NRI Tax on Employer Expat Benefits: COLA, Housing, School Fees and Tax Equalisation

An Indian software architect at a Bengaluru IT company is posted to Dubai for two years. His Indian contract stays intact, his CTC goes up by about AED 11,000 a month in location allowances, and his HR team tells him not to worry because he is "going NRI." Six months after he moves, his employer's payroll team calls to say the Dubai allowances need to be included in his Indian TDS calculation. He had spent those allowances. He had not set aside a rupee for Indian tax on them.

This is not a rare story. It happens across every sector where Indian employers post staff abroad: IT services, engineering, banking, pharmaceuticals. The tax on expat allowances is one of the most consistently mishandled areas of NRI compliance, and the mishandling almost always runs in the same direction. The employee assumes NRI status frees him entirely from Indian tax on the foreign posting income. The employer's payroll team either makes the same assumption or quietly excludes the allowances from the TDS computation to keep the cost-to-company figure tidy. The result is an underreported liability that sits quietly until a notice or a job change brings someone's attention to it.

The 30-second answer: Salary and allowances paid by an Indian employer are taxable in India under Sections 5 and 15 of the Income Tax Act, even if payment is made in Dubai dirhams, Singapore dollars or British pounds, and even if the work is performed entirely outside India. Becoming a non-resident for Indian tax purposes removes you from tax on foreign-source income, but it does not remove you from Indian tax on income whose source is an Indian employer obligation. The exemptions under Rule 2BB cover specific allowances (HRA, conveyance, a handful of duty-specific categories) but do not blanket-exempt COLA, housing or school fees. On the other side: allowances paid by a foreign employer for work done outside India are not taxable in India when the employee is non-resident for that year. The practical risk is that most Form 16s from Indian employers on foreign postings incorrectly handle this, and tax equalisation, if offered, has its own gross-up trap that compounds the liability if not modelled correctly.

This guide is for two sets of people. The first is the Indian employee posted abroad by an Indian employer, which is the far more common situation and the one that creates most of the compliance gaps. The second is the foreign employee posted to India, where the direction of the problem is different but the concepts overlap. What follows covers the legal basis, the exemptions that actually apply, the tax equalisation mechanics, and a worked example using an Indian IT engineer posted to Dubai.

The legal basis: why NRI status does not solve the problem

The widespread belief that becoming an NRI exempts you from Indian tax on everything earned abroad rests on a real rule applied to the wrong situation. The rule is in Section 5 of the Income Tax Act: a non-resident is taxable in India only on income that is received or deemed to be received in India, or that accrues or arises in India, or that is deemed to accrue or arise in India.

The key is what "accrues or arises in India" means for salary. Section 9(1)(ii) of the Act deems income to accrue or arise in India if it is earned in respect of services rendered in India. But salary from an Indian employer does not stop being Indian-source simply because the employee is physically working in Dubai. The employer is an Indian entity. The contract is governed by Indian law. The obligation to pay flows from the Indian employment agreement. The employer's cost is accounted for in India.

The courts and the department have consistently treated salary paid by an Indian employer under an Indian contract as having an Indian source, regardless of the physical location of the employee. The exemption for non-residents is designed for genuinely foreign-source income, the classic case being a former India resident who takes up employment in a foreign country with a foreign company and receives salary from that foreign entity. When the employer is Indian and the contractual obligation is Indian, the non-resident exemption for foreign-source income does not apply. You are a non-resident, but your salary income still has an Indian source.

This is the legal underpinning of the problem. The engineer in Dubai on an Indian IT company's payroll owes Indian tax on his full package, base and allowances, not because India is overreaching but because the income genuinely originates in India by the statutory test.

What Rule 2BB actually exempts, and what it does not

Rule 2BB of the Income Tax Rules prescribes the allowances that are either fully or partially exempt under Section 10(14) of the Act. Knowing what Rule 2BB covers precisely, rather than relying on a general sense that "allowances are partly exempt," is the difference between correct planning and an inadvertent shortfall.

The Rule 2BB exemptions that are relevant for a foreign posting fall into two groups.

Group one: fully exempt regardless of amount. These include allowances to meet costs of travel on tour or transfer, daily allowances on official tour (covering food and accommodation costs on genuine business travel), allowances for research or training, and allowances paid to tribal-area employees in specified states. For an employee on a foreign posting, daily allowances for specific business trips within the posting country fall here, but the ongoing cost-of-living allowance covering the higher general cost of living in the host city does not.

