Taxability of Retirement Benefits
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)]:
Taxable Gratuity Calculator
- Any death cum retirement gratuity received by Central and State Govt. employees, Defense employees and employees in Local authority shall be fully exempt.
- Any gratuity received by persons covered under the Payment of Gratuity Act, 1972 shall be exempt subject to following limits:-
- In case of any other employee, gratuity received shall be exempt, subject to the following exemptions
- Exemption shall be limited to 15 day salary (based on last 10 months average salary*) for each completed year of service or ₹ 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 ₹ 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)(i)]:
- 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).
- If the employee does not receive gratuity, one half of full value of commuted pension will be exempt from tax under section 10(10A)(iii).
Leave Encashment [Section 10(10AA)]:
- 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 ₹ 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. ₹ 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 ₹ 5,00,000/- for retrenchment on or after 1.1.1997.
Compensation on Voluntary Retirement or 'Golden Handshake' [Section 10(10C)]:
Least of the following is exempt from tax:
- Actual amount received as per the guidelines i.e. least of the following
- 3 months salary for each completed year of services
- Salary at the time of retirement X No. of months of services left for retirement; or
- ₹ 5,00,000
Taxability of Contribution by Employer, Employee, Interest credited to various types of Provident Funds and payment received therefrom:
|Statutory Provident Fund||Recognised Provident Fund||Un-recognised Provident Fund||Public Provident Fund
|Employer's contribution||Exempt||Exempt upto 12% of salary (#)||Exempt||Not Applicable
|Benefit of deduction u/s 80C for Employee's contribution ||Yes||Yes||No||Yes
|Interest credited||Exempt||Exempt if rate of interest is upto 9.5%. Interest in excess of 9.5% is charged to tax.||Exempt||Exempt
|Payment received at the time of retirement or termination of service||Exempt||If certain conditions are satisfied, then lump sum amount is exempt from tax
(##)||(###)||Exempt from tax
(#) Salary for this purpose will include the following :
- Basic salary,
- Dearness allowance, if the terms of service so provide,
- Commission based on fixed percentage of turnover achieved by the employee.
(##) Accumulated balance from a recognised provident fund will be exempt from tax if following conditions are satisfied :
- If the employee has rendered a continuous service of 5 years or more.
If accumulated balance includes amount transferred from other recognised provident fund, 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 reasons beyond his control.
- If on termination, the employee takes employment with any other employer and the balance becoming payable to him is transferred to his account in any recognised fund maintained by such other employer, then the amount so transferred will not be charged to tax.
(###) Treatment of payment received from un-recognised provident fund :
Payment on termination will include four components, viz, employee's contribution and interest thereon and employer's contribution and interest thereon. The tax treatment of such payments is as follows :
- Employee's contribution is not charged to tax; interest thereon is taxed under the head 'Income from other sources'.
- Employer's contribution as well as interest thereon will be taxable as salary income. However, relief under Section 89 will be available.
Payment from Superannuation Fund:
Approved superannuation fund means superannuation fund which is approved by the Commissioner of Income-tax. With effect from assessment year 2010-11, employer's contribution to an approved superannuation fund in excess of ₹ 1,00,000 is charged to tax as perquisite.
Employee's contribution will qualify for deduction under section 80C and interest on accumulated balance is not liable to tax. Payments in following cases will be exempt from tax under section 10(13):
- Payment on death of beneficiary; or
- Payment to an employee in lieu of, or in commutation of an annuity on his retirement at or after the specified age or on his becoming incapable prior to such retirement; or
- Refund of contribution to an employee on leaving the service (otherwise than above mentioned reason) to the extent to which such payment does not exceed the contribution made prior to April 1, 1962.
- By way of refund of contributions on the death of a beneficiary.
Payments from New Pension Scheme
- As per section 80CCD, an individual who is employed by the Central Government/any other employer on or after January 1st, 2004 or a self employed assessee can claim deduction under section 80CCD in respect of contribution to NPS.
- Amount paid/deposited (during the previous year) in assessee's account, under NPS will qualify for deduction under section 80CCD.
- Amount of deduction will be as follows :
- Employee's contribution during the year to notified pension scheme, subject to condition that maximum of 10% of salary is deducted in the year in which contribution is made.
- Employer's contribution during the year to notified pension scheme is first included in the income of the assessee, and then such contribution, subject to maximum of 10% of salary, is deducted in the year in which contribution is made.
- On closure of aforesaid account or in case the employee opts out of the said scheme or on receipt of pension from the annuity plan, credit balance in such pension account for which deduction is claimed and accretion to such account is taxed in the hands of receiver in the year of receipt. If amount received on closure is used for purchasing an annuity plan in the same previous year, then such amount will be exempt from tax.
- If deduction in respect of above amount is claimed under section 80CCD, then deduction of the same amount cannot be claimed under section 80C.
- Aggregate deduction under sections 80C, 80CCC and 80CCD(1), (i.e., employee's contribution) cannot exceed ₹ 1,50,000.
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