The Headline Change
For nearly four decades, only four Indian cities — Mumbai, Delhi, Kolkata and Chennai — were classified as "metropolitan" for the purpose of the House Rent Allowance exemption. Under the old framework carried over from Section 10(13A) of the Income-tax Act, 1961 read with Rule 2A of the Income-tax Rules, 1962, salaried employees living in these four cities could claim HRA exemption up to 50% of salary, while employees in every other Indian city — including Bengaluru, Pune, Hyderabad and Ahmedabad — were restricted to 40% of salary.
The Central Board of Direct Taxes has now corrected this anomaly. With the Income-tax Act, 2025 taking effect from 1 April 2026 and the new Income-tax Rules, 2026 notified alongside it, the list of cities eligible for the 50% salary ceiling has been expanded to include Bengaluru, Pune, Hyderabad and Ahmedabad. The revised classification takes effect from 1 April 2026, which means it applies to HRA exemption computations for Tax Year 2026-27 onwards (the new Act replaces the earlier "previous year/assessment year" framework with a single "Tax Year" concept). From this date, the 50% cities list stands at eight: Mumbai, Delhi, Kolkata, Chennai, Bengaluru, Pune, Hyderabad and Ahmedabad.
The Least-of-Three Formula
Before looking at what changed, it helps to restate what does not change. The mechanics of HRA exemption — preserved in the Income-tax Rules, 2026 and earlier embodied in Rule 2A of the 1962 Rules — compute the exemption as the least of the following three amounts:
- The actual HRA received from the employer for the period during which rented accommodation was occupied
- Rent paid minus 10% of salary for the relevant period
- 50% of salary if the accommodation is in a qualifying city, or 40% of salary in any other case
"Salary" for this purpose means basic salary plus dearness allowance (to the extent it forms part of retirement benefits) plus any commission based on a fixed percentage of turnover. The exemption is available only under the old tax regime. Employees who opt for the new regime — which has been the default since the concessional slab rates became the standard — forfeit the HRA exemption entirely, a point we return to below.
What Actually Changed — and What Did Not
The only limb of the formula affected by the Income-tax Rules, 2026 is the third one: the city-based ceiling. The first two limbs — actual HRA received, and rent minus 10% of salary — are unchanged. That matters, because in most real-life cases the binding constraint is not the city percentage but the "rent minus 10% of salary" figure. The expansion to 50% will meaningfully increase exemption only where the third limb was previously the lowest of the three.
Why the Change Was Overdue
The four-metro classification dates back to an era when Bengaluru, Pune, Hyderabad and Ahmedabad were second-tier cities in population and cost-of-living terms. That ceased to be true years ago. Bengaluru has been, for most of the last decade, the most rent-inflation-prone city in the country, with prime residential rents in areas like Indiranagar, Koramangala and Whitefield now comparable to south Mumbai. Pune, Hyderabad and Ahmedabad have all seen similar trajectories driven by IT, pharma and GCC expansion. Continuing to classify them as 40% cities created an inequity that employers, employees and the CBDT itself had acknowledged for years. The Income-tax Rules, 2026 finally aligns the statutory ceiling with economic reality.
Illustrative Computation: Bengaluru Employee, Tax Year 2026-27
Consider Priya, a salaried employee in Bengaluru with the following annual figures for Tax Year 2026-27:
- Basic salary: Rs 15,00,000 (no DA, no commission)
- HRA received: Rs 5,00,000
- Rent paid: Rs 45,000 per month = Rs 5,40,000 annually
- 10% of salary: Rs 1,50,000
The three limbs of the formula work out as follows:
| Limb | Computation | Amount (Rs) |
|---|---|---|
| (a) Actual HRA received | As per salary structure | 5,00,000 |
| (b) Rent paid minus 10% of salary | 5,40,000 - 1,50,000 | 3,90,000 |
| (c) City ceiling — old (Bengaluru at 40%) | 40% x 15,00,000 | 6,00,000 |
| (c) City ceiling — new (Bengaluru at 50%) | 50% x 15,00,000 | 7,50,000 |
Under both the old and the new classification, the least of the three amounts is limb (b) — Rs 3,90,000. In Priya's case, the shift from 40% to 50% does not change her exemption: it remains Rs 3,90,000 either way, because the rent-minus-10%-of-salary figure is the binding constraint.
Now suppose Priya's rent increases to Rs 70,000 per month (Rs 8,40,000 annually), which is not unusual for a family apartment in central Bengaluru. Limb (b) becomes Rs 8,40,000 - Rs 1,50,000 = Rs 6,90,000. Her HRA received is still Rs 5,00,000. Under the old 40% classification, the city ceiling was Rs 6,00,000, so the exemption was restricted to the least of (5,00,000; 6,90,000; 6,00,000) = Rs 5,00,000. Under the new 50% classification the city ceiling is Rs 7,50,000, and the least of (5,00,000; 6,90,000; 7,50,000) remains Rs 5,00,000. In this scenario too, the actual HRA received is the binding limb and the city percentage does not drive the outcome.
