less.

New provision:

The GTI threshold for the travel cost exemption has been raised to Rs. 8,00,000.

The expenditure on medical treatment and stay abroad continues to be exempt only up to the limit permitted by the Reserve Bank of India.

4. Leave Travel Concession (LTC)

Old provision:

Section 10(5) of the old Act.

New provision:

Schedule III of the Income Tax Act, 2025.

Three specific changes have been made to the LTC provisions.

The old restriction to National Carrier fares for air travel has been removed. The exemption is now based on the actual fare of the entitled class on the shortest route.

For journeys to destinations not connected by a recognized public transport system, the exemption is now calculated at a standardized rate of Rs. 30 per kilometer.

A new compliance requirement has been introduced: employees must submit travel evidence using the prescribed Form 124. Failure to submit Form 124 will result in forfeiture of the LTC exemption even if travel was actually performed.

5. Standard Deduction and Other Salary Deductions

Old provision:

Section 16 of the old Act.

New provision:

Section 19 of the Income Tax Act, 2025.

The standard deduction remains at Rs. 75,000 for Tax Year 2026-27, unchanged from what was introduced in the Budget 2024. Professional tax paid by the employee remains deductible. The entertainment allowance deduction for government employees remains unchanged. The relief provision for arrears of salary continues under the new Act, with the computation done using the notified online form.

Quick Reference Summary Table

For payroll teams and HR professionals who need a quick reference, here is a consolidated summary of all the key changes.

What This Means in Practice

If you need help reviewing your salary structure for Tax Year 2026-27, restructuring allowances under the new rules, or updating your payroll and accounting systems to reflect the new section references, book a free 30-minute consultation with our team.