Sei sulla pagina 1di 35

TAXABILITY OF RETIREMENT BENEFITS

OF AN EMPLOYEE

Hidayatullah National Law University


Raipur, Chhattisgarh
Submitted To: Mr. Rana Navneet Roy
Assistant Professor, Faculty of Taxation law.
Submitted By:

ACKNOWLEDGEMENTS
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Thanks to the Almighty who gave me the strength to accomplish the project with sheer hard
work and honesty. This research venture has been made possible due to the generous cooperation of various persons. To list them all is not practicable, even to repay them in words is
beyond the domain of my lexicon.
This project wouldnt have been possible without the help of my teacher Mr. Rana Navneet
Roy, Faculty of Taxation Law, who had always been there at my side whenever I needed some
help regarding any information. He has been my mentor in the truest sense of the term. The
administration has also been kind enough to let me use their facilities for research work. I thank
them for this would be grateful to receive comments and suggestions for further improvement of
this project report.
Thanking You!
Sirshendu Mazumdar
Roll No.152, Semester V,
Batch XIII

Table Of Contents

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

1.

Introduction..
05

2.

Objectives.
..05

3.

What are Retirement Benefits..06

4.

Taxability of Retirement benefits: Provisions and


Analysis..
08-32

Death cum Retirement Gratuity.


Pension.
Leave Encashment.
Retrenchment Compensation.
Compensation on Voluntary Retirement or Golden Handshake.
Provident Fund.
Superannuation Fund.
Deposit Scheme.

5.References.
.33

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

RESEARCH METHODOLOGY
The research methodology used in this project is analytical and descriptive. Data has been
collected from various books, articles, papers and web sources. This project is based upon nondoctrinal and secondary method of research. This project has been done after a thorough research
based upon intrinsic and extrinsic aspects of the project.

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

INTRODUCTION
Retirement marks the beginning of a new chapter in life. People rely on investment and savings
they have made during their working life to enjoy this phase. Retirement benefits are financial
instruments designed to help individuals after they stop working. Individuals typically receive
retirement benefits in the form of regular cash instalments or as protection in the form of
insurance coverage.
Tax implication of income during the retirement years is an important aspect as it affects the
actual cash flows. The Income-Tax Act, 1961, provides higher tax slabs for senior citizens to
ensure that their tax-liability is lower than others. For tax purposes, an individual who is 60 years
old or more at any time during the financial year qualifies as a senior citizen. Any person who
is 80 years or more qualifies as a very senior citizen.
On retirement, an employee normally receives certain retirement benefits. Such benefits are
taxable under the head Salaries as profits in lieu of Salaries as provided in section 17(3) of
The Income Tax Act, 1961. However, in respect of some of them, exemption from taxation is
granted u/s 10 of the Income Tax Act, either wholly or partly.
This project would deal in detail and would analyze and explain the concept of retirement
benefits, its need and mainly the tax provisions applicable on such benefits.

OBJECTIVES:
1. To analyze the concept of Retirement Benefits.
2. To study and explain the provisions of Taxability of Retirement Benefits as per Income
Tax Laws.
3. To study the exemptions on taxability of Retirement Benefits.

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

I.
i.

What are Retirement Benefits ?


Meaning of Retirement:

According to the oxford dictionary retirement means to leave one's job and cease to work,
especially because one has reached a particular age. The American Heritage Dictionary defines
retirement as to withdraw from one's occupation, business, or office.
Retirement is the point of time or age where a person stops employment completely. Some
people choose to retire voluntarily known as the VOLUNTARY RETIREMENT SCHEME
(VRS) whereas some are forced to retire when physical conditions no longer allow the person to
work anymore (by illness or accident) or as a result of legislation concerning their position. In
most countries, the idea of retirement is of recent origin, being introduced during the late 19th
and early 20th centuries. Previously, low life expectancy and the absence of pension
arrangements meant that most workers continued to work until death. Germany was the first
country to introduce retirement, in 1889. 1Nowadays most developed countries have systems to
provide pensions or such other monetary benefits on retirement in old age, which may be
sponsored by employers and/or the state. In many poorer countries, support for the old is still
mainly provided through the family. Today, retirement with a pension or other benefits is
considered a right of the worker in many societies, and hard ideological, social, cultural and
political battles have been fought over whether this is a right.
This can be seen as the evolution of the concept of RETIREMENT BENEFITS which relates
moreover with the SOCIAL SECURITY BENEFITS .
ii.

The Concept and meaning of Retirement Benefits:

On retirement, an employee normally receives certain monetary benefits which are known as
Retirement Benefits. These can be understood as monthly payment made to someone who is
retired from work or a regular payment to a person that is intended to allow him to subsist
without working.
These benefits are provided mainly for 2 reasons:
11. The German Precedent" Social Security History, US Social Security Administration.
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1. To promote voluntary retirement schemes so that a person after a certain age agrees to take
retirement and vacates the places of employment for the new generation.
2. To provide social security to persons getting retired so that other than his own savings some
monetary relief could be provided for living a standard life.
Retirement benefits are financial instruments designed to help individuals after they stop
working. Individuals typically receive retirement benefits in the form of regular cash installments
or as protection in the form of insurance coverage.2
Sources of Retirement Benefits:-Retirement benefits can come from a number of sources.
Employers offer them to employees as an incentive to stay with the company until retirement.
The federal government provides retirement benefits in the form of Social Security payments.
Individuals can also save for retirement on their own with plans such as IRAs.
iii.

