January 24, 2012

Income tax on 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:-

1.  GRATUITY (Sec. 10(10)): (i)   Any death cum retirement gratuity received by Central and State Govt. employees, Defense employees and employees in Local authority shall be exempt.

(ii)      Any gratuity received by persons covered under the Payment of Gratuity Act, 1972 shall be exempt subject to following limits:-
(a)      For every completed year of service or part thereof, gratuity shall be exempt to the extent of fifteen days Salary based on the rate of Salary last drawn by the concerned employee.
 (b)      The amount of gratuity as calculated above shall not exceed Rs 10 Lakh.


(iii) In case of any other employee, gratuity received shall be exempt subject to the following limits:-
(a) Exemption shall be limited to half month salary (based on last 10 months average) for each completed year of service
 (b) Rs. 10 Lakhs whichever is less.

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 Rs. 10 Lakhs.

As per Central Board of Direct Tax’s letter F.No. 194/6/73-IT(A-1) dated 19.6.73, exemption in respect of gratuity is permissible even in cases of termination of employment due to resignation. The taxable portions 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(Circular No. 573 dated 2 1.8.90).

2. COMMUTATION OF PENSION (SECTION 10(10A)): In case of employees of Central & State Govt. Local Authority, Defense Services and Corporation established under Central or State Acts, the entire commuted value of pension is exempt.

3.  LEAVE ENCASHMENT (Section 10(10AA)): (i) Leave Encashment during service is fully taxable in all cases, relief u/s 89(1) if applicable may be claimed for the same.

(ii)      Any 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.

(iii)     In case of other employees, the exemption is to be limited to the least of following: (a) Cash equivalent of unutilized earned leave (earned leave entitlement can not exceed 30 days for every year of actual service) (b) 10 months average salary (c) Leave encashment actually received. This is further subject to a limit of Rs.3,00,000 for retirements after 02.04.1998.

(iv) 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.

For the purpose of Section 10(10AA), the term ‘Superannuation or otherwise’ covers resignation (CIT Vs. R.V. Shahney 159 ITR 1 60(Madras).

4.  COMPENSATION ON VOLUNTARY RETIREMENT OR ‘GOLDEN HANDSHAKE’(Sec. 10(10C)): (i) Payment received by an employee of the following at the time of voluntary retirement, or termination of service is exempt to the extent of Rs. 5 Lakh:

 (ii)      The voluntary retirement Scheme under which the payment is being made must be framed in accordance with the guidelines prescribed in Rule 2BA of Income Tax Rules. In case of a company other than a public sector company and a co-operative society, such scheme must be approved by the Chief Commissioner/Director General of Income-tax. However, such approval is not necessary from A.Y. 2001- 2002 onwards.

(iii)     Where exemption has been allowed under above section for any assessment year, no exemption shall be allowed in relation to any other assessment year. Further, where any relief u/s 89 for any assessment year in respect of any amount received or receivable or voluntary retirement or termination of service has been allowed, no exemption under this clause shall be allowed for any assessment year.

5.  PAYMENT FROM PROVIDENT FUND (Sec. 10(11), Sec. 10(12)): Any payment received from a Provident Fund, (i.e. to which the Provident Fund Act, 1925 applies) is exempt. Any payment from any other provident fund notified by the Central Govt. is also exempt. The Public Provident Fund(PPF) established under the PPF Scheme, 1968 has been notified for this purpose. Besides the above, the accumulated balance due and becoming payable to an employee participating in a Recognised Provident Fund is also exempt to the extent provided in Rule 8 of Part A of the Fourth Schedule of the Income Tax Act.

6.  PAYMENT FROM APPROVED SUPERANNUATION FUND (Sec.10(13)): Payment from an Approved Superannuation Fund will be exempt provided the payment is made in the circumstances specified in the section viz. death, retirement and incapacitation.

7. DEPOSIT SCHEME FOR RETIRED GOVT/PUBLIC SECTOR COMPANY EMPLOYEES: Section 10(15) of the Income Tax Act incorporates a number of investments, the interest from which is totally exempt from taxation. These investments may be considered as one of the options for investing various benefits received on retirement. One among them, notified u/s 10(1 5)(iv)(i), is the DEPOSIT SCHEME FOR RETIRED GOVT/PUBLIC SECTOR COMPANY EMPLOYEES which is a particularly attractive option for retiring employees of Govt. and Public Sector Companies. W.e.f. assessment year 1990-91, the interest on deposits made under this scheme by an employee of Central/State Govt. out of the various retirement benefits received is exempt from Income-tax. This exemption was subsequently extended to employees of Public Sector companies from assessment year 1991-92 vide notification No. 2/19/89-NS-II dated 12.12.1990. Salient features of the scheme are discussed below:

Rate of Return – Tax free interest @ 9% P.A. payable half yearly on 30th June and 31st December
Limit of Investment –   Minimum Rs. 1000. Maximum not exceeding the total retirement benefits.
Liquidity – Entire balance can be withdrawn after expiry of 3 years from the date of deposit. Premature encashment can be, made after one year from the date of deposit in which case interest on amount withdrawn will be payable @ 4% from the date of deposit to the date of withdrawal.
Other considerations: Only 1 account can be opened in own name or jointly with spouse. Account is to be opened within 3 months of receiving retirement benefits. Scheme is operated through branches of SBI and its subsidiaries and selected branches of nationalised banks.
[This scheme has been discontinued w.e.f. 10.07.2004 vide notification F. No.15-01/2004-NS-2, dated 09.07.2004.]

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