Retirement Benefits

1. Gratuity Section 10(10)

Gratuity is a payment made by the employer to an employee for the services rendered during the period of employment by the employee. It is usually paid at the time of retirement but it can be paid before provided certain conditions are met. It applies to enterprises having 10 or more employees on a single day in preceding 12 months. And once an organisation comes under the purview of the gratuity Act, then it will always remain covered even if the number of employees falls below 10.

Gratuity can either be received by:

  1. the employee himself at the time of his retirement; or
  2. The legal heir on the event of the death of the employee.

When are you Eligible?

You will be Eligible for gratuity if you have completed minimum 5 years of Service under your employer. It is not applicable to interns or temporary employees.

Calculation of amount of gratuity exempted from tax (on Retirement):

a) In case of Government Employee : Any gratuity received by a Government employee is wholly exempt from tax. This exemption is not available to employees of statutory corporation.

b) In case of Employees covered by Payment of Gratuity Act: An amount equal to the least of the following will be exempt from tax –

  • 15/26 x Salary last drawn x No. of completed years of service or part thereof in excess of 6 months.
  • 20,00,000 (hiked up from Rs. 10,00,000 as per the amendment)
  • Gratuity actually received

Example: Last drawn salary (Basic + Dearness Allowance) of MR X was Rs.1,00,000 per month. He is entitled to receive a gratuity of Rs.11,00,000. His tenure of employment was 19 years and 9 months.

Tax exemption on Gratuity – Lower of the below three:

Sr. No. Particulars Amount  
1 Gratuity computed 15/26*1,00,000*20 = 11,53,846
2 Exemption allowance (maximum) 20,00,000
3 Actual received 11,00,000
4Amount of exemption (least of the above ) 11,00,000
5 Taxable gratuity Nil

c) In Case of Employees not Covered under the Payment of Gratuity Act :An amount equal to the least of the following will be exempt from tax –

  • ½ x Average salary of last 10 months preceding the month of retirement x Completed year of service (fraction of a year is ignored)
  • 10,00,000
  • Gratuity actually received

Important Points:

  1. Gratuity received during the period of service by any category of employees i.e. government, covered or not covered under the act is fully taxable.
  2. Gratuity received at the time of death by the legal heir of any government employee is fully exempt u/s 10(10)(i)
  3. Gratuity received at the time of death by the legal heir of employees covered or not covered under gratuity act is taxable as per the limits mentioned, when gratuity was received on retirement.

2. Pension [Section 10(10A)]

Pension can be divided into two types:

  1. Uncommuted Pension is received in regular instalments is taxable for all employees. I.e. both Government and non – Government employees.
  2. Commuted Pension is received in one time rather in instalments.

Taxability for commuted pension:

a) For Government employees: Commuted pension is exempt for the employees of Central & State Govt. or Local Authority or statutory corporation.

b) Any Other Employees: The amount of exemption will be as follows.

  • Employees who also receives gratuity: 1/3 of 100% Commuted value of pension.
  • Employees who does not receives gratuity: 1 /2 of 100% Commuted value of pension.

Notes:

  • Commuted value of pension = Pension received / Percentage of pension commuted
  • If pension is partly commuted and partly uncommuted then each portion’s exemption is calculated accordingly.

Pension Received by a Family member

  • Pension received by a family member is taxed under income from other sources in  Income Tax Return.
  • If this pension is commuted or is a lump sum payment it is not taxable.
  • Uncommuted pension received by a family member is exempt to a certain extent. i.e. Rs 15,000 or 1/3rd of the uncommuted pension received -whichever is less is exempt from tax.

For Example:  If a family member receives pension of Rs 1,00,000 the exemption available is least of – Rs 15,000 or Rs 33,333 (1/3rd of Rs 1,00,000).
Thus the taxable family pension will be Rs 100000 – Rs 15000 = Rs 85,000

3. Voluntary Retirement Scheme [Section 10(10C)]

What is Voluntary Retirement Scheme (VRS)?

VRS is an early Retirement option given by employer to its eligible employee by compensating them for taking an early retirement.

