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For tax year 2026-27, a private-sector employee posted in a metropolitan city receives a city compensatory allowance in cash to meet the higher cost of living there. How is it treated under the…

Question and options

For tax year 2026-27, a private-sector employee posted in a metropolitan city receives a city compensatory allowance in cash to meet the higher cost of living there. How is it treated under the Income-tax Act, 2025?

  1. Taxable in full under the head “Salaries”

  2. Exempt up to the limit prescribed for special allowances

  3. Exempt in full as a compensatory allowance

  4. Taxable only on the amount above actual extra costs

Answer and explanation

Correct answer: A - Taxable in full under the head “Salaries”

A city compensatory allowance is not among the special allowances that the Act and the Rules exempt, so the whole of it is added to salary. Only notified allowances, such as those met wholly for official duties or certain area and children's allowances, are exempt up to prescribed limits; a cost-of-living allowance for a city is not one of them.

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