Group two: exempt up to a prescribed limit. The relevant ones for a foreign posting are:

• House Rent Allowance under Section 10(13A): Exempt subject to the least of: actual HRA received, rent paid minus 10% of salary, and 50% of salary for metros or 40% for other cities. In the Indian context this is computed against Indian salary, and for an employee actually living in Dubai the rule applies oddly because the "city of residence" is not an Indian city, but the exemption calculation is still made on the Indian salary figure. In practice many employers apply the formula against the base Indian salary component only, which limits the exempt amount. The housing allowance paid separately as a Dubai-specific allowance is not HRA; it is a separate allowance and does not automatically inherit the Section 10(13A) treatment.

• Conveyance allowance: Exempt up to Rs 19,200 per year (Rs 1,600 per month) where no transport is provided by the employer.

• Children's education allowance: Exempt at Rs 100 per month per child for a maximum of two children, so Rs 2,400 per year. If an Indian employer posts an employee to Dubai and pays a school fees allowance of, say, Rs 2,50,000 per year for two children in an international school, the exempt portion is a flat Rs 2,400 and the remaining Rs 2,47,600 is taxable. This is the number that shocks most families: the exemption is calibrated for Indian government schools and has not moved materially in decades. It bears no relationship to what international school fees cost.

• Hostel expenditure allowance: Rs 300 per month per child, maximum two children, Rs 7,200 per year.

• Specific duty-related allowances: Border area allowances, tribal area allowances, island duty allowances, and so on. None of these cover foreign postings in a commercial sense.

The practical conclusion from scanning Rule 2BB carefully: COLA, housing allowances above the HRA formula, school fees above Rs 2,400 per year, and home-leave flight tickets are taxable. The exemptions are small, fixed, and were designed for the domestic posting context. They do not provide meaningful relief for the allowance packages typical of foreign postings.

The home-leave ticket: specifically taxable, frequently missed

Home-leave travel allowance is the annual or biannual company-paid flight between the posting city and the employee's home city. In a Dubai posting this is typically a return business or economy ticket from Dubai to the employee's home city in India, paid by the employer or reimbursed on submission.

The exemption that sometimes gets applied here is the leave travel concession (LTC) under Section 10(5), which exempts the cost of travel in India for the employee and family on leave, twice in a block of four years. The exemption covers the shortest route in India only. A Dubai-to-Mumbai flight reimbursed as home leave is not LTC: the journey starts abroad, the exemption covers journeys within India, and the block-of-four-years structure applies to Indian domestic travel only. The employer-paid or reimbursed Dubai-Mumbai return ticket is fully taxable as a perquisite under Rule 3 of the Income Tax Rules, which values employer-provided travel at the cost of economy class fares on the national carrier. If the employer pays business class, the entire amount is the taxable perquisite value. There is no partial exemption for cross-border home leave in the rules.

Tax equalisation: the mechanics and the gross-up trap

Tax equalisation is a promise the employer makes: you will not be financially worse off on tax just because we sent you abroad. In exchange for giving up any windfall from a low-tax posting, you are protected from additional tax cost at a high-tax posting. The mechanism works as follows.

The employer calculates a notional tax: what you would have paid in India if you had stayed home and earned only your home-country package. That notional tax is deducted from your gross pay, as if you had paid it. The employer then picks up the actual Indian tax liability and any host-country tax liability in full.

The problem in the Indian context is that the employer-paid tax is itself additional taxable income in your hands. When an employer pays Rs 8,00,000 in Indian income tax on your behalf, that Rs 8,00,000 is a perquisite under Section 17(2) read with the perquisite valuation rules, and it must be included in your taxable salary. That inclusion increases your taxable income, which increases the tax due, which the employer again pays, which again becomes income. In practice this is modelled as a gross-up calculation, where the final taxable salary figure incorporates the employer-paid tax through an iterative formula. The mathematics are straightforward once you recognise the loop; the problem is that many employer payroll teams do not run the loop correctly, or at all.

The gross-up formula for Indian purposes: if the tax rate applicable to the employer-paid tax portion is T, then the grossed-up taxable amount is the employer-paid tax divided by (1 minus T). At a combined marginal rate of 34.32% (30% base plus 4% cess), the gross-up multiplier is approximately 1.52. An employer paying Rs 5,00,000 in Indian tax on your behalf needs to gross up your salary by approximately Rs 7,60,000 to account for the tax-on-tax effect. Form 16 should reflect this grossed-up figure. When it does not, the reported income is too low, and the assessment-year gap is precisely the kind of entry the income tax department's data-matching systems flag.

When allowances are genuinely not taxable in India

There is a scenario where the Indian tax on expat allowances genuinely does not apply, and it is worth being precise about the conditions.

