The Draft Income‑tax Rules, 2026, issued under the new Income‑tax Act, 2025, do much more than just renumber old provisions. They propose a long‑pending overhaul of exemptions on common salary components like house rent, children education, hostel expenses, transport, meals and even gift vouchers.
For many salaried taxpayers who opt for the old tax regime, these changes can translate into a very real reduction in tax outgo from FY 2025–26 (AY 2026–27) onwards, once the rules are notified.
1. Big Jump In Children‑Related Allowances
1.1 Children Education Allowance
Under the existing Income‑tax Rules, 1962, the exemption for children education allowance is a token amount: just ₹100 per month per child, up to a maximum of two children (₹2,400 a year).
The Draft Income‑tax Rules, 2026 propose a dramatic increase:
- New limit: ₹3,000 per month per child
- Maximum: Up to two children
- Annual potential exemption: ₹72,000 (₹3,000 × 12 × 2) if fully utilised
This single change takes a decades‑old, almost irrelevant figure and aligns it with the reality of current school fees in metros and Tier‑1 cities.
1.2 Children Hostel Expenditure Allowance
Similarly, hostel expenditure allowance has been largely symbolic so far: only ₹300 per month per child, limited to two children (₹7,200 a year max).
The draft rules propose:
- New limit: ₹9,000 per month per child
- Maximum: Up to two children
- Annual potential exemption: ₹2,16,000 (₹9,000 × 12 × 2) if fully utilised
Together, the enhanced education and hostel allowances create a potential tax‑free component of up to ₹2,88,000 per year for a salaried parent with two children, if the employer structures salary accordingly.
2. HRA: Wider “Metro” List And Higher Exemption Impact
The methodology of HRA exemption broadly continues: the exempt amount is the least of actual HRA received, a percentage (40% or 50%) of salary, or rent paid minus 10% of salary.
The draft rules, however, tweak the city classification in favour of taxpayers:
- Currently, only Delhi, Mumbai, Kolkata and Chennai qualify for the 50% of salary cap.
- Draft rules propose adding cities like Bengaluru, Hyderabad, Pune and Ahmedabad to this higher 50% category.
For salaried employees in these expanding metros, the move from 40% to 50% of salary in the HRA calculation can significantly increase the exempt portion, especially when rent is high relative to basic pay.
Note: HRA exemption remains available only if you choose the old tax regime. Under the new regime, HRA received becomes fully taxable without these exemptions.
3. Transport, Conveyance And “On Duty” Allowances
The draft rules also modernise transport‑related exemptions, which have long been stuck at low flat amounts.
Key points emerging from the draft framework and commentary:
- The traditional flat transport allowance exemption (for commuting) is proposed to be replaced with a formulation pegged to a percentage of basic salary, with reports pointing to a 15%‑of‑basic type formula for certain official‑duty allowances instead of a fixed ₹800 per month.
- The intent is to recognise increased fuel, commuting and travel costs, especially for employees whose roles require substantial field work or official travel.
Exact percentages and conditions will need to be tracked in the final notified rules and employer policies, but directionally, the draft clearly favours higher meaningful exemptions on genuine business‑linked travel.
4. Meal, Refreshment And Gift Vouchers
4.1 Meal / Refreshment Benefits
The draft rules seek to make employer‑provided meals and refreshments more tax‑efficient, particularly when they are provided during working hours or in the course of employment.
- Existing rules already permit certain canteen / meal benefits as perquisites with limited taxation.
- Draft Rules, 2026 reportedly enhance the value limits of such tax‑favoured meal benefits to better reflect current food prices, though final figures and caps will be clearer in the notified version.
Structured cafeteria plans and subsidised canteens could become more attractive tools in salary design for corporates.
4.2 Gift And Festival Vouchers
Under current practice, employer gifts and vouchers have a small annual tax‑free cap (commonly cited around ₹5,000).
The draft rules propose:
While still modest in absolute rupee terms, tripling the gift exemption makes festive or performance‑linked vouchers more tax‑efficient and better aligned with actual corporate gifting values.
5. Other Key Salary‑Linked Tweaks
Beyond the headline items, the draft rules hint at a broader clean‑up of perquisite valuation and salaried benefits.
Examples include:
- Perquisite valuations (such as for interest‑free or concessional loans) being recalibrated to current market rates and more transparent rule‑based computations.
- Enhanced clarity on what qualifies as “for official purposes” so that genuine business reimbursements continue to be tax‑efficient while personal benefits remain taxable.
- A more harmonised structure for multiple small exemptions, so HR and payroll teams can implement them without interpretational disputes.
These changes collectively aim to reduce litigation and create predictable treatment for common components of a salary package.
6. Old Regime vs New Regime: Critical Caveat
A very important fine print for readers is regime choice. As per current reporting on the draft rules:
- The enhanced exemptions for HRA, children education allowance, hostel allowance, various conveyance allowances and many such traditional perks are available only in the old tax regime.
- If you opt for the new regime, you get lower slab rates and a higher basic exemption, plus standard deduction, but you lose key exemptions such as HRA and children allowances; HRA becomes fully taxable and no exemption can be claimed for children education or hostel allowance.
This means high‑deduction salaried individuals (especially those with rent and children‑related costs) must carefully re‑work their old‑vs‑new regime comparison once the new draft rules are finalised.
7. How Much Can A Typical Salaried Parent Gain?
Illustration (conceptual, based on draft numbers):
- Assume a salaried employee with two school‑going children, eligible education and hostel allowance, and adequate HRA structure.
- Under current rules, they can claim at most ₹9,600 per year for education + hostel allowances together for two children.
- Under Draft Income‑tax Rules, 2026, this can jump to ₹2,88,000 per year (₹72,000 education + ₹2,16,000 hostel), plus a potentially higher HRA exemption if they live in newly upgraded “metro” cities like Bengaluru or Pune.
For a taxpayer in a 20% or 30% tax slab, the pure tax saving from children‑linked allowances alone can be substantial once employers restructure pay components to take full benefit.
8. Practical Takeaways For Salaried Individuals And Employers
For employees:
- Revisit your salary structure with HR / payroll once the rules are notified—ensure that children education, hostel and relevant allowances are explicitly built‑in.
- If you pay significant rent and have school‑going children, re‑do your old vs new regime calculator; the old regime may become more attractive for you.
- Keep proofs: rent receipts, school fee and hostel fee confirmations, and employer policy documents to substantiate claims in case of scrutiny.
For employers:
- Redesign CTC structures to take advantage of the higher exemption limits while keeping overall CTC cost constant.
- Update HR and payroll systems for new city classifications in HRA and revised caps on allowances and perquisites.
- Clearly communicate the impact of old vs new regime choices to employees, including illustrative tax‑saving comparisons under the updated draft rules.
9. Final Word: Still A Draft, But A Strong Signal
All of the above changes are contained in draft rules and could see minor refinements before final notification. That said, the direction is unmistakable: the government is trying to modernise salary‑related exemptions, especially for housing and children’s education, which had not kept pace with inflation for decades.
For a tax or finance blog, this is the right time to educate readers and clients so they can plan salary restructuring and regime choice ahead of time, instead of reacting at the last minute when rules are finally notified.
FCA, CWM (AAFM-US), CBV, CIFRS, R-ID, B.COM (H), RV* (IBBI)
Practising Chartered Accountant in Delhi NCR Since 2011. He can be contacted at ankitgulgulia@gmail.com or +91-9811653975.