Understanding Dearness Allowance (DA): Calculation, Types, and Tax Implications

Dearness Allowance(DA) is the additional payment paid by the employers to the employee as a cost-of-living adjustment. It is a component of compensation structures globally, which is designed to address the impact of inflation on the real income of employees. In simple terms, it is a percentage of salary which will be revised every 6 months according to the inflation(increase or decision in cost-of-living goods or services). It is a monetary benefit granted to employees by the government and some private sectors. The primary objective of offering the Dearness Allowance is to balance the erosion of real income over time. It acts as a cost-of-living adjustment, ensuring that employees can maintain their purchasing power with the raising in price of goods and services. The Dearness Allowance is different for every employee. It varies from location like urban areas, semi-urban areas and rural areas.

Increase in Dearness Allowance

 Recently the Union Cabinet announced a new update on the Dearness Allowance (DA) and Dearness Relief (DR) for central government employees. They announced a 4% hike in the DA and DR. It became 50% from 46% with an immediate effect for 1 jan, 2023. According to the government report, 67.95 lakh pensioners and 49.18 lakh central government employees will get benefits with this announcement. It is an update from the government for government employees. Hence, private companies may or may not follow it.

Types of Dearness Allowance

Dearness Allowance can be categorised into two types based on its purpose and specific sector. The two main types are Variable Dearness Allowance or Central Dearness Allowance(CDA) and Industrial Dearness Allowance(IDA).

Variable Dearness Allowance:

Variable Dearness Allowance is a form of compensation for employees which is designed to address the impact of inflation. It is not a fixed allowance, it is dynamic and fluctuates based on changes in the Customer Price Index(CPI). It is a type of Dearness Allowance which applies to government employees, especially in countries like India. The primary purpose of this Dearness Allowance is to counteract the impact of inflation on the real income of central government employees.

Three essential components make up VAD(Variable Dearness Allowance):

• Variable DA that remains fixed

• Base index

• CPI

Until the government raises or lowers the base minimum wage, the first part of VAD remains set. Similarly, the base index is fixed for a predetermined period. Nonetheless, the monthly fluctuations in the CPI impact the VAD’s value.

Industrial Dearness Allowance (IDA):

Industrial Dearness Allowance (IDA) is a form of compensation for employees in the industrial sector, who work in the government sector or public sector employees. Unlike Central Dearness Allowance (CDA), Industrial Dearness Allowance is specific to industrial employees and is subject to revision based on changes in the All India Consumer Price Index(CPI). The purpose of Industrial Dearness Allowance(IDA) is to counteract the impact of inflation to ensure the real income of industrial workers with the general cost of living. Industrial Dearness Allowance(IDA) adjustment is done every six months as per the fluctuations in economic conditions and inflation rates.

How To Calculate Dearness Allowance(DA)?

Dearness Allowance is calculated as a percentage of an employee’s basic salary. Calculating the Dearness Allowance requires multiple factors. The calculation of the Dearness Allowance is performed periodically. Let’s understand the calculation of Dearness Allowance-

1. Base Index: First, identify the base Consumer Price Index (CPI) or Wholesale Price Index (WPI) against which DA is calculated.

2. Current Index: Identify the current Consumer Price Index (CPI) or Wholesale Price Index (WPI). It is based on the latest data available on the internet which reflect the cost of living.

Calculate the Index Point Increase

• Base Index – Current Index = Increase in Index Points

Now, apply the approved formula-

• Dearness Allowance(DA) = (Average Index-Base Index)/Base Index * 100

Specific formulas vary according to the organisation or government policies.

Dearness Allowance(DA) in Percentage: The above formula represents the Dearness Allowance(DA) as a decimal. You can convert this decimal to a percentage by

• Dearness Allowance(DA) * 100

Final Salary

• DA Increment = (DAPercentage/100)×BasicSalary

Revised Salary

• Revised Salary=Basic Salary+DA Increment

It is good to calculate the Dearness Allowance(DA) monthly, and quarterly. half-yearly or annually as per your organisation.

For accurate Dearness Allowance(DA) data, keep accurate records of the base index, current index, calculation formula, and revised DA.

Is Dearness Allowance (DA) Under Income tax?