Where the 50% ceiling genuinely bites is the case of an employee with a very high HRA component and high rent. Take the same Rs 15,00,000 basic, but assume HRA of Rs 8,00,000 and rent of Rs 80,000 per month (Rs 9,60,000 annually). Limb (a) is Rs 8,00,000. Limb (b) is Rs 9,60,000 - Rs 1,50,000 = Rs 8,10,000. Under the old 40% rule, limb (c) was Rs 6,00,000 and the exemption was capped at Rs 6,00,000. Under the new 50% rule, limb (c) is Rs 7,50,000, so the exemption rises to Rs 7,50,000 — a jump of Rs 1,50,000 in exempt income and, at a 30% marginal rate, roughly Rs 46,800 of additional tax saving in a single year. That is the archetypal case the amendment is designed to address.
Interplay with the New Tax Regime
None of this benefits employees who file under the new tax regime. The new regime, which has been the default for several years in return for concessional slab rates, disallows the HRA exemption entirely. A pure salaried employee does not need any special form to choose the old regime: the option can be exercised directly in the income-tax return for the year by ticking the "opting out of the new regime" box. It is only taxpayers with business or professional income who must file Form 10-IEA within the prescribed time to opt out — the form does not apply to a salaried employee with no business income. For most salaried employees earning between Rs 10 lakh and Rs 25 lakh who are paying substantial rent in a metro, the old regime with HRA plus 80C, 80D and standard deduction often remains more tax-efficient — but the comparison has to be run on actual numbers, not on defaults. The expanded HRA ceiling is one more data point pushing the math in favour of the old regime for high-rent metro employees.
Employer Payroll Impact
Employers with offices in Bengaluru, Pune, Hyderabad and Ahmedabad will need to update their payroll systems in time for the April 2026 salary run. Specifically:
- Payroll software masters must be updated to treat these four cities as 50% cities for TDS-on-salary computation
- Form 12BB declarations submitted by employees for Tax Year 2026-27 should be processed using the revised ceiling where the employee is in the old regime
- HR and payroll teams should proactively communicate the change so that employees who previously opted for the new regime because HRA was capped are given a fresh opportunity to reassess the regime choice
- Finance teams should expect a small reduction in TDS deducted at source for affected employees and plan cash-flow accordingly
Employee Action Items
- Confirm your regime. The expanded ceiling is useful only under the old regime. A pure salaried employee can simply opt out of the new regime directly in the ITR; only taxpayers with business or professional income need to file Form 10-IEA within the prescribed time.
- Re-run the comparison. If you are in Bengaluru, Pune, Hyderabad or Ahmedabad and pay substantial rent, recompute your tax liability under both regimes using the new 50% ceiling. Many borderline cases will flip in favour of the old regime.
- Keep rent documentation watertight. Rent receipts, a rent agreement, the landlord's PAN (mandatory where annual rent exceeds Rs 1,00,000) and bank transfers remain non-negotiable. The expanded ceiling does not relax any documentation requirement.
- Update Form 12BB with your employer. Your employer can give you the benefit of the higher exemption during the year only if your declaration is current.
- Remember the disclosure tightening. Alongside this change, employees are also required to disclose their relationship with the landlord to prevent sham HRA claims involving family members. Plan your documentation accordingly.
Conclusion
The extension of the 50% HRA ceiling to Bengaluru, Pune, Hyderabad and Ahmedabad is one of the rare tax changes that costs the exchequer relatively little while correcting a long-standing equity gap for India's salaried middle class in its largest metros. The benefit is real but narrowly targeted: it helps employees whose rent and HRA are high enough that the third limb of the least-of-three formula (the city-percentage ceiling under the Income-tax Rules, 2026) is the binding constraint. For everyone else — and that is still the majority of salaried taxpayers — the old limbs (a) and (b) will continue to govern the exemption. The honest answer to "how much will I save?" is: run the numbers for your specific salary, rent and regime choice, and do not assume the amendment automatically translates into a lower tax bill.
Comments (7)
Ran the numbers for three of my Pune clients this morning. Two of them the old regime now beats new by about Rs 35-50k after the ceiling change. Third one still comes out ahead on new regime because her rent is modest.
Clean writeup. One thing worth adding in a follow-up — this only corrects Rule 2A for HRA. Other Rule 3 perquisite valuations still use the old metro definitions. The city lists are not fully harmonised yet.
Good point about the landlord relationship disclosure. The department has been tightening HRA claims involving rent paid to parents and spouses for a while now.
The reminder about Form 10-IEA is crucial. I still see employees who assume HRA is automatic under the new regime. It is not.
From a payroll perspective this is a small but real system change. Already flagged to our HCM vendor to push the city master update before the April run.
The illustration is exactly right — in most cases limb (b) binds and the 50% change does nothing. The people who actually benefit are the high-HRA, high-rent segment. Worth flagging to clients who kept asking me if they'll save lakhs.
Finally. Was overdue by at least a decade. Bengaluru rents have been at Mumbai levels for years and my clients were getting squeezed by the 40% cap.