Every April, some HR manager in Pune or Hyderabad gets the same email from a confused employee: “Why did my HRA exemption change this year?” Until FY 2025-26, the honest answer was that Bengaluru, Pune, Hyderabad and Ahmedabad were treated as non-metro cities for tax purposes — capped at 40% HRA exemption — even though rents there rival Mumbai and Delhi. From FY 2026-27, that has changed. If you’re running payroll for an Indian SME, this one rule shift touches almost every CTC structure you own.
TL;DR
- HRA exemption is the tax-free slice of House Rent Allowance under Section 10(13A) of the old Income Tax Act (now Section 11 read with Schedule III of the Income Tax Act, 2025) — available only under the old tax regime.
- From FY 2026-27, eight cities — Delhi, Mumbai, Kolkata, Chennai, Bengaluru, Pune, Hyderabad and Ahmedabad — qualify for the higher 50% exemption rate. Every other city stays at 40%.
- Exemption = the lowest of: actual HRA received, 50%/40% of Basic + DA, or rent paid minus 10% of Basic + DA.
- Get the metro classification wrong in payroll and you’ll either over-deduct TDS or misreport exempt income — both land as employee complaints and Form 16 mismatches.
What HRA exemption actually is (and why it lives inside your CTC)
House Rent Allowance is the salary component employers pay to help employees cover rent. It is not extra money outside CTC — it’s carved out of the same annual number you quote at offer stage, usually structured as 40-50% of Basic pay. HRA exemption is the portion of that allowance that escapes income tax under Section 10(13A), provided the employee is salaried, lives in rented accommodation, and files under the old tax regime.
Because HRA sits inside CTC, how you structure the Basic-HRA split directly decides how much of an employee’s package is tax-free versus fully taxable. This is exactly the calculation our free CTC Salary Calculator handles automatically when you’re building an offer or explaining a payslip to someone who thinks their “in-hand” number should match their CTC.
The 2026 change: four more cities join the 50% club
Since 1971, only four cities — Delhi, Mumbai, Kolkata and Chennai — got the 50% HRA exemption rate. Every other city, including Bengaluru and Pune, was stuck at 40%, a classification that hadn’t kept pace with how expensive those rental markets had become. The Income Tax Act, 2025 (effective 1 April 2026) revised this through updated rules that extend the 50% rate to Bengaluru, Hyderabad, Pune and Ahmedabad as well.
Two things HR teams need to get right here:
- It applies from FY 2026-27 onward, not retroactively. If you’re still closing FY 2025-26 payroll or filing that year’s ITR, the old 40% rate applies to these four cities.
- Employees need to re-declare. Anyone in these newly-added cities should submit a fresh rent declaration (Form 12BB) so payroll applies the correct 50% exemption instead of defaulting to the old 40% slab.
The three-way formula, worked out
HRA exemption is always the lowest of three amounts. Here’s the comparison HR teams should be running for every rent declaration:
| Condition | Metro cities (8, FY 2026-27) | Non-metro cities |
|---|---|---|
| 1. Actual HRA received | Actual HRA received | |
| 2. Percentage of salary | 50% of Basic + DA | 40% of Basic + DA |
| 3. Rent-based limit | Rent paid − 10% of Basic + DA | |
Take Rahul, an employee at a 120-person IT firm in Pune, drawing Basic ₹30,000/month and HRA ₹15,000/month, paying ₹18,000/month rent. Annualised: Basic + DA = ₹3,60,000; HRA received = ₹1,80,000; rent minus 10% of Basic = ₹2,16,000 − ₹36,000 = ₹1,80,000.
- Old classification (Pune at 40%): lowest of ₹1,80,000, ₹1,44,000, ₹1,80,000 → exemption = ₹1,44,000.
- FY 2026-27 classification (Pune at 50%): lowest of ₹1,80,000, ₹1,80,000, ₹1,80,000 → exemption = ₹1,80,000 (his entire HRA is now tax-free).
That’s ₹36,000 of additional exempt income — roughly ₹7,200-11,000 back in Rahul’s pocket depending on his slab, just from a classification update your payroll system needs to catch.
Old regime vs new regime: does this even matter for your employees?
HRA exemption is only available under the old tax regime. Under the new regime, the entire HRA is taxable, but slab rates are lower and the standard deduction is more generous. This is why so many employees genuinely don’t know which regime saves them more — and why “just pick the new regime, it’s simpler” is bad advice for anyone paying substantial rent in a metro city.