Types of Retirement benefits:

The following incomes are generally received on retirement:

II.

Death cum Retirement Gratuity.


Pension.
Leave Encashment.
Retrenchment Compensation.
Compensation on Voluntary Retirement or Golden Handshake.
Provident Fund.
Superannuation Fund.
Deposit Scheme for retired Govt./Public Sector Company Employees.

Taxability of Retirement Benefits:

On retirement, an employee normally receives certain retirement benefits. Such benefits are
taxable under the head Salaries as profits in lieu of Salaries as provided in section 17(3).
2 http://www.incometaxindia.gov.in/Taxation_Of_Salaried_Employees
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

However, in respect of some of them, exemption from taxation is granted u/s 10 of the Income
Tax Act, either wholly or partly.
Section 17 (3) of The Income Tax Act, 1961 reads as:" profits in lieu of salary" includes(i) the amount of any compensation due to or received by an assessee from his employer or
former employer at or in connection with the termination of his employment or the modification
of the terms and conditions relating thereto;
(ii) any payment (other than any payment referred to in clause (10), clause (10A)] , clause (10B)],
clause (11), clause (12) , clause (13)] or clause (13A)] of section 10), due to or received by an
assessee from an employer or a former employer or from a provident or other fund 7 (not being
an approved superannuation fund)], to the extent to which it does not consist of contributions by
the assessee or interest on such contributions.3
The Chapter III of The Income Tax Act, 1961 provides for INCOMES WHICH DO NOT
FORM PART OF TOTAL INCOME. Under this chapter comes the Section 10 which provides
for the exemption from taxation of some of the retirement benefits.
A. Taxation of Gratuity and its allowable exemption limit:Here I have discussed the various provisions regarding gratuity and its taxationGratuity is a retirement benefit. It is generally payable at the time of cessation of employment
and on the basis of duration of service. To discuss the tax treatment of the gratuity, the employees
have been divided in two types:(i) Government
(ii) Non-government.
In case of government employees:-

3 Section 17 (3), The Income Tax Act, 1961


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Any death cum retirement gratuity received by Government employees (i.e. Central or State
Government employees, or employees of a local authority, but not employees of a statutory
corporation) is wholly exempt from tax under section 10(10)(i).
In case of non-government employees:To discuss the tax treatment of Gratuity received by a non government even more
comprehensively, I have sub-divided non-government employees into 2 types:(i) Employees covered under the Payment of Gratuity Act 1972
(ii) Employees who are not covered under the Payment of Gratuity Act 1972.
In the case of employees covered by the payment of gratuity act, 1972:Any gratuity received by such employees is exempt from tax to the extent of the least of the
following:
1) 15 days salary (7 days salary in the case of employees of a seasonal establishment) based on
salary last drawn for each year of service (i.e. 15 days salary *Length of Service)
2) Rs. 10,00,000/3) Gratuity actually received
The least of the above three is exempt from tax. Gratuity in excess of the aforesaid limits is
taxable in the hands of the assessee. However, the assessee can claim relief under section 89.
In the above calculation, the length of service is estimated as follows If the period of service is
6 months or less than 6 months it shall be ignored for this purpose. Conversely, if the period of
the service is more than 6 months, it shall be taken as one full year.
To illustrate:If the employee has worked for 25 years, 5 months and 29 days, the length of service shall be
taken as 25 years. But if the employee has worked for 25 years, 6 months and 1 day, the length of
service shall be taken as 26 years. Salary for the purpose of aforesaid limits means salary last
drawn by an employee and includes dearness allowance but does not include any bonus,
commission, house rent allowance, overtime wages and any other allowance. In the above
calculation 15 days salary is calculated by dividing the last drawn salary by 26 i.e. maximum

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number of working days in a month. For instance, if the monthly salary at the time of retirement
is Rs. 30,000/-, 15 days salary would come to Rs. 17,307/- [i.e. Rs. 30,000 * 15/26].
If the 15 days salary was to be determined for a piece-rated employee, the daily wages shall
be computed on the average of the total wages received by him for a period of three months
immediately preceding the date of retirement. For this purpose, the wages paid for any overtime
work shall not be taken into account.
In the case of employees not covered by the payment of gratuity act, 1972:Any gratuity received by such employees is exempt from tax to the extent of the least of the
following
1) Half months average salary for each completed year of service
2) Rs. 10,00,000/3) Gratuity actually received
The least of the above three is exempt from tax. Gratuity in excess of the aforesaid limits is
taxable in the hands of the assessee. However, the assessee can claim relief under section 89.
In the above calculation each completed year of service is determined as follows For
calculating the length of service, any fraction of the year shall be ignored. To illustrate, if the
employee has worked for 25 years, 6 months and 15 days, the length of service would still be
taken as 25 years.
Average monthly salary for the aforesaid calculation is determined on the basis of average salary
for the ten months immediately preceding the month in which the employee has retired. For
instance if a person retires on March 16 201, average salary will be considered on the basis of
salary drawn from May 1, 2011 to February 28, 2012. Salary for this purpose means basic salary.
It includes dearness allowance if the terms of employment so provide (or if dearness allowance is
taken into account for computing retirement benefits). It also includes commission if commission
is payable at a fixed percentage of turnover achieved by an employee.
In a situation where gratuity is received from two or more employers by a non-Governmental
employee (not covered by the Payment of Gratuity Act either in the same year or in different

