Tax on retirement benefits

Written by Govardhan Purohit | Govardhan Purohit | Updated: Dec 15 2008, 04:52am hrs
Retirement benefits are offered to employees to ensure an independent life and maintenance of the standard of living even after their retirement. Different companies formulate different plans of compensating their employees. Contributions to some of the funds may be mandatory due to statutory provisions, whereas few other plans may be voluntary. The existence of a remunerative retirement benefit plan not only boosts the motivation level of the employees to perform at their best, it also helps the employers in attracting and retaining the talent. There are several types of retirement benefits such as gratuity, pension, superannuation, provident fund, etc.

The taxability of retirement benefits need to be examined at two stages, i.e. one at the time of contribution by the employer and other at the time of payment to employee on retirement.

Generally, during the course of employment, the employer contributes to certain funds like superannuation fund, provident fund, gratuity fund, etc for payment in the year of retirement to the eligible employees. The employer's contribution to approved superannuation fund, recognised provident fund and gratuity fund are considered tax exempt in the hands of the employee in the year of contribution. Though, the employer is required to pay FBT on the contributions made to the approved superannuation fund for the employees [contribution in respect of each employee in excess of Rs 1 lakh].

On the one hand, the employers' contribution to recognized provident fund is not taxable in the hands of the employee, the employee is also eligible to claim deduction from total income under section 80C of the Income Tax Act in respect his/her own contribution to such fund up to a maximum of Rs 1 lakh. [Certain other payments/investments are also eligible for such deduction within this overall limit].

At the time of retirement, the taxability of receipts generally depends upon the type of retirement benefit and the mode of payment. Though regular monthly pension is taxable in full in the hands of the employee, the tax exemption may be claimed for several one time payments like gratuity, leave encashment, commuted pension etc, based on the prescribed formulas under the Income Tax Act.

Generally, the employer and employee both contribute to recognised provident fund during the course of exercise of employment. This consolidated amount is invested and interest is earned on the same. The withdrawal from such fund may be claimed as tax exempt provided certain conditions are met. One of the conditions of claiming exemption is rendering of continuous service of five years either with the current employer or along with the period of services with the previous employer from whom the recognised provident fund balance was transferred to the last employer served.

Apart from the above, international assignees who come to India for few years for the purposes of employment, generally do not contribute to the Indian retirement benefits. Even after coming to India, they continue their contributions with their home country social security schemes.

Though there are no specific provisions for taxability of contribution to foreign social security in India in the hands of employees, there are few judicial precedents on the basis which the employer's contribution to some of the mandatory social security schemes can be claimed as not chargeable to tax. However, in case of voluntary schemes, the contributions related to period of services in India are taxable as income in India in the hands of concerned employees.

Though, the international workers were not mandatorily required to contribute to Indian retirement benefits, a recent amendment in the Employees Provident Fund Act has extended the applicability of the Act to international workers as well. Broadly, the individuals coming to India from the countries with which India does not have a Social Security Agreement (SSA) are covered within the definition of international worker. The individuals who are covered by virtue of this amendment are mandatorily required to contribute 12% of their salary to the provident fund/employee pension scheme and the employer is also required to make a matching contribution. The employees can withdraw the amount at the time of leaving employment in India. However, they may have to pay taxes on such withdrawal, as may be required under the relevant provisions of law.

The author is executive director, PricewaterhouseCoopers