A S BANKA ADVISORS

For more than four decades, only four cities, Delhi, Mumbai, Kolkata and Chennai, let a salaried employee claim House Rent Allowance (HRA) exemption at 50% of salary. Everywhere else was capped at 40%. The Income-tax Rules, 2026, notified to operationalise the Income-tax Act, 2025 from 1 April 2026, quietly changed that. From Financial Year 2026-27, four more cities join the 50% club: Bengaluru, Hyderabad, Pune and Ahmedabad. If you employ people in any of these tech hubs, this is a payroll change you act on now, not in March.

What actually changed, and what did not

The HRA exemption used to sit in Section 10(13A) of the Income-tax Act, 1961, read with Rule 2A of the Income-tax Rules, 1962. Under the new framework it is carried into the Income-tax Act, 2025 (Schedule III, Table, Serial No. 11), with the percentages and the city list now living in the Income-tax Rules, 2026. The substantive change is narrow but real: the 50% city list expands from four to eight. Every other city in India stays at 40%. This is a one-time expansion of the list, not a blanket increase for everyone.

The exemption formula itself is untouched. HRA exempt from tax is still the least of three amounts: the actual HRA received, rent paid minus 10% of salary, and 50% of salary (now for eight cities) or 40% (everywhere else). Only the third limb moves.

The trap: a higher percentage does not always mean a bigger exemption

This is where well-meaning employers over-promise. Because the exemption is the lowest of three numbers, the 50% rate only helps when that third limb is the binding one, which happens when rent is high relative to salary. Take a Bengaluru employee on Rs 1,00,000 basic, Rs 50,000 HRA and Rs 40,000 rent per month. Rent minus 10% of salary is Rs 30,000. That stays the lowest of the three in both FY 2025-26 and FY 2026-27, so moving from 40% to 50% changes the exempt amount by nothing. For someone paying Rs 60,000 rent on the same salary, the picture flips and the 50% rate genuinely helps. The lesson for finance teams: run the three-limb test on real numbers before adjusting anyone’s TDS.

Two more catches founders keep missing

It is old regime only. The new tax regime, which is the default, allows no HRA exemption at all, in any city. This expanded list is a reason to re-run the old-versus-new comparison for affected employees, not an automatic win. Whether old wins still depends on the full deduction profile, including Section 80C, home loan interest and the rest.

The timing is period-based. For the return you file this year, for FY 2025-26 (AY 2026-27), the four new cities are still at 40%. The 50% rate applies only to salary earned on or after 1 April 2026. Apply it early and you create an excess exemption and a notice risk; apply it late and you short-change take-home pay.

A quieter compliance change: Form 124

From 1 April 2026, the employee investment and exemption declaration moves from Form 12BB to the new Form 124, governed by Section 392(5)(b) of the Income-tax Act, 2025 read with Rule 205 of the Income-tax Rules, 2026. For HRA, Form 124 now requires the employee to disclose their relationship with the landlord. Rent-to-relatives arrangements, always a soft target in scrutiny, will face sharper questions. Update your declaration collection process before the new financial year, not after.

What to do now

• Employers: reconfigure salary TDS for the four new cities from April 2026 payroll, and switch declaration collection to Form 124.
• Employees: re-run the old-versus-new regime comparison; the higher cap only matters under the old regime and only if your rent is high enough.
• Founders: revisit CTC and rent-allowance structuring for teams in Bengaluru, Hyderabad and Pune, where a large share of your headcount likely sits.

For a slide-by-slide breakdown, including the eight-city table, the three-limb test and the worked example, download the full carousel PDF.

Getting payroll structuring and the old-versus-new regime call right for a growing team is rarely a one-line answer. Need help working through it for your company? Talk to an Expert. Book a quick call: https://calendly.com/asbanka-info/30min