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years), the maximum amount of exemption under section 10(10)(iii) during the lifetime of the
concerned employee cannot exceed the notified amount i.e., Rs. 10,00,000.
Any gratuity paid to an employee while he continues to remain in service (whether or not after
he has put in a minimum specified period of service) is not exempt from tax, though the assessee
can claim relief under section 89.
Gratuity received by family member after the death of the employee
If gratuity is paid after the death of an employee (say X is the employee), then the case may fall
in one of the following situations
Normal
date
retirement of X

of When
gratuity Date of payment of Date of
becomes due
gratuity
death of X

Situation
June 30, 2011
1

June 30, 2011

July 11, 2011

July 20, 2015

Situation
June 30, 2011
2

June 30, 2011

July 11, 2011

July 6, 2011

Situation
June 30, 2017
3

July 6, 2011*

July 11, 2011

July 6, 2011

the

*After the death of X.

In Situation 1:-

The gratuity becomes due (and is paid) during the lifetime of X. Therefore, it is taxable in the
hands of X. However, he can claim exemption under section 10(10).

In Situation 2:-

Gratuity becomes due on June 30, 2011 at the time of retirement. It is taxable in the hands of X
even if it is received by his legal heirs on July 11, 2011 after his death. After claiming exemption
under section 10(10)(ii)/(iii), the balance shall be included in the salary income of the X. It is
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incorrect to state that in this case income is taxable in the hands of Mrs. X as income from other
sources.

In situation 3:-

X dies on July 6, 2011 while in service. Gratuity is sanctioned after his death on July 6, 2011. It
cannot be taxed in the hands of deceased employee X as it becomes due and is paid after his
death. This amount is not taxable in the hands of legal heirs also as it does not partake the
character of income in their hands but is only a part of the estate developing upon them. It is
incorrect to state that income is taxable in the hands of Mrs. X as income from other sources.
B. Taxation of Pension:
The tax treatment of pension in various cases is discussed below
There are different situations in which pension is received by an employee. Accordingly the tax
treatment for the same also differs.
In a situation where pension is received by an employee after retirement but during his
lifetime, it is chargeable to tax as follows
To discuss the tax treatment of the pension received, comprehensively, the employees have been
divided in two types:(i)Government
(ii)Non-government.

Even the pension received can be of two types:(i)Commuted.


(ii)Uncommuted.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

Uncommuted pension is the periodical payment of pension. For instance, X gets monthly
pension of Rs. 2,000/-. It is taxable as salary under section 15 in the hands of a government as
well as a non government employee.
Commuted pension is a lump sum payment in lieu of periodical payment. For instance after his
retirement, X gets 25 percent of his pension commuted for Rs. 60,000/- (after commutation he
will get the remaining 75% i.e. Rs. 1,500/- by way of monthly pension). In this case, Rs. 60,000/is commuted pension which X has received in lieu of 25% of his monthly pension. The taxability
of the commuted pension is dependent upon the status of the employee and whether or not such
employee has received gratuity.

Government employee:
If such commuted pension is received by a government employee (i.e. employee of the Central
Government, State Government, Local Authority and Statutory Corporation) who may or may
not have received gratuity, then such commuted pension would be completely exempt from tax.
Non-government employee:
If such commuted pension is received by a non-government employee who has received gratuity,
then only one-third of the pension which he is normally entitled to receive, would be exempt
from tax. If the same commuted pension is received by a non-government employee who has not
received gratuity, then only one-half of the pension which he is normally entitled to receive is
exempt from tax.
If the payment in commutation of pension received by an employee exceeds the aforesaid limits,
such excess pension received is liable to tax in the assessment year relevant to the previous year
in which it is due or paid. The assessee can however, claim relief under section 89.
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Judges of Supreme Court and High Courts:


Under section 10(10A)(i) of the Income-tax Act, 1961 any payment in commutation of
pension received, inter alia, under the Civil Pension (Commutation) Rules of the Central
Government, shall not be included while computing the total income of the recipient.
The issue regarding the applicability of section 10(10A)(i) to the computation of pension
received by Judges of the Supreme Court and the High Courts was considered by the
Board. The Board was advised that under section 19 of the High Court Judges
(Conditions of Services) Act, 1954 and the corresponding provisions in the Supreme
Court Judges (Conditions of Service) Act, 1958, the Civil Pension (Commutation) Rules
for the time being in force shall, with necessary modifications, apply to Judges. The
Board was further advised that the Judges would be governed by Rule 3 of the Civil
Pension (Commutation) Rules, which provide for commutation for a lump sum portion
not exceeding one-half of the pension. Since the commutation is under the aforesaid
Rules, Judges of the Supreme Court and High Courts will be entitled to the exemption of
the commuted portion under section 10(10A)(i) of the Act.
Therefore The Honble Judges of Supreme Court and High Courts shall be entitled to
exemption of commuted value upto of the pension (Circular No. 623 dated 6.1.1992).4
New Pension Scheme or NPS:
Another situation is where pension is received by an employee as per the NPS. The New Pension
Scheme or NPS is applicable to new entrants to Government Service or any other employer. As
per the scheme, it is mandatory for persons entering the Government service on or after January
1, 2004 to contribute 10 per cent of their salary every month towards a notified pension account.
A matching contribution is required to be made by the employer to the said account. The tax
treatment under the new scheme is as follows
4[F. No. 200/161/91-IT(AI), dt. 6-01-1992 from CBDT] http://incometaxindiapr.gov.in/- Commutation of
pension received by Judges of the Supreme Court and High Courts - Applicability of section 10(10A)(i)
of the Income-tax Act, 1961-Central Board of Direct Taxes.
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1)

Contribution by the employer to the notified pension scheme (NPS) is first included under

the head Salaries in the hands of the employee.