Certain conditions to be fulfilled to get exemption for VRS:

Rule 2BA of Income tax rules provides following requirement to claim exemption.

  • It applies to an employee who has completed 10 years of service or completed 40 years of age. (This condition doesn’t apply to employees of Public Sector Company).
  • It applies to all employees except directors of a company
  • The scheme of voluntary retirement [or voluntary separation] has been drawn to result in overall reduction in the existing strength of the employees
  • The retiring employee of a company shall not be employed in another company or concern belonging to the same management

It shall be exempted up to least of following:

  1. Statutory Limit 5,00,000.
  2. 3 months x salary last drawn x completed year of service
  3. Salary last drawn x balance of months left before the date of retirement or superannuation.
  4. Actual amount received.

*Salary for this purpose will include basic salary, dearness allowance (if it forms a part of retirement benefits) and Percentage wise fixed commission on Turnover.

Notes:

  • If the assesse has already taken relief under section 89, then exemption under this section is not available.
  • Deduction under section 10(10C) can be taken once only, therefore if deduction under this section is taken once then deduction is not available in any subsequent years.

4. Statutory Provident Fund [Section 10(11)]

Statutory Provident Fund (SPF) is governed by provident Funds act, 1925. It applies to employees of government, railways, semi-government institution, local bodies, universities and all recognized educational institution.

Tax Treatment :

  1. Employer’s Contribution – Employer’s contribution to such fund is not treated as income of the employee.
  2. Employees Contribution – Entitled to Deduction u/s 80C.
  3. Interest credited – Exempt from tax.
  4. Lumpsum received – Exempt from tax.

5. Recognized Provident Fund [Section 10(12)]

a) Recognized Provident Fund (RPF) is a scheme to which the Employee’s Provident Funds and Miscellaneous Provisions Act, 1952 applies. It applies to enterprises employing 20 or more employees.

Tax Treatment :

  1. Employer’s Contribution – Excess of 12% of Salary is taxable as income of employee.
  2. Employees Contribution –  Entitled to Deduction u/s 80C
  3. Interest Credited – Excess of 9.5% interest is taxable as income of employee.
  4. Lump sum received – Exempt upon satisfying the conditions.

The Conditions for the purpose of exemption of lump sum payment of RPF are as follows:

  • If the employee has rendered a continuous service of 5 years or more. If the accumulated balance includes amount transferred from other recognized provident fund maintained by previous employer, then the period for which the employee rendered service to such previous employer shall also be included in computing the aforesaid period of 5 years.
  • If the service of employee is terminated before the period of 5 years, due to his ill health or discontinuation of business of the employer or other reason beyond his control.
  • If on retirement, the employee takes employment with any other employer and the balance due and payable to him is transferred to his individual account in any recognized fund maintained by such other employer, then the amount so transferred will not be charged to tax.

b) Un-Recognized Provident Fund (URPF) is a fund not recognized by the Commissioner of Income-tax

Tax Treatment :

  1. Employers Contribution: It is not treated as income of the employee.
  2. Employees contribution: No deduction under section 80C available
  3. Interest: It is not taxable.
  4. Lump sum received at termination: Payment on termination/retirement will include 4 things, viz., employee’s contribution and interest thereto and employer’s contribution and interest thereto, the tax treatment of such payment is as follows:
    • Employee’s contribution is not chargeable to tax; interest on employee contribution is taxed under the head “Income from other sources”.
    • Employer’s contribution and interest thereon are taxed as salary income.

c) Public Provident Fund: Public Provident Fund (PPF) was introduced in India in 1968 with the objective to mobilize small saving in the form of an investment, coupled with a return on it. Any Individual (whether Salaried or Self-Employed or any other category) can invest in this scheme.

Tax Treatment :

  1. Employers Contribution: Employer’s do not contribute to such fund.
  2. Interest: Interest credited to such fund is exempt.
  3. Employees Contribution –  Entitled to Deduction u/s 80C
  4. Lump sum received at the time of termination : Lump sum amount   received from such fund at the time of termination of services is exempt from tax.

