While the severance pay offered to laid-off employees is not tax-free, there are some options for them to claim tax exemptions/reliefs. Under the Income Tax rule, the following options are available to such employees.
1. Retrenchment Exemption u/s 10(10B)
If the employee is receiving any compensation under the Industrial Dispute Act, 1947 at the time of retrenchment, such employee may claim the exemption under Section 10(10B) of the IT Act, according to Dr Suresh Surana, Founder, RSM India. However, the exemption would be restricted to lower of the following amounts:
a) Actual amount received
b) Amount calculated in accordance with the provisions of Section 25F(b) of the Industrial Disputes Act, 1947 which is equal to 15 day’s average pay for every completed year of service or part thereof in excess of 6 months
c) Amount specified by the Central Government, i.e. Rs 5,00,000
“Any compensation exceeding the aforementioned threshold limit would be subjected to tax under the head ‘Salary’ against which the employee would be eligible to claim relief u/s 89 of the IT Act, 1961,” says Dr Surana.
However, there is one situation in which the above limit would not apply.
“The proviso to Section 10(10B) provides that where the compensation is received by the employee under any scheme approved by the Central Government having regard to the need for extending special protection to the workmen in the undertaking to which such scheme applies and other relevant circumstances, approve in this behalf, the entire amount received would be exempt from tax and the aforementioned limits would not apply in such case,” says Dr Surana.
2. Voluntary Retirement Scheme (VRS) Exemption u/s 10(10C)
Tax experts say that an employee can claim tax exemption if s/he has received compensation under Voluntary Retirement Scheme (VRS).
According to Dr Surana, the exemption with respect to such severance pay would be subject to the following conditions:
a) The employee is employed under specified categories of employers such as Public sector company, any authority established under Central, State or Provisional Act, Central or State Government, etc.
b) The amount of exemption would be restricted to Rs 5 lakh and accordingly, any amount over and above the said threshold would be subject to tax.
c) The employee should fall within the guidelines prescribed under Rule 2BA of the Income Tax Rules, 1962 as follows:
- The employee has completed 10 years of service or completed 40 years of age (Such condition is not applicable in case of severance pay/ compensation received by an employee of a Public sector company owing to any Voluntary separation);
- Applicable to all employees including workers and executives of a company or of an authority or of a co-operative society, as the case may be, except directors of a company or of a co-operative society;
- The scheme of voluntary retirement has been drawn to result in overall reduction in the existing strength of the employees;
- The vacancy caused by the voluntary retirement is not to be filled up;
- The retiring employee of a company shall not be employed in another company or concern belonging to the same management;
- The amount receivable on account of voluntary retirement of the employee does not exceed the amount equivalent to 3 month’s salary for each completed year of service or salary at the time of retirement multiplied by the balance months of service left before the date of his retirement on superannuation
However, an employee cannot claim deduction u/s 10(10C) of the Income Tax Act if s/he is claiming relief under Section 89 of the Act.
3. Relief under Section 89 on Salary received in arrears
With respect to the salary received in arrears, employees can claim relief under section 89 of the IT Act read with Rule 21A of the Income Tax Rules, 1962. However, the underlying condition for availing relief under Section 89 is that the employee should have provided continuous service for at least 3 years and the unexpired portion of the term of employment of such employee should not be less than three years.