2)

Such contribution is deductible to the extent of 10 per cent of the salary of the employee

under section 80 CCD(2)


3)

Employees contribution to the notified pension scheme (NPS) to the extent of 10 per cent

of the salary of the employee is also deductible under section 80CCD (1)
4)

When pension is received out of the aforesaid amount it will be chargeable to tax in the

hands of the recipient.


5)

Salary for the purpose of points 1 and 2 includes dearness allowance, if the terms of

employment so provide, but excludes all other allowances and perquisites.


6)

The aggregate amount of deduction under section 80C, 80CCC and 80CCD (1) i.e.

contribution by the employee towards the notified pension scheme cannot exceed Rs. 1,00,000/-

Although from the assessment year 2012-13 onwards, employers contribution towards NPS
is NOT considered for the purpose of the monetary ceiling of Rs. 1,00,000/-. Which means
that any contribution made by the employer to the NPS would be deductible in the hands of the
employee over and above the Rs. 1,00,000/- monetary limit but subject to 10 per cent of the
salary. This section is called, section 80CCD (2).
Other situations are as follows
Sr. No.

Different Situations

Tax Treatment

Pension received from the UNO by the employee

It is not chargeable to tax.

or his family members


2

Family pension received by the family members

It is exempt under section


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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

of the armed forces

10(19) in some cases

Family pension received by the family members

It is taxable in the hands of the

after the death of an employee (not covered by

recipients under section 56

case 2)

under the head Income from


other

sources.

Standard

deduction is available under


section 57 which is 1/3rd of
such pension or Rs. 15,000/whichever is lower.

C. Taxation of Leave Encashment:


(i). What is Leave Encashment? :
While an employee is in service, he is allowed various types of leaves like Medical Leave,
Gazetted Holidays, Casual Leaves etc. There are some types of leaves which can be carried
forward to the next year whereas there are some leaves which cannot be carried forward to the
next year. In case an employee does not avail all the leaves which were allowed to him, he may
also encash these leaves and earns salary for the no. of the days which were allowed to be taken
as leaves but were not availed as leave. The policy of no. of leaves allowed to be taken and

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the leave encashment depends on the employer for whom you are working and different
employers have different policies for leave encashment.
(ii).Tax on Leave Encashment:
In case the employee has not taken leaves and have opted for encashing these leaves, then
employer would be paying some amount as leave encashment. The amount so received on
account of encashing the leaves not availed would be liable to tax under head Income from
Salary.56 However, at the time of filing of income tax return, certain exemptions would be
allowed from the amount received as leave encashment and the balance amount would be taxable
as per the Income Tax Slab Rates in force for that year.
The manner of computation would be as under:-

(Less)

Amount received as Leave Encashment

xxx

Amount exempted

(xxx)

Amount chargeable to tax as per Income Tax Slab Rates

xxx

Computation of Amount Exempted from Leave Encashment:


Encashment of leave during tenure of service: Leave encashment to an employee, while he
continues to be in service with the same employer is fully taxable and no exemption is allowed.
Encashment of leave salary at the time of retirement:

5 Heads of Income, Section 14, The Income Tax Act, 1961.


6 Income Under the Head Salaries, Section 15 to 17, The Income Tax Act, 1961.
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Exemption from amount received as leave salary is available under Section 10(10AA). For the
purpose of availing exemption under section 10(10AA)7, the employees are divided into 2 types
of categories:1.

Govt Employees (Central Govt and State Govt employees only): Leave encashment of
accumulated leave at the time of retirement, whether on superannuation or otherwise,
received by a Govt employee, is fully exempt from tax. No tax would be levied on any
amount received as leave encashment by govt employees on retirement.

2.

Other Employees: Leave encashment of accumulated leave at the time of retirement


whether on superannuation or otherwise received by any other employee (except those
covered above) is exempt from tax to a certain limit. In such a case, the least of the following
shall be exempted:1.

Leave encashment actually received

2.

10 months average salary

3.

Cash equivalent of unavailed leave calculated on the basis of maximum 30 days


leave for every year of completed service.

4.

Amount specified by the Govt. i.e. Rs. 3,00,000.

RELEVANT POINTS REGARDING TAX ON LEAVE ENCASHMENT:


1.

Salary for the purpose of above computation means Basic + Dearness Allowance. It
also includes commission based on fixed percentage of turnover achieved by the employee. 8
However, any other allowance received is not to be included in the computation of Salary.

2.

Average Salary is to be computed on the basis of the average salary drawn by the
employee during the period of 10 months immediately preceding his retirement.

