Dearness Allowance (DA)

Types of Dearness Allowance

DA is classified by nature of employment and applicability of the allowances. The two primary types of DA are:

1. Industrial Dearness Allowance (IDA)

Industrial Dearness Allowance is allowed to precisely those employees who are in the public sector area and especially those in public sector undertakings (PSUs).

• Calculation: IDA is revised quarterly based on the consumer price index for industrial workers (CPI-IW).
• Purpose: It ensures that employees in industrial sectors can cope with fluctuations in inflation.

2. Variable Dearness Allowance (VDA)

Variable Dearness Allowance applies to government employees, particularly in the Central Government.

VDA consists of:

• Base Index: The benchmark inflation index.
• Consumer Price Index (CPI): Reflecting inflation trends.
• Fixed Amount: Updated periodically by the government.
• Revision Frequency: Reviewed biannually to reflect current economic conditions.

By segmenting DA into these types, employers ensure tailored adjustments that align with the economic realities of different sectors.

How is Dearness Allowance Calculated?

Dearness Allowance (DA) calculation is quite systematic on the trends of inflation and the consumer price index. Understanding what is dearness allowance is important so that the employees' salaries' value remains uncompromised during inflationary trends. The calculation of da differs slightly for Central Government employees and those in public sector undertakings (PSUs).

DA calculation formula is:

DA (%) = [(Current CPI - Base CPI) ÷ Base CPI] × 100

• Current CPI: The current CPI index shows the current rate of inflation.
• Base CPI: The index value from the base year.

For Central Government Employees (Variable Dearness Allowance)

The Variable DA is calculated biannually based on the CPI for industrial workers (CPI-IW), released by the Labour Bureau.

• The government announces the percentage DA hike after reviewing inflationary trends.
• As such when the inflation rate escalates, the DA percentage also increases for the same purpose of counteracting a hike in the cost of living.

DA calculation formula for central government employees:

DA% = [(Average of AICPI (Base Year 2001 = 100) for the last 12 months – 115.76)/115.76] x 100DA% = [(Average of AICPI (Base Year 2001 = 100) for the last 12 months – 115.76)/115.76] x 100

For Public Sector Employees (Industrial Dearness Allowance)

The Industrial DA for PSU employees is revised quarterly.

• It is directly linked to changes in the CPI-IW.
• A 3-month average CPI is used to determine the updated DA percentage.

DA calculation formula for public sector employees:

DA% = [(Average of AICPI (Base Year 2001 = 100) for the last 3 months – 126.33)/126.33] x 100DA% = [(Average of AICPI (Base Year 2001 = 100) for the last 3 months – 126.33)/126.33] x 100

Example of DA Calculation

Let’s assume:

Current CPI: 350

Base CPI: 250

Using the formula:

DA (%) = [(350 - 250) ÷ 250] × 100 = 40%

This means employees will receive an additional 40% of basic pay as Dearness Allowance.

Key Factors Impacting DA

1. Consumer Price Index (CPI)

The essential element in DA computation is the consumer price index, which is mainly the CPI for industrial workers (CPI-IW).

• Impact: If CPI is increasing, it indicates higher inflation for which DA would escalate.
• Example: If the CPI has grown significantly because of rising prices of basic goods, DA percentages are adjusted upwards.

2. Inflation Rates

DA is directly tied to inflation rates since it seeks to act as a neutralizing factor for price rises.

• High Inflation: Results in a more frequent increase in DA for adjustment in purchasing power.
• Low Inflation: Causes stable or slight adjustments to DA.

3. Government Policies

Regular government policies, mainly for central and state employees, affect DA changes a lot.

• Example: The Central Government generally revises DA twice a year (January and July). The revision is done considering the inflation rates.
• Policy decisions such as wage reforms or economic packages can also affect DA adjustments.

4. Base Year for CPI

The DA rate is affected by the CPI calculation base year.

• A new updated base year will ensure a much more precise inflation tracking process.
• If the base year changes, the CPI figures may change accordingly and thus affect the DA formula.

5. Wage Structures

The DA amount is determined by the basic pay of the employees, as it is usually calculated on a basic salary with a percentage factor.

• Higher Basic Pay: A higher basic pay results in a proportionately higher DA amount.
• Revised Pay Scales: Tends to get corresponding updates on DA rates. Typically results in changes at the same rate in DA.

Tax Implications of Dearness Allowance

• DA is fully taxable for all employees and is included in the gross salary. It is taxed according to the individual’s income tax slab rates.
• For the House Rent Allowance (HRA) exemption, DA is considered part of the salary if it is factored into retirement benefit calculations. This inclusion impacts the formula for HRA exemption.
• Minimum of actual HRA received, 50% of salary (40% for non-metros) including DA, or rent paid minus 10% of salary (including DA).
• Tax Deducted at Source (TDS) applies to DA along with other components of salary. Employers deduct TDS based on the total taxable income of the employee.
• DA affects retirement benefits, such as pension, gratuity, and leave encashment, of government employees. This is because DA will fall in the computation of the taxability of retirement benefits.
• Tax Deducted at Source (TDS) applies to DA along with other components of salary. Employers deduct TDS based on the total taxable income of the employee.
• Arrears of DA (backdated payments due to DA hikes) can push an employee into a large tax range. Relief under Section 89 of the Income Tax Act can help reduce the excess tax paid based on DA arrears.

Role of Pay Commissions in DA Adjustment

• The Pay Commissions constituted every 10 years assess the structures of remunerations and suggest changes according to prevailing situations in the economy.
• They determine and adjust Dearness Allowance (DA) for government employees as well as pensioners, according to the inflation index.
• In the case of DA calculation, the CPI base year is determined and at present the 7th Pay Commission employs a new and more relevant index.
• The formulas for calculating the DA should be standardized, and guidelines for biannual revisions in January and July.
• With regard to the 7th Pay Commission, it was stressed that DA is applicable to pensioners in order to stabilize their purchasing power.
• This step should guarantee that the DA adjustments are fair and change according to the current inflation rates.

Dearness Allowance for Pensioners

DA for pensioners is provided to retired Central Government employees, including individual and family pension recipients, to offset inflation. Revisions of DA happen biannually leading to pensions aligning with the changing economic conditions. The DA is calculated as a percentage of the basic pension, offering crucial financial support to retirees.

Re-employed pensioners generally do not receive DA, except in cases where it is limited to the last drawn salary. Pensioners living abroad can continue to receive DA, unless they are re-employed in another country. These rules help make sure that DA remains manageable and is properly given to support pensioners' needs.

Dearness Allowance Merger

• The DA Merger can be described as the integration of a part of DA to the basic wages or pension when the DA is a little over 50% or 100% of basic pay.
• The reason for this merger is to manage the current inflation and ensure that employees' and pensioners’ purchasing power matches the cost of their salary.
• DA, when added to the basic pay, helps the employee and retired employee to have a better and more stable income to live on.
• The DA merger also impacts retirement benefits by increasing the base salary on which pension and gratuity are calculated.
• Even though the merger enhances total compensation for the employees, it produces higher tax amount due to a rise in taxable income.

Recent Changes and Updates in DA

The Bihar government has approved a hike in Dearness Allowance (DA) and Dearness Relief (DR) for its employees and pensioners. The decision was taken during a state cabinet meeting. Under the 7th Pay Commission, DA and DR have been raised to 55%. Employees covered under the 6th and 5th Pay Commissions will also receive corresponding increases.