how are the towns classified on …

A built-up area with a name, defined boundaries, and local government, that is larger than a village and generally smaller than a city.
Before the Sixth Central Pay Commission, the classification of cities in India was based on two parameters — Compensatory City Allowance (CCA), further divided into categories A-1, A, B-1 and B-2, and HRA, further divided into categories A-1, A, B-1, B-2 and C.
The Classification of Indian cities comprises a ranking system used by the Government of India to allocate House Rent Allowance (HRA) to public servants employed in different cities in the country. HRA is also used by the Indian Revenue Service (IRS) to provideincome tax exemptions. Cities are classified on the basis of their population, as recommended by the Sixth Central Pay Commissionin 2008 and Reserve Bank of India respectively.
Under the recommendation of the Sixth Central Pay Commission, the CCA classification was abolished in 2008. The earlier HRA classification of cities was changed from A-1 to X, A, B-1 and B-2 to Y and C and unclassified cities to Z.X, Y and Z are more commonly known as Tier-1, Tier-2 and Tier-3 cities respectively.