7 Incomes which do not form part of Total Income-Section 10. Leave Encashment-Section 10(10AA),
The Income Tax Act, 1961.
8 www.charteredclub.com/leave-encashment-tax/.
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3.

If the employee has received leave encashment in any one or more earlier previous
year(s) also and had availed of the exemption in respect of such amount, the limit of Rs.
3,00,000 specified above shall be reduced by the amount of exemption availed earlier.

4.

Leave encashment received by the family members after the death of an employee is not
chargeable to tax in the hands of the family member.

5.

The retirement of employee may be of various kinds. It may be on superannuation or


voluntary such as resignation. This section applies equally to a case of voluntary retirement
on account of resignation.

D. Taxation of Retrenchment Compensation:

What is Retrenchment?
There are times when an organization or a company is forced to close down its operations due to
various reasons such as Lack of sufficient funds to continue the operation in its existing shape
and form, Death of the proprietor, inability to survive in the competitive environment, Bad
Management, Major failure of products, Professional Incompatibility between the founding
members of the Organization, Major changes in market trends making a company obsolete,
Inability to pay its major debtors and many more such reasons.
Whatever be the reason for closure, the Indian Industrial Disputes Act of 1947, stipulates that the
workers who have been working in such organization are adequately compensated to take care of
their immediate future. This is where retrenchment of workers comes into picture.9
Hence when an organization asks to leave the organization, she / he cant be asked to walk out,
just waving hands! They are supposed to be compensated for the same. The amount of
compensation is decided by the management of the organization, in a justifiable manner, within
the guidelines stipulated under Indian Income Tax Laws, under various sections. What we are
trying to explain is how the Indian Income Tax Laws, treat such compensations received.
9http://incometaxindia.gov.in/publications/7_Tax_Benefits_for_Pensioners/Chapter4.asp#RetrenchmentC
ompensationSubSection10BofSection10.
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How does it work?


Retrenchment compensations are classified under the Indian Income Tax Act as Retrenchment
Compensation u/s 10 (Sub Section 10B) 10. However it has a lot of conditions, which needs to
be met in order to qualify for the compensation. Let us understand those conditions, as well as
what is the amount that is exempt from Income Tax of India, under retrenchment compensation.
Any compensation received by a person due to the Retrenchment shall be exempt to the extent as
stipulated underneath.

An amount calculated in accordance with the provisions of Section 25F(b) of the


Industrial Disputes Act, 194711
OR

Such amount, not being more than Rs. 5,00,000 as the Central Government has specified
in this matter, if the management has not filed for insolvency / bankruptcy to the Board
for Industrial & Financial Reconstruction (in Short it is called as BIFR)12.

OR
The amount received whichever is the least.

In simple terms all the amounts upto Rs 5 Lacs received as Retrenchment Compensation is
fully exempt from Income Tax of India.
10 Section 10 (10B), Income Tax Act, 1961- Retrenchment Compensation received by a workman under
the IDA, 1947, etc.
11 Section 25F(b), The Industrial Disputes Act, 1947- The workman has been paid, at the time of retrenchment,
compensation which shall be equivalent to fifteen days' average pay 2 for every completed year of continuous
service] or any part thereof in excess of six months.

12Board for industrial and financial reconstruction regulations 1987-bifr.nic.in


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Compensations in excess of the above mentioned limits is taxable as salary or profit in lieu of
salary which is however eligible for relief under
The Section 25F(b) of Industrial Disputes Act provides for payment of retrenchment
compensation equivalent to 15 days average pay for every completed year of continuous service
or any part thereof in excess of six months.
For this purpose, average pay will be calculated as explained underneath:

if the person is getting monthly salary, then on the basis of the salary of last three
calendar months
OR

If the person is getting weekly wages, then on the basis of wages of last four completed
weeks
OR

If the person is getting daily wages, then on the basis of wages of last twelve full working
days.

Under the Industrial Disputes Act13, for this purpose salary or wages mean all remuneration
capable of being expressed in terms of money, which would be payable to a person in respect of
the his employment or work done in such employment, including the value of benefits mentioned
in the Explanation to such Act.
Compensation received by a person at the time of the closing down of the Organization in which
she / he is employed is treated as compensation received at the time of his retrenchment. If
ownership or management of the undertaking in which the person is employed is transferred and
he takes up employment with the transferee, the consideration received by him at the time of
13 Industrial Disputes Act, 1947.
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transfer of ownership or management will also qualify for the aforesaid tax exemption if it meets
criteria cited underneath.

If the service of the person has been interrupted by such transfers of the managements.
OR

If the terms and conditions of service applicable to the employee after such transfer are in
any way less favorable to the person, than those that were applicable to him immediately
before the transfer of the management
OR

If the new employer under the terms of such transfer, is legally not liable to pay to the
retrenched employee in the event of her / his retrenchment, Retrenchment compensation
on the basis that her / his service had been continuous and had not been interrupted by the
transfer.