6. Leave Encashment or Leave Salary [Section 10(10AA)]

What is Leave Salary?

Leave salary is a payment received by a employee as the cash equivalent of the leave salary in respect of the period of earned leave at his credit at the time of his retirement whether on superannuation or otherwise.

Computation of Leave Salary:

a) In Case Of Government Employee: Total amount received as leave encashment is exempt from tax

b) In Case Of Non-Government Employee: Total leave encashment received is the least of the following –

  1. 10 months average salary.
  2. Leave encashment actually received
  3. Amount equal to salary for the period of leave earned (based on last 10 months average salary)
    [Leave due = Leave allowed – Leave taken]
    [Leave Due(in days)/30days * Average salary p.m]
  4. Rs.3,00,000/-

Notes:

  • Leave Salary received during the period of service is fully taxable.
  • Average salary= Salary of 10 months immediately preceding the retirement or resignation.
  • Salary means basic salary and dearness allowance, if provided in the terms of employment for retirement benefits and commission which is expressed as a fixed percentage of turnover, excludes all allowances and perquisites
  • Leave earned should not exceed 30 days for a year of actual service

Example: Mr Gupta retired on 1.12.2017 after 20 years 10 months of service, receiving leave salary of Rs 5,00,000. Other details of his salary income are:

  1. Basic Salary: Rs. 5,000 p.m.(Rs 1,000 was increased w.e.f. 1.4.2017)
  2. Dearness Allowance:  Rs. 3,000 p.m. (60% of which is for retirement benefits)
  3. Commission: Rs 500 p.m.
  4. Leave availed during service: 480 days
  5. He was entitled to 30 days leave every year.

Now, the exempted amount of Leave salary will be least of the following four figures:

Statutory Limit Rs 3,00,000
Leave encashment amount actually received Rs 5,00,000
10 months’ salary
({(5000*8 months) +(4000*2 months)+(60% of 3,000 *10 months)*10 months}/10 months)           
Rs 66,000
Amount equal to salary for the period of leave earned
[({20*30}- 480)/30*6600]
Rs 26,400

The least of the four is Rs 26,400; therefore, in this particular case Mr.Gupta is entitled for leave salary exemption of Rs. 26,400/-.

7. Retrenchment Compensation [Section 10(10B)]

What is Retrenchment Compensation?

The compensation received by a workman under the Industrial Disputes Act, 1947, or under any other Act or Rules, orders or notifications issued there under or under any standing orders or under any award, contract of service or otherwise, at the time of his retrenchment  is called Retrenchment compensation.

Computation of Leave Salary:

A deduction from retrenchment compensation is allowed under section 10(10B), which is least of the following: –

  • an amount calculated in accordance with the provisions of clause (b) of section 25F of the Industrial Disputes Act, 1947 (14 of 1947) ; or
  • such amount, not being less than fifty thousand rupees, as the Central Government may, by notification in the Official Gazette, specify in this behalf.

8. National Pension Scheme [Section 10(12A)]

What is National Pension Scheme?

National Pension Scheme is a voluntary and long-term investment plan for retirement under the purview of the Pension Fund Regulatory and Development Authority (PFRDA) and Central Government.

Tax Treatment:

9. Approved Superannuation Fund [Section 10(13)]

Approved superannuation fund means a superannuation fund or any part of a superannuation fund which has been and continues to be approved by the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner

Exemption : Any payment from an approved superannuation fund is made—

  • 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 the death of a 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; or
  • by way of transfer to the account of the employee under a pension scheme referred to in section 80CCD and notified by the Central Government;

Tax Treatment:

  • Employee’s contribution to an approved superannuation fund is eligible for deduction under section 80C.
  • Interest received on the superannuation funds is exempt from tax.
  • Employer’s contribution to a superannuation fund upto Rs. 1 lakh is exempt from tax.( Any amount above Rs. 1 lakh will be subject to taxation).
  • If an employee wants to withdraw their superannuation fund at the time of resigning from a company, the entire amount will be subject to tax subject to certain exceptions.

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