Voluntary retirement or retrenchment, your compensation is taxable but with some exemptions

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We are going through tough times where companies trimming on staff strength has become very common news. In between March 2020 to 2021, LinkedIn has witnessed a peak in the posts related to job losses by its online users across the world. Hence, it is important for you to be aware of the compensation details. The compensation received from the employer is taxable as per the slab rate.

According to a recent report by Taxmann, there are several salary components that are deemed as payments to the employees in lieu of salary, called ‘profits in lieu of salary. It includes compensation paid for termination of employment, payment from the provident fund, payment under the keyman insurance policy for those key employees who have significantly contributed to the success of the business, etc. These components, which are part of the profit in lieu of salary, are taxable in the hands of employees, except for VRS and retrenchment compensation which has an exemption up to Rs 5,00,000.

Please find the list below along with their taxability:

1.Voluntary Retirement Compensation- Exempt up to Rs. 5,00,000

2. Retrenchment Compensation- Exempt up to Rs. 5,00,000

3. Unrecognized Provident Fund- Taxable

4. Sum received under a Keyman insurance policy- Taxable

5. Payment received from an employer before joining or after cessation from employment- Taxable

6. Gratuity- Exempted to a certain extent

7. Leave Encashment- Exempted to a certain extent

Another Taxmann Report on Voluntary Retirement Compensation (VRS), states that VRS is an early retirement option given by an employer to its employees to take retirement before the decided age of retirement. To ensure social security for the retiring employees, employers provide ‘voluntary retirement compensation to their employees. Such compensation is taxable in the hands of the employees as profit in lieu of salary. If an employee has been retrenched by the employer and in lieu of that he is paid retrenchment compensation, it shall also be exempt up to Rs. 5,00,000 if other conditions are satisfied.

Any compensation received on voluntary retirement or separation is exempt from tax as per Section 10(10C). However, some conditions must be fulfilled, says Archit Gupta, Founder & CEO, ClearTax. He said exemption can be made only in the following conditions:

a. Compensation received is towards voluntary retirement or separation

b. Maximum compensation received does not exceed Rs 5,00,000.

c. The recipient is an employee of an authority established under the Central or State Act, local authority, university, IIT, state government or central government, notified institute of management, or notified institute of importance throughout India or any state, PSU, company, or a cooperative society.

d. The receipts are in compliance with Rule 2BA.

He also added that exemption can only be claimed in the assessment year the compensation is received.