In simple words what this condition means is, if the new management has entered into agreement
of the old management that only the old management is liable to pay the retrenchment
compensations.
A Simple Example:
Ms / Mr. Z is an employee working with M/s. ABC Limited. She / he is retrenched from service
by the management and paid a compensation of Rs. 460000 under the Industrial Disputes Act,
1947. The receipt of Rs. 460000 will be exempt from tax.
However it must be noted that the exemption is applicable only once. That is if such a
retrenchment compensation is deposited in banks (Which will generate interest amount) or
deployed in other investments such as Shares, Stocks, Mutual Funds and deposits with large
Corporates, and if any profit is derived out of such investment, they are liable for Income Tax, as
per the prevalent rules.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

E. Taxation of Voluntary Retirement Scheme or Golden Handshake:


What is Volunatary Retirement Scheme (VRS) or Golden Handshake?
Income economy is now in a dynamic stage. It is under constant evolution, betterment, up
gradation and getting rid of old and moribund ways of conducting business.
As a by-product (Can also be called as consequence) the old days when a person started and
remained an employee until retirement in the same organization has become a thing of the past.
Multiple jobs across a persons working span of life, is the order of the day. So it would be no
surprise to see people in their 50s and 40s who have already changed over half a dozen jobs, and
may be even changed their line of profession.
The companies and businesses are also facing equally daunting situation due to global
competition, better technologies being made available in India at much cheaper costs, newer
technological innovations from foreign shores making the existing product lines of Indian
Companies unattractive and redundant to the Indian consumers.
Under such a severe onslaught, the Indian Companies have to either perform or perish. So, they
are making drastic changes to their products, infrastructures, Human Capital (Man Power) and at
the same time taking variety of measures to cut costs on all fronts. One of the major areas where
the companies have found that they can cut cost is to reduce the man power. In effect, what 1000
people use to produce, is now being done with half or less than half of the same. This is very
widely prevalent in the manufacturing sector. Now how does a company reduce man power?
They cant be asked to leave overnight, after having worked for many years in a particular
organization.
Hence the Indian Industry came up with the idea of VRS or Voluntary Retirement Scheme,
whereby the employees are offered a onetime lump-sum amount. Many employees in their 50s
have opted for this scheme. This is also called as Golden Handshake Scheme. What we are
now going to analyze is how does the Income Tax Department interprets money received in this
manner.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

Taxation of amounts received under VRS:

Is compensation receiver in connection with the termination of employment


taxable?

Normally, it is taxable as profit-in-lieu-of-salary. However, Under the existing provisions


contained in clause (10 C) of section 10 14, any amount received by an employee of a public
sector company- any other company or an authority established under a Central, State or
Provincial Act or a local authority or a co-operative society or a university or an Indian Institute
of Technology or a notified institute of management, at the time of his voluntary retirement is not
included in computing his total income. The exemption is available for amounts upto Rs 5 Lacs,
but only if the payment is in accordance with a voluntary retirement scheme as per the prescribed
guidelines. The guidelines are discussed separately in one of the following Question & Answers.

Has the exemption of amount received under VRS now been extended to central and
state government employees?

Yes. The exemption of amount received under the Voluntary Retirement Scheme is extended to
employees of the Central Government w.e.f. Assessment Year 2002-2003 and for State
Government employees w.e.f. Assessment Year 2001-2002.15

If this exemption has been allowed to any employee for any assessment year can it
be allowed in another assessment year also?

No. It shall be allowed to him only once in a life time.

What are the guidelines for exemption from tax of compensation received or golden
handshake (VRS) given to an employee under a scheme of voluntary retirement?

14 Section 10 (10C), Income Tax Act, 1961- Compensation received at the time of voluntary retirement.
15 http://finmin.nic.in/- Ministry of Finance, Government of India.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

The guidelines for the exemption from tax on the Golden Handshake (VRS) are explained
underneath.
1. VRS applies to an employee of the company who has completed 10 years of service or 40
years
2. It applies to all employees and executives (excluding directors).
3. It has been drawn to result in overall reduction in the existing strength of the employees
of the company.
4. Vacancy caused by the VRS is not to be filled up.
5. The retiring employee is not to be employed in other business belonging to the same
management.
6. The amount should not exceed Rs. 5 lacs.
7. The employee has not Availed in the past the benefit of any other voluntary scheme.
The above guidelines are to be strictly followed, and in case, the payments on account of
voluntary retirements are not strictly made as per the prescribed guidelines, the payment will not
be exempt.16

In the amount of VRS, whether the entire amount receivable or only the excess of
the amount above Rs. 5 lacs, is to be subjected to income-tax?

Only the amount representing the excess and above the limit of Rs. 5 lacs is to be subjected to
Income-tax.

Is the VRS receivable by an employee of a company which has been set up less than
10 years ago, exempt?

16 Singhania Vinod K., Singhania Kapil, Direct Taxes, 50th Edition, P 124, Para 49.20.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

No. The scheme is applicable to the employees who have completed 10 years of service with a
company, so it will not be exempted.

Can such scheme only be drawn by loss making companies?

The guidelines require that the scheme should result in overall reduction in the existing strength
of the employees of the company. Therefore, the Scheme can be drawn even by the profit making
companies, but the company should be older than 10 years.

Whether income tax exemption of VRS is available when the amount payable is in
addition to normal retirement benefits like PF., gratuity, pension etc. under the
terms governing employment?

Yes. The provisions governing exemption of VRS are separate from the provisions which govern
taxation of provident Fund, Gratuity, Pension and other retirement benefits.

Whether any Tax Deducted at Source (TDS) has to be made from VRS amount?