Foreign employer, work outside India, non-resident employee: If you take up employment with a foreign company, your work is physically performed outside India, your salary and allowances are paid by the foreign employer from foreign funds, and you are a non-resident for Indian tax purposes in that year, your employment income has no Indian source and is not taxable in India. This is the textbook NRI exemption and it works exactly as the popular understanding suggests, but only in this specific configuration.

Foreign employer, India assignment: The reverse case, where a foreign employer posts an employee to India, is fully taxable in India once the employee is resident. Income from services rendered in India by a non-resident may also be taxable in India under Section 9(1)(ii) even if the employee remains technically non-resident for the year, if they cross into Indian taxability under treaty provisions or the 120-day/182-day tests. The foreign employer will often have a shadow payroll obligation in India and a TDS withholding requirement if the assignment is substantial.

Indian employer, salary for genuinely India-based work only: If the Indian employer posts an employee abroad but there is a formal split in the employment contract such that part of the compensation is paid by a foreign affiliate for local employment services, the foreign-affiliate portion may have a foreign source and may escape Indian tax. This requires a genuine arm's-length arrangement with a separate foreign employment agreement, not merely routing a portion of the same Indian salary through a foreign payroll. Transfer pricing rules and the controlled transaction tests mean this needs to be documented properly to survive scrutiny, and many arrangements that look like a clean split on paper do not pass that test in practice.

The honest summary: if the employer is Indian and the contract is Indian, becoming NRI helps your tax position on truly foreign-source income (returns on overseas investments, dividends from a foreign employer's equity held abroad, etc.) but does not help on the employer's compensation package.

Worked example: Indian IT engineer posted to Dubai

Arjun is a senior software engineer at a mid-sized Indian IT services company. On 1 June 2025 he is posted to Dubai to lead a client delivery project. His employment contract remains with the Indian entity. His FY 2025-26 Indian salary before the posting (April and May 2025) is Rs 3,00,000 per month, so Rs 6,00,000 for the two months in India. For the ten months from June 2025 he receives the following from the Indian entity:

• Base salary: Rs 3,00,000 per month (paid to his Indian account, unchanged)
• COLA: AED 3,000 per month (approximately Rs 68,400 per month at AED 1 = Rs 22.80)
• Housing allowance: AED 8,000 per month (approximately Rs 1,82,400 per month)
• School fees allowance: Rs 25,000 per month (one child)
• Home leave ticket: one business class return Dubai-Mumbai flight per year, actual cost Rs 1,20,000

Arjun is in India for April and May 2025 (61 days) and in Dubai from 1 June 2025 to 31 March 2026 (304 days). His physical presence in India in FY 2025-26 is 61 days. Under Section 6(1), a person is resident if present in India for 182 days or more in the year, or 60 days or more in the year and 365 days or more in the preceding four years. Arjun likely crosses the four-year test (he was India-based until May 2025), so with 61 days in the current year he is resident for FY 2025-26. He will turn non-resident the following year if he stays in Dubai.

For FY 2025-26 Arjun is resident, so all his income is taxable, including the Dubai allowances. The tax position for FY 2025-26 is relatively clean because his residency is clear. The complex year is FY 2026-27, his first full non-resident year, when the allowances are still being paid by an Indian employer.

FY 2026-27 scenario (first full non-resident year):

Arjun is in Dubai from 1 April 2026 to 31 March 2027, with two short trips to India totalling 25 days for client meetings and training. He is a non-resident for FY 2026-27. His package is:

Component	Monthly	Annual
Base salary (Indian payroll)	Rs 3,00,000	Rs 36,00,000
COLA (AED 3,000 at Rs 22.80)	Rs 68,400	Rs 8,20,800
Housing allowance (AED 8,000 at Rs 22.80)	Rs 1,82,400	Rs 21,88,800
School fees allowance	Rs 25,000	Rs 3,00,000
Home leave ticket	(one flight)	Rs 1,20,000
Gross package		Rs 70,29,600

Now the exemption analysis:

• Base salary Rs 36,00,000: Fully taxable. Indian employer, Indian source.
• COLA Rs 8,20,800: No specific Rule 2BB exemption covers cost-of-living allowances for foreign postings. Fully taxable.
• Housing allowance Rs 21,88,800: This is not paid as HRA within the Section 10(13A) formula. It is a location-specific housing allowance and does not meet the definition of house rent allowance under the rules. Even if the employer labels it HRA, the HRA exemption is calculated on actual rent paid less 10% of salary, and Arjun is paying rent to a Dubai landlord, not in India, so the formula gives an odd result. The more defensible position, and the one most advisers take, is that this amount is taxable in full, with no HRA exemption available on the Indian salary computation.
• School fees allowance Rs 3,00,000: Rule 2BB exemption for children's education allowance is Rs 100 per month per child, Rs 1,200 per year for one child. Taxable amount: Rs 2,98,800.
• Home leave ticket Rs 1,20,000: Taxable perquisite. No LTC exemption applies to cross-border home leave. Taxable in full.