When employees ask HR to help them decide, you’re really running two payroll scenarios side by side: one with HRA exemption plus other old-regime deductions, one without. Statutory deductions like professional tax and PF/ESI also shift the comparison, so it helps to have the Professional Tax Calculator and PF & ESI Calculator open alongside the CTC breakup rather than doing this on a notepad every appraisal season.
How this changes CTC structuring for HR teams
A practical checklist for the April payroll cycle:
- Update the city-to-metro mapping in your payroll master before the first FY 2026-27 payslip runs — don’t leave Bengaluru, Pune, Hyderabad and Ahmedabad employees on the old 40% default.
- Collect fresh rent receipts and Form 12BB declarations, with landlord PAN wherever annual rent exceeds ₹1 lakh.
- Re-check your Basic:HRA ratio during offer and appraisal cycles — a 40:50 split that made sense under the old classification may now under-utilise the exemption headroom.
- Communicate the change proactively. A payslip that suddenly shows a different take-home number without explanation is how HR inboxes fill up every April.
- Reconcile TDS on salary against the new exemption before Form 16 generation, so Q4 numbers don’t need correction later.
If you’re revising salary structures anyway, this is a good moment to run the full breakup — Basic, HRA, special allowance, PF, ESI, professional tax — through the CTC Salary Calculator rather than rebuilding the formula in a spreadsheet every cycle. EZHRM’s TDS & Form 16 module also picks up the correct exemption automatically once the city mapping is updated, so you’re not reconciling it manually at year-end.
Common mistakes HR managers get wrong on HRA
- Applying the old 40% rate to newly-metro cities out of habit. Payroll systems that weren’t updated after April 2026 are still under-crediting employees in Bengaluru, Pune, Hyderabad and Ahmedabad.
- Skipping the landlord PAN requirement. Annual rent above ₹1 lakh without a PAN (or a signed no-PAN declaration) means the exemption gets disallowed at assessment, and the employee blames HR.
- Exempting the full HRA without running all three conditions. It’s tempting to just exempt whatever HRA was paid — but the least-of-three rule can cap it well below the actual amount, especially for low-rent, high-HRA structures.
- Not distinguishing regime choice at the individual level. Every employee can choose their regime independently; a blanket assumption for the whole company skews TDS for anyone who opts out.
- Forgetting mid-year city moves. An employee transferred from Chennai to a non-metro branch mid-year needs a split calculation, not one rate applied to the full year.
Frequently asked questions
Is HRA exemption available under the new tax regime?
No. HRA exemption under Section 10(13A) applies only if the employee opts for the old tax regime. Under the new regime, the full HRA amount is added to taxable salary.
Which cities qualify for the 50% HRA exemption rate from FY 2026-27?
Eight cities: Delhi, Mumbai, Kolkata, Chennai (the original four), plus Bengaluru, Pune, Hyderabad and Ahmedabad, added under the Income Tax Act, 2025 rules effective 1 April 2026. All other cities remain at 40%.
Do employees need to submit landlord PAN for HRA claims?
Yes, if annual rent exceeds ₹1 lakh. Without it, employees need a self-declaration from the landlord confirming they don’t have a PAN, otherwise the exemption can be disallowed.
Can an employee claim HRA exemption while paying rent to parents?
Yes, provided the arrangement is genuine, rent is actually paid, and the parent reports it as rental income in their own ITR. Rent paid to a spouse is not eligible.
Does the new metro classification apply to FY 2025-26 filings?
No. The 50% rate for Bengaluru, Pune, Hyderabad and Ahmedabad applies from FY 2026-27 onward. FY 2025-26 returns (filed by July 2026) still use the 40% rate for these cities.
Does changing the HRA exemption change an employee’s CTC?
No — CTC itself doesn’t change. What changes is how much of the existing HRA component is tax-free, which affects take-home pay and TDS, not the cost to the company.
Getting this one classification wrong is a small payroll error with a very visible consequence — a payslip that doesn’t match what an employee expected. If you’re structuring offers, running appraisals, or just want a quick sanity check on a Basic-HRA split, EZHRM’s free CTC Salary Calculator applies the current metro rules automatically. You’ll find it alongside our other free HR calculators, and more compliance breakdowns like this one on the EZHRM blog.
Sources: Income Tax Department — Old vs New Tax Regime FAQs, incometax.gov.in.