No. If all specified conditions are satisfied the employer need not deduct the TDS from the VRS
Amount.

Has there been any recent change in the VRS scheme?

Yes. The words termination of his service have been added to the word Voluntary retirement
and in the case of a public sector company a scheme of voluntary separation have been added.
So this is mainly all about the taxability of VRS.

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

F. Taxability of Provident Funds.


What is Provident Fund?
Provident Fund refers to a trust, or an account or a fund, to which a fixed contribution is made
periodically, not having interval more than one year, both by employer and employee, which is
accumulated for the benefit of the employee and repayable to him on the day he ceases to be an
employee.17
There are several "Provident Fund" schemes as discussed below: 1. Statutory Provident Fund (SPF) :
SPF refers to the Provident Fund formed under the Provident Fund Act, 1925. 18 This fund is
maintained by Government and Semi Government organisations, local authorities, railways,
universities and recognised educational institutions.
2. Public Provident Fund (PPF) :
PPF is a scheme notified by the Central Government as Public Provident Fund Scheme, 1968
operated by the State Bank of India or its subsidiaries.
3. Recognised Provident Fund (RPF) :
RPF refers to the Provident Fund formed and operated by the employers not under any statute
but on their own and approved by the Chief Commissioner of Income-tax or the Commissioner
of Income-tax. Till such approval is accorded by the Chief Commissioner of Income-tax or
17 http://www.epfindia.com/
18 Section 1(1), Provident Funds Act, 1925.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

Commissioner of Income-tax, the said Provident Fund would be treated as "Un-Recognised


Provident Fund" (URPF).

Tax on Provident Funds & various exemptions:


The following table shows Tax on Provident Funds and the various exemptions/reliefs available
to each of the funds: Particulars

SPF/PPF

RPF
Tax on Provident Funds is

Employer's

exempt to the extent of 12%

Contribution to the Not Taxable

of Salary (refer point 1

Fund

below)

Employee's

Deduction under

Contribution to the section


Fund

available

Interest Credited to
the Fund
Lumpsum

amount

withdrawn from the


Fund

80C

Not Taxable in the


year
Contribution

Deduction under section 80C No


available

of

Benefit

Available

Exempt up to 9.5% rate of Not Taxable at the

Exempt

Exempt

URPF

Interest

time of Credit

under Exempt under section 10(12) Taxable fully as per

section 10(11)

subject to Note 2 below.

Note point 3 below.

The table is being explained further with the help of following 4 points19:
1. Tax on Provident Fund: The transferred balance in a recognized provident fund, to the extent
provided in rule 11(4) of Part A of the Fourth Schedule, viz., the Assessing Officer shall, subject
to such rules as the Board may make in this behalf, make a calculation of the aggregate of all
19 www.accounting-n-taxation.com/Tax-On-Provident-Funds
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

sums comprised in a transferred balance which would have been liable to income-tax, if it has
been recognised from the date of the institution of the fund, without regard to any tax which may
have been paid on any sum, and such aggregate (if any) shall be deemed to be income received
by the employee in the previous year in which the recognition of the fund takes effect and shall
be included in the employee's total income for that previous year, and, for the purposes of
assessment, the remainder of the transferred balance shall be disregarded, but no other
exemption or relief, by way of refund or otherwise, shall be granted in respect of any sum
comprised in such transferred balance.
Any portion of the balance to the credit of an employee in the existing fund which is not
transferred to the recognised fund shall be excluded from the accounts of the recognised fund
and shall be liable to income-tax in accordance with the provisions of this Act.
2. The accumulated balance due and becoming payable to an employee participating in a
Recognised Provident Fund is exempt only under the following circumstances: a). Tax on Provident Funds: In the case of an employee who has been in service for a continuous
period of at least 5 years. In computing the aforesaid period of 5 years, if any amount has been
transferred from a RPF of a former employer, then the period of service with the former
employer is also to be taken into account.
b). If he has not rendered service for a continuous period of 5 years, and if his retirement is due
to his ill-health, contraction or discontinuance of the employer's business, other reasons beyond
the control of the employee the amount of balance transferred on his cessation of employment,
from RPF maintained by the former employer to the RPF maintained by the present employer.

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

3. Tax on Provident Funds: Any payment made under the Unrecognised Provident Fund or
Unapproved Superannuation Fund is taxable, as per section 17(3) 20 read together with
section 5621, as under:

To the extent of Employer's Contribution and Interest thereon, taxable as Salaries.

To the extent of Employee's Contribution - not taxable.

To the extent of Interest on Employee's Contribution is taxable as Income from Other


Sources.