Taxable salary for FY 2026-27: Rs 70,28,400 (after the Rs 1,200 school fees exemption).

Tax computation under the new regime (no rebate for non-residents, 4% cess):

Slab	Income	Rate	Tax
Nil band	Rs 4,00,000	0%	Nil
Rs 4,00,001 to Rs 8,00,000	Rs 4,00,000	5%	Rs 20,000
Rs 8,00,001 to Rs 12,00,000	Rs 4,00,000	10%	Rs 40,000
Rs 12,00,001 to Rs 16,00,000	Rs 4,00,000	15%	Rs 60,000
Rs 16,00,001 to Rs 20,00,000	Rs 4,00,000	20%	Rs 80,000
Rs 20,00,001 to Rs 24,00,000	Rs 4,00,000	25%	Rs 1,00,000
Above Rs 24,00,000	Rs 46,28,400	30%	Rs 13,88,520
Total before cess			Rs 15,88,520
4% cess			Rs 63,541
Total Indian tax			Rs 16,52,061

Surcharge applies at incomes above Rs 50 lakh: 10% surcharge on the tax, adding roughly Rs 1,65,206, bringing the total closer to Rs 18,17,267. At Rs 70 lakh of income the surcharge rate is 10%, and total tax is approximately Rs 17,94,000 to Rs 18,20,000 depending on exact computation. Arjun has not paid any TDS because his employer's Dubai operation is not deducting Indian TDS and his payslip shows only the net dirhams. His Indian employer's Indian payroll team has processed only the base Indian salary for TDS purposes. He now owes Indian tax of roughly Rs 18,00,000 on allowances he received in dirhams and has spent on Dubai rent and school fees.

This is the situation the tax equalisation arrangement is supposed to prevent. Where the employer does not offer equalisation, the employee needs to set aside Indian tax on the allowances himself, which requires knowing about this liability in advance. Advance tax instalments are due in June, September, December and March; missing them triggers Section 234B and 234C interest on the shortfall. On a tax liability of Rs 18,00,000, interest can add Rs 1,50,000 to Rs 2,00,000 if the full amount is paid only at filing.

Form 16 and the verification gap

The worked example above describes a situation where Arjun's Form 16 from the Indian employer reflects only the base salary for Indian TDS purposes, because the HR system has been configured to treat the Dubai allowances as outside the Indian payroll. This is incorrect.

The correct Form 16 should include:

• Base salary: Rs 36,00,000
• COLA: Rs 8,20,800
• Housing allowance: Rs 21,88,800
• School fees allowance (net of Rs 1,200 exemption): Rs 2,98,800
• Perquisite for home leave ticket: Rs 1,20,000

Total taxable salary per Form 16: Rs 70,28,400, with TDS deducted on this figure.

When the Form 16 shows only Rs 36,00,000 and TDS computed on that, the gap of Rs 34,28,400 is unreported income. Arjun has two options when filing ITR-2. He can file on the Form 16 figure and underreport (which is a compliance risk), or he can include the full Rs 70,28,400 in Schedule S of ITR-2 even though the Form 16 does not match, compute the correct tax, and either arrange for his employer to issue a revised Form 16 or file with an explanation in the return. The latter is the correct approach and is legal: you are entitled to report more income than Form 16 shows. The uncomfortable implication is that you will owe tax your employer's payroll team has not deducted, and you will need to pay it through advance tax or self-assessment.

Employers with a mature global mobility function will have a shadow payroll process that brings the foreign allowances into the Indian TDS computation monthly and accounts for any treaty relief where available. Employers without this process, which is the majority of mid-sized Indian IT and engineering companies, rely on the employee or a shared services team to raise the issue, and it often is not raised until the year is over.

The India-UAE DTAA: does it help?

For an Indian employee on an Indian employer's payroll in Dubai, the India-UAE DTAA does not provide a straightforward escape from Indian salary tax. The DTAA's employment income article (Article 15 of the India-UAE treaty) gives the residence country the right to tax employment income, but it preserves India's right to tax income from employment exercised in India. The critical question is whether the Dubai work is "exercised in India," and where the employer is an Indian entity but the work is physically done in Dubai, the treaty position is that the work is exercised in Dubai, not India. That would suggest the UAE should tax the income, not India.