As per the Income Tax Act, Dearness Allowance (DA) is treated as taxable income. It is included in the total income of an individual. It follows the same rules of taxation as other salary components. If a Dearness Allowance (DA)  is received from the employee’s salary, then it forms a gross income. Your credited salary includes the Dearness Allowance (DA). Hence, you can pay tax for it under the income tax slab.

Usually, employers deduct Tax Deducted at Source (TDS) from the salary, including DA, and deposit it with the government on behalf of the employee. Hence, employees must declare the Dearness Allowance (DA) and other income details when filing their income tax return with Form 16 or other. The Income Tax Department uses all this information to tax liability and a final amount of tax.

Challenges in Dearness Allowance (DA)

There are some challenges faced in Dearness Allowance (DA) too, which include-

• Reactivity vs. Proactivity:  Dearness Allowance (DA) is needed to be reactive and adjust the salaries as per current inflation rather than proactively addressing economic challenges.

• Standardised Approach: the use of inflation is based on calculating the  Dearness Allowance, which is a standardised approach. It does not fully capture an individual’s financial needs and spending needs. It is just based on inflation rather than personal expenses.

• Financial Strain On Organisation: During high inflation,  Dearness Allowance (DA) can impose significant financial strain on organisations, especially in the public sector.

• Personalization Concerns: Many critics focus on a personalised approach for compensation over inflation. Likewise, it can better address the unique circumstances of each employee.

FAQs On Dearness Allowance (DA):-

Q.1 What is dearness allowance DA?

DA is an additional payment in the basic salary to the employee by the employer. It is a cost of living adjustment which is determined by inflation for the convenience of employees. It is a taxable allowance which comes with the gross salary. Consumer Price Index (CPI) is the primary factor needed for the calculation of DA(Dearness Allowance).

Q.2 What is the DA dearness allowance for class A?

Dearness Allowance(DA) for Class A refers to the officer and managerial position in the government of the public sector. Class A means a high position in the firm or organisation. It is also a percentage of the basic salary as per the impact of inflation. Consumer Price Index (CPI) is the primary factor needed for the calculation of DA(Dearness Allowance) for Class A category.

Q.3 What is dearness allowance DA for class A in Karnataka?

Dearness allowance DA for the class a in Karnataka is also the percentage of basic salary as per the All India Consumer Index(CPI).

Q.4 What happens when DA reaches 50%?

When DA reaches 50%, it signifies a significant adjustment in employees’ compensation to counter inflation. As a result, the real income of employees increases as per the rising cost of living.

Q.5 What is the DA rate for 6 pay?

The DA rate for the 6 pay Commission is calculated based on the all-India Consumer Price Index (CPI). It is revised twice in a year like January or July as per the Inflation or cost of Living. However, the specific rate varies for the central government and private sector.

Q.6 What is the DA rate for the 5th Pay Commission?

DA rate for 5th Pay Common is the calculation based on the CPI. The Dearness Allowance was increased from 381 to 396 percent under the 5th pay commission.

Q.7 Is Dearness Allowance taxable?

Yes, Dearness Allowance is taxable. It is fully taxable with salary, but you have to mention it at the time of Income tax Return filing.

Q.8 What is the DA on basic salary?

As per the latest update, the DA on basic salary is 50 percent which is a 4% hike. Last year it was 46 %, now it reaches 50% as per the inflation. It is applicable from 1 January.

Q.9 Who pays dearness allowance?

The employer pays Dearness Allowance. If you are a central government employee then you are paid by the government. If you are a private sector employee, then your CEO will pay you.

Q.10 Is Dearness Allowance paid monthly?

Yes, it is paid monthly. It is an additional payment which is included in your basic salary.

Q.11 What is the current DA rate?

The current DA rate is 50% from 1 January 2024. It is a hike of 4% from last year.

Q.12 How is Dearness Allowance calculated?

You can calculate Dearness Allowance with the approved formula which is DA percentage = (Average CPI – Base CPI/ Base CPI) * 100

Q.13 Do private employees get a Dearness Allowance?

As per the law, private employees are not entitled to get Dearness Allowance. However, there are many private organisations which work on these policies and provide DA to their employees.

Q.14 Is Dearness Allowance compulsory?

Yes, as per the Government of India, Dearness Allowance is compulsory in all government sectors. It is not compulsory in the private sector.