4. Any payment made to the employee from an ASAF is exempt under section 10(13) 22 only
in the following circumstances:

on the death of a beneficiary; or

to an employee in lieu of or in commutation of an annuity on his retirement at or after a


specified age or on his becoming incapacitated prior to such retirement, or

by way of refund of contributions on his death of the beneficiary; or

by way of refund of contributions to an employee on his leaving the service in connection


with which the fund is established otherwise than by retirement at or after a specified age
or on his becoming incapacitated prior to such retirement, to the extent to which such

20 Profit in lieu of Salary- Section 17(3), Income Tax Act, 1961.


21 Income from other sources- Section 56, Income Tax Act, 1961.
22 Payment from an unapproved superannuation fund- Section 10(13), Income Tax Act, 1961.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

payment does not exceed the contributions made prior to the commencement of this Act
and any interest thereon.
G. Taxability of Superannuation Fund:
What is Superannuation Fund?
Superannuation Fund (SAF) refers to a fund to which the employer alone contributes.
However, the employee is also permitted to make contributions voluntarily. Established with
sole purpose of, providing annuities for employees in the trade or undertaking on their
retirement at, or after a specified age, or on their becoming incapacitated prior to such
retirement, or for the widows, children or dependents of persons who are or have been such
employees on death of those persons.
SAF, if approved by the Chief Commissioner of Income-tax or Commissioner of Income-tax,
will be known as Approved Superannuation Fund (ASAF).
The employee has the option to transfer his Superannuation Fund to the current employer
from previous employer. If the current employer does not have a Super Annuation fund
scheme, then the employee shall withdraw the amount.
Tax on SAFs & various exemptions:
Particulars

ASAF

Employer's Contribution to

Not Taxable up to Rs.1,00,000

the Fund

per annum per employee

Employee's

Contribution

to the Fund
Interest Credited to the
Fund

Other SAF

Not Taxable

Deduction under section 80C

No

available

Available

Exempt

Benefit

Not Taxable at the


time of Credit
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

Lumpsum

amount

withdrawn from the Fund

Exempt under section 10(13)

Taxable as per point

subject to point 3 below.

3.

1. Tax on Provident Funds: Any payment made under the Unrecognised Provident Fund or
Unapproved Superannuation Fund is taxable, as per section 17(3) read together with section
56, as under: -

To the extent of Employer's Contribution and Interest thereon, taxable as "Salaries".

To the extent of Employee's Contribution - not taxable.

To the extent of Interest on Employee's Contribution is taxable as "Income from


Other Sources".

2. Any payment made to the employee from an ASAF is exempt under section 10(13) only in
the following circumstances: -

on the death of a beneficiary; or

to an employee in lieu of or in commutation of an annuity on his retirement at or after


a specified age or on his becoming incapacitated prior to such retirement, or

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

by way of refund of contributions on his death of the beneficiary; or

by way of refund of contributions to an employee on his leaving the service in


connection with which the fund is established otherwise than by retirement at or after
a specified age or on his becoming incapacitated prior to such retirement, to the
extent to which such payment does not exceed the contributions made prior to the
commencement of this Act and any interest thereon.

Payment from an Approved Superannuation Fund will be exempt provided the payment is
made in the circumstances specified in the section 23 i.e. death, retirement and
incapacitation.

H. Taxability of Deposit Scheme for retired Govt./Public Sector Company Employees:


Section 10(15) of the Income Tax Act24 incorporates a number of investments, the interest from
which is totally exempt from taxation. These investments may be considered as one of the
options for investing various benefits received on retirement. One among them, notified u/s
10(15)(iv)(i), is the DEPOSIT SCHEME FOR RETIRED GOVT/PUBLIC SECTOR
COMPANY EMPLOYEES which is a particularly attractive option for retiring employees of
Govt. and Public Sector Companies. W.e.f. assessment year 1990-91, the interest on deposits
made under this scheme by an employee of Central/State Govt. out of the various retirement
benefits received is exempt from Income-tax. This exemption was subsequently extended to
employees of Public Sector companies from assessment year 1991-92.25
Salient features of the scheme are discussed below:
23 Payment from an approved superannuation fund. Sec 10 (13), Income Tax Act, 1961.
24 Exemption from Interest on securities- Section 10 (15), Income Tax Act, 1961.
25 Notification No. 2/19/89-NS-II dated 12.12.1990.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

Rate of Return:- Tax free interest @ 9% P.A. payable half yearly on 30th June and 31st

December
Limit of Investment:- Minimum Rs.1000. Maximum not exceeding the total retirement

benefits.
Liquidity: - Entire balance can be withdrawn after expiry of 3 years from the date of
deposit. Premature encashment can be, made after one year from the date of deposit in
which case interest on amount withdrawn will be payable @ 4% from the date of deposit
to the date of withdrawal.26

III.

References:

1. Income Tax Department, Government of India Website:


http://www.incometaxindia.gov.in/Taxation_Of_Salaried_Employees

2. Central Board of Direct Taxes Website:


www.cbdt.co.in
3. Ministry of Finance, Government of India Website:
http://finmin.nic.in/
4. Institute of Chartered accountants of India Website:
www.ICAI.com
5. CA Club India website:
www.caclubindia.co.in
6. www.accounting-n-taxation.com/
7. The Employees Provident Fund website:
http://www.epfindia.com/

Acts/ Statutes referred:

The Income Tax Act, 1961.


Provident Funds Act, 1925.
The Industrial Dispute Act, 1947.
Board for Industrial and Financial Reconstruction Regulations, 1987.
Employees provident Funds Act.

26 www.incometaxindia.gov.in/Archive/Taxation_Of_Salaried_Employees.
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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

Books Refered:

Vinod K. Singhania, Kapil Singhania, Direct Taxes- Law and Practice, 50th Edn.

Girish Ahuja, Systematic Approach to Income Tax, 28th Edn.

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TAXABILITY OF RETIREMENT BENEFITS UNDER INCOME TAX LAW

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