However, Section 9(1)(ii) of the Indian Act deems income from services under an Indian employer to have an Indian source even when rendered outside, and domestic law takes precedence over treaty where the domestic provision expressly deems the income to arise in India. Indian courts have generally upheld the deemed-accrual provision for Indian-employer salary, so the treaty analysis ends up less decisive than it sounds. The more principled view is that Arjun should claim treaty protection under Article 15 on the grounds that his work was physically done in Dubai, file the return on that basis with a UAE TRC and Form 10F, and be prepared to defend the position. Some advisers take this route. Others consider the deemed-accrual provision in domestic law too embedded to fight and pay the Indian tax in full.

What the India-UAE DTAA definitively helps with is the Indian TDS rate on other income categories, NRO interest and dividends, as detailed in the DTAA relief guide. For salary from an Indian employer, the treaty answer is genuinely contested, and the safest default for most employees without litigation appetite is to pay Indian tax and claim the UAE position only where the employer's legal team is prepared to support it.

Checklist before a foreign posting

If you or your employer is planning a foreign posting and wants to handle the tax correctly from the start:

Before departure:

• Confirm whether your employment contract stays Indian or splits into Indian and host-country.
• Ask your employer's tax team whether a tax equalisation arrangement is in place and, if so, request the gross-up model so you understand the notional tax you will pay.
• Set up advance tax payments or confirm the employer's TDS deduction will cover the full package including allowances.
• Open or verify an NRE account for the first year you turn non-resident, as surplus savings from abroad will benefit from NRE treatment once you qualify.

During the posting:

• Confirm annually whether you are resident or non-resident based on your India day-count for that financial year. The first year of departure is often still a resident year.
• File Indian ITR-2 by July 31 each year, including all allowances in Schedule S.
• If your Form 16 excludes offshore allowances, report the correct figure in the return anyway and keep the computation in writing.
• Pay advance tax by the instalment deadlines if TDS is not covering the full liability.

If a discrepancy is flagged:

• A notice under Section 142(1) or Section 148 asking about salary discrepancies between Form 26AS, AIS and the ITR is not unusual for foreign posting situations. Respond within the deadline, provide the employment agreement, Form 16, and the allowance calculation. Guidance on responding to notices sits in the faceless assessment and scrutiny guide.

The closing read

The central fact is simple and consistently misunderstood: Indian employer equals Indian-source salary, regardless of where the work is done or where the money is paid. Becoming non-resident does not move an Indian IT company's Dubai allowances outside Indian tax jurisdiction. The exemptions under Rule 2BB help at the margins, covering small fixed amounts for conveyance and education that bear no relationship to the actual costs of a foreign posting. The big-ticket allowances, COLA, housing, school fees above Rs 1,200 per year, home leave flights, are taxable, and the tax on a Rs 70 lakh package can comfortably exceed Rs 18 lakh.

Tax equalisation removes the personal cash-flow problem but creates its own gross-up trap if not modelled correctly. Form 16 from most Indian employers on foreign postings does not reflect the full taxable package, leaving the compliance gap sitting unreported until a data-match notice makes it visible. The advance tax instalments that should have been paid in June, September and December of the posting year are the earliest point the problem can be corrected at no interest cost.

The cleanest protection is to know the numbers before you board the flight, not after you have spent the allowances.

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Cross-references

• NRI Residency and RNOR Rules
• ITR Filing for NRIs, AY 2026-27
• DTAA Relief for NRIs
• DTAA Mechanics: TRC and Form 10F
• TDS for NRIs and Refunds
• Foreign Tax Credit: Form 67
• Advance Tax for NRIs
• NRI Tax Calendar 2026: Key Dates
• RSU and ESOP Taxation for NRIs
• NRI Gratuity, Leave Encashment and Pension Tax
• Lower TDS Certificate: Form 13
• Responding to NRI Tax Notices
• NRI Faceless Assessment and Scrutiny Process
• PAN for NRIs
• NRE, NRO and FCNR Accounts

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Tax disclaimer: This article is for general information only and does not constitute tax advice. Indian tax law and DTAA provisions change frequently, and individual circumstances vary widely. Consult a qualified chartered accountant or tax adviser before making filing decisions or structuring employment arrangements. The worked example uses illustrative exchange rates and approximate tax figures; actual liability will depend on exact income, applicable surcharge, and the exchange rate on the date of receipt. All figures and law references are as understood at the date of this article.