Exemptions on Retirement Benefits

The Income-tax Department allows certain exemptions on the taxability of benefits which are provided to an employee after retirement. In this article, we discuss the exemptions provided to a retired employee under Section 10 of the Income Tax Act, 1961.

Death cum Retirement Gratuity

This kind of gratuity is accorded to Central Government/State Government employees/Local authority/Non-Governmental employees covered under the Gratuity Act, 1972 and other Non-Governmental employees. The quantum of exemption varies according to the type of employee. In the following paragraphs we examine the exemptions provided to each of these employees:

Central Government/State Government/Local Authority

Employees who had represented the Government or local authority will be granted a complete exemption from taxes; which effectively means that the concerned taxpayer will be allowed to reap the fruits of labour without losing any savings to tax.

Employees Covered Under Gratuity Act, 1972

In the case of employees, who are covered under the Payment of Gratuity received would be exempt to the extent it does not exceed the amount calculated in accordance with the provisions of the Payment of Gratuity Act, 1972. As per section 4(1) of the Payment of Gratuity Act, 1972, a gratuity would be due to an employee on the termination of his job after the employee has rendered continuous service for not less than 5 years, and discontinued the employment for the following reasons:

Upon the retirement or resignation, or
On the death or disablement due to accident or disease.

The completion of 5 years would not be necessary where the termination of the job of any employee is due to death/ disablement. With respect to the employees who have not served the Government, but who are covered under the Gratuity Act of 1972, the least of the below listed will be exempted:

15 days salary for every year of service or a part of the same. (However, in the case of an employee who is employed in a seasonal enterprise and is not employed throughout the year, the exemption would be for 7 days wages for each season.)
Actual gratuity received.
Rs. 20,00,000. (Notification No. 16/2019 dated 8.3.2019)

In the case of such employees, the gratuity received in excess of the above exempt amount would be included in the gross salary. The gratuity received by the legal heir of the deceased employee in excess of the above exempt amount shall be taxable in his hands under the head "Income from other sources".

Other Non-Government Employees

For Non-Governmental employees who are not covered under the Payment of Gratuity Act 1972, the least of the following will be exempt:

Half months average salary for every year of service.
Actual gratuity received.
Rs. 20,00,000.

Commuted Pension

Commuted pensions are granted to employees connected with Central Government/State Government/Local authority; and Non-governmental employees. Pensions provided to the former wouldn’t be included in the purview of taxation, whereas non-governmental employees will receive any of the following exemptions:

1/3rd of the total pension value if the employee is provided with gratuity.
Half of the total pension value if the employee is not provided with any gratuity.

Encashment of Leave Salary

Employees will be provided with monetary benefits for non-utilization of eligible leaves. The benefit is offered to the Central Government/State Government employees and other employees. The Central/State Government employees will receive exemptions for the entire leave salary received by them; whereas in the case of other employees, least of the following will be exempted:

Leave salary standing credit for the period of earned leave at the time of retirement.
Amount of leave encashment received.
The average salary for the last ten months.
A stipulated sum of Rs 3,00,000.

Voluntary Retirement Scheme

Voluntary Retirement Scheme was added to compensate the employee on the event of a job loss due to a reduction in the workforce. It is provided to the employees who are associated with the following entities:

Public sector company
Local authority
Co-operative society
Authority established under a Central, State or provincial Act
A business entity or commercial organisation which is manufacturing any of the following items:
- Electronic, aerospace and defence equipment
- Items related to the production or use of atomic energy as per the Atomic Energy Act, 1962
State Government
Central Government
An Indian Institute of Technology (IIT) within the meaning of clause (g) under Section 3 of the Indian Institutes of Technology Act, 1961; or such Institute of management as the Central Government would, by notification in the Official Gazette, mention in this behalf.
The institutions having importance throughout India or in any State or States as may be notified. The Exemption would be available that is subject to the following conditions:
- The compensation that is received only at the time of voluntary retirement or termination of his services in accordance with the scheme or schemes of voluntary retirement or in the case of the public sector company, a scheme of voluntary separation. W.e.f assessment year 2004-05, even if the composition is received in instalment, the exemption shall be allowed.
- Further, the scheme of the said that the companies or authorities or societies or universities or the institutes referred above, as the case may be, governing the payment of such amount, are framed in accordance with such guidelines (including the criteria of economic viability) as would be prescribed. In the case of the public sector companies, if there is any scheme of voluntary separation, it would also be according to the said prescribed guidelines.
Employees in receipt of the VRS will receive the least of the following exemptions:
- A sum which is equivalent to 3 months of salary for every completed year of service.
- Salary received during retirement*remaining months of service left.
- Rs. 5,00,000.

Contribution by the Employer to Recognised Provident Fund

Any contribution by the employer to the recognised provident fund in excess of 12% of the salary of the employee, is taxable in the hands of the employee and hence included in the gross salary of the employee.

Interest Credited to Recognised Provident Fund

Any interest credited to employees recognised provident fund in excess of 9.5% per annum is taxable for the employee and that is included in the gross salary of the employee.

Transferred Balance

The aggregate of all sum that is comprised in the transferred balance of the unrecognised provident fund, when it is converted into the recognised provident fund, is also taxable in the income tax assessment of the employee and hence included in the gross salary.