Taxability of Retirement Benefits
- Gratuity • Commutation of Pension• Leave Encashment • Retrenchment Compensation• Compensation on Voluntary Retirement • Provident Fund• Payment from Superannuation Fund • Payment from New Pension Scheme
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). However, in respect of some of them, exemption from taxation is granted u/s 10 of the Income Tax Act, either wholly or partly. These exemptions are described below:-
Gratuity [Section 10(10)]:
Any death cum retirement gratuity received by Central and State Govt. employees, Defense employees and employees in Local authority shall be exempt.
Any gratuity received by persons covered under the Payment of Gratuity Act, 1972 shall be exempt subject to following limits:-
For every completed year of service or part thereof, gratuity shall be paid at the rate of 15 days’ salary based on the salary last drawn by the concerned employee. Salary for this purpose will include basic salary and dearness allowance only. 15 days salary is to be computed by the formula
15 days’ salary = Salary last drawn x 15/26.
The amount of gratuity as calculated above shall not exceed Rs. 10,00,000/-.
In case of any other employee, gratuity received shall be exempt, subject to the following exemptions
Exemption shall be limited to 15day salary (based on last 10 months average salary*) for each completed year of service or Rs. 10,00,000/- whichever is less.
While computing year of service, any fraction of year is to be ignored.
Salary for this purpose will include basic salary, dearness allowance, if the terms of service so provide and commission based on fixed percentage of turnover achieved by the employee.
* Average monthly salary is to be computed on the basis of average of salary for 10 months immediately preceding the month (not the day) of retirement.
Where the gratuity was received in any one or more earlier previous years also and any exemption was allowed for the same, then the exemption to be allowed during the year gets reduced to the extent of exemption already allowed, the overall limit being Rs. 10,00,000/-.
The exemption in respect of gratuity is permissible even in cases of termination of employment due to resignation. The taxable portion of gratuity will quality for relief u/s 89(1).
Gratuity payment to a widow or other legal heirs of any employee who dies in active service shall be exempt from income tax.
Commutation of Pension [Section 10(10A)]:
In case of employees of Central & State Govt., Local Authority, Defense Services and corporations established under Central or State Acts, the entire commuted value of pension is exempt.
In case of any other employee
If the employee receives gratuity, one third of full value of commuted pension will be exempt from tax under section 10(10A)(ii)(a).
If the employee does not receive gratuity, one half of full value of commuted pension will be exempt from tax under section 10(10A)(ii)(b).
Leave Encashment [Section 10(10AA)]:
Leave Encashment during service is fully taxable in all cases, relief u/s 89(1), if applicable, may be claimed for the same.
Payment by way of leave encashment received by Central & State Govt. employees at the time of retirement in respect of the period of earned leave at credit is fully exempt.
In case of other employees, the exemption is to be limited to a maximum of 10 months of leave encashment, based on last 10 months average salary. This is further subject to a limit of Rs. 3,00,000/-.
Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to the credit of such employee at the time of death is not taxable.
Provided that where any such payments are received by an employee from more than one employer in the same previous year, the aggregate amount exempt from income-tax under sub-clause 42 shall not exceed the specified limit i.e. Rs. 300000/-.
For the purpose of Section 10(10AA), the term ‘Superannuation or otherwise’ covers resignation.
Retrenchment Compensation [(Section 10(10B)]:
Retrenchment compensation received by a workman under the Industrial Dispute Act 1947 or any other Act or Rules is exempt subject to following limits:
Compensation calculated @ fifteen days average pay for every completed year of continuous service or part there of in excess of 6 months.
The above is further subject to an overall limit of Rs. 5,00,000/- for retrenchment on or after 1.1.1997.
Compensation on Voluntary Retirement or ‘Golden Handshake’ [Section 10(10C)]:
Payment received by an employee of an undertaking specified in section 10(10C) at the time of voluntary retirement, or termination of service is exempt to the extent of Rs. 5 Lakh:
The voluntary retirement Scheme under which the payment is being made must be framed in accordance with the guidelines prescribed in Rule 2BA of Income Tax Rules.
Where exemption has been allowed under above section for any assessment year, no exemption shall be allowed in relation to any other assessment year.
Taxability of Contribution by Employer, Employee, Interest credited to various types of Provident Funds and payment received therefrom: