Whenever any employer organisation decides to introduce a scheme of Voluntary Retirement from the service, the main issue with employees' union, apart from consensus on VRS Compensation amount, is Taxability of that amount since the amount is a significantly huge sum of money and thus attract much more tax. So, just to reduce the tax burden, they try many ideas. Generally they know about Section 10 (10C) of the Income Tax Act that the VRS compensation is exempt to the extent of Rupees FIve Lakhs. So, One such "excellent" idea I recently came across was somewhat like this: "We will take the VRS compensation in two parts, half in this year, half in next year and so we can claim exemption upto Rs.5 Lakhs in both the years". Now, how fantastic was that! (I enquired whether the concerned person was a MBA & to my amazement, he was not!)
However, the question remains as to the taxability of VRS Compensation. To study the taxability of VRS compensation, we have to consider several Sections and Rules of the Income Tax act together.
1. Section 5
This section explains about General scope of the phrase "Total Income", for chargeability under Section 4, which says that total income of the resident person includes all the income from whatever source derived which-
(a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or
(c) accrues or arises to him outside India during such year
So, it is clear even from the plain reading of the section that not only the income actually received is considered as total income for the purpose of chargeability to tax but also the income which has accrued is also chargeable to the tax.
2. Section 15
This section gives what is chargeable to tax under the Head Salaries. It reads as follows,
The following income shall be chargeable to income-tax under the head
“Salaries”—
(a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not;
(b) any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him;
(c) any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.
[Explanation 1].—For the removal of doubts, it is hereby declared that where any salary paid in advance is included in the total income of any person for any previous year it shall not be included again in the total income of the person when the salary becomes due.
So, as per section 15, salary is charged to tax on the basis of Accrual or Receipt, whichever is earlier. i.e., Where the the salary is received in advance by the employee, it is charged to tax in the year of receipt. But, as per Explanation 1 to section 15, such salary which is received in advance, if taxed in the year of receipt, shall not be taxable again in the year in which it becomes due.
Likewise, any salary is due from the employer for the previous year, it will be charged to tax whether it is actually paid or not. Also, in case of arrears of salary, it becomes taxable in the year of receipt or accrual, whichever is earlier, if it is not taxed in any of the earlier years.
The intention of law behind this particular provision is ensuring the Revenue of the Government at as early stage as possible. If there is advance salary, Department doesn't want to wait till it becomes legally due since it will amount to deferment of revenue for the department. And whenever it becomes due but the employee has not actually received it, the Department books the revenue on an advance basis. The clear intention is not to defer the revenue in any case!
Now the question is, whether VRS Compensation can be considered under the head Salary? The answer to this question can be found out in Section 17.
3. Section 17 (1) and 17 (3)
17(1): For the purposes of sections 15 and 16 and of this section,—
(1) “salary” includes—
(i) wages;
(ii) any annuity or pension;
(iii) any gratuity;
(iv) any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages;
(v) any advance of salary;
(va) any payment received by an employee in respect of any period of leave not availed of by him;]
(vi) the annual accretion to the balance at the credit of an employee participating in a recognized provident fund, to the extent to which it is chargeable to tax under rule 6 of Part A of the Fourth Schedule;
(vii) the aggregate of all sums that are comprised in the transferred balance as referred to in sub-rule (2) of rule 11 of Part A of the Fourth Schedule of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under sub-rule (4) thereof; and
(viii) the contribution made by the Central Government [or any other employer in the previous year, to the account of an employee under a pension scheme referred to in section 80CCD;
17(3): “profits in lieu of salary” includes—
(i) the amount of any compensation due to or received by an assessee from his employer or former employer at or in connection with the termination of his employment or the modification of the terms and conditions relating thereto;
(ii) any payment (other than any payment referred to in clause (10) clause (10A), clause (10B), clause (11), clause (12), clause (13) or clause (13A) of section 10, due to or received by an assessee from an employer or a former employer or from a provident or other fund, to the extent to which it does not consist of contributions by the assessee or interest on such contributions or any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy.
Explanation.—For the purposes of this sub-clause, the expression “Keyman insurance policy” shall have the meaning assigned to it in clause (10D) of section 10;
(iii) any amount due to or received, whether in lump sum or otherwise, by any assessee from any person—
(A) before his joining any employment with that person; or
(B) after cessation of his employment with that person.
I have intentionally taken up these two sub-sections together.
Under Sec 17(1), the act has defined "Salary" and it mentions in 17(1)(iv) that profits in lieu of salary is also included in the term Salary. Further, Sec 17(3) states what does profits in lieu of salary mean and include. In here, very first clause [17(3)(i)] says that any compensation due to or received by an assessee, at or in connection with the termination of his employment. This wording clearly suggests that Voluntary Retirement Compensation is a part of Salary and taxable under the same head of Income.
Now let us look at the exemption Section i.e. Section 10(10C). It reads as follows:
10 (10C): any amount received or receivable by an employee of—
(i) a public sector company ; or
(ii) any other company ; or
(iii) an authority established under a Central, State or Provincial Act ; or
(iv) a local authority ; or
(v) a co-operative society ; or
(vi) a University established or incorporated by or under a Central, State or Provincial Act and an institution declared to be a University under section 3 of the University Grants Commission Act, 1956 (3 of 1956) ; or
(vii) an Indian Institute of Technology within the meaning of clause (g) of section 375 of the Institutes of Technology Act, 1961 (59 of 1961) ; or
(viia) any State Government; or
(viib) the Central Government; or
(viic) an institution, having importance throughout India or in any State or States, as the Central Government may, by notification in the Official Gazette79, specify in this behalf; or
(viii) such institute of management as the Central Government may, by notification80 in the Official Gazette, specify in this behalf, on his voluntary retirement or termination of his service, in accordance with any scheme or schemes of voluntary retirement or in the case of a public sector company referred to in sub-clause (i), a scheme of voluntary separation, to the extent such amount does not exceed five lakh rupees :
Provided that the schemes of the said companies or authorities or societies or Universities or the Institutes referred to in sub-clauses (vii) and (viii)], as the case may be, governing the payment of such amount are framed in accordance with such guidelines (including inter alia criteria of economic viability) as may be prescribed
Provided further that where exemption has been allowed to an employee under this clause for any assessment year, no exemption thereunder shall be allowed to him in relation to any other assessment year :]
Provided also that where any relief has been allowed to an assessee under section 89 for any assessment year in respect of any amount received or receivable on his voluntary retirement or termination of service or voluntary separation, no exemption under this clause shall be allowed to him in relation to such, or any other, assessment year;
It's a big section now, isn't it? Let me sum it up for you. It says that any amount received or receivable by an employee from the employer (the list of employers given and it is exhaustive; not inclusive- see the last one) on voluntary retirement or termination is exempt upto Rs. 5,00,000/-. However, proviso 1 to the section says that to avail this exemption, a few conditions need to be satisfied by the companies. These guidelines are given in Rule 2BA of the Income tax Rules which are as follows
Rule 2BA
At the time of his voluntary retirement [or voluntary separation] shall be exempt under clause (10C) of section 10 only if the scheme of voluntary retirement framed by the aforesaid company or authority [or co-operative society or University or institute], as the case may be [or if the scheme of voluntary separation framed by a public sector company,] is in accordance with the following requirements, namely :—
(i) it applies to an employee who has completed 10 years of service or completed 40 years of age;
(ii) it applies to all employees (by whatever name called) including workers and executives of a company or of an authority or of a co-operative society, as the case may be, excepting directors of a company or of a co-operative society;
(iii) the scheme of voluntary retirement [or voluntary separation] has been drawn to result in overall reduction in the existing strength of the employees;
(iv) the vacancy caused by the voluntary retirement [or voluntary separation] is not to be filled up;
(v) the retiring employee of a company shall not be employed in another company or concern belonging to the same management;
(vi) the amount receivable on account of voluntary retirement [or voluntary separation] of the employee does not exceed the amount equivalent to three months salary for each completed year of service or salary at the time of retirement multiplied by the balance months of service left before the date of his retirement on superannuation :
Provided that requirement of (i) above would not be applicable in case of amount received by an employee of a public sector company under the scheme of voluntary separation framed by such public sector company.
So, after going through the rule cum guidelines, it is advised that before claiming the exemption, such employees should make sure that the VRS Agreement made between them and the Management meets all the conditions for claiming the exemption!
Now, a combined reading and interpretation of Sections 15, 17 and clause 10C of Section 10 states that
i. compensation received under VRS is taxable as salary
ii. it is taxable in the year of accrual or receipt, whichever is earlier (i.e. whether paid or not). So, even if part of the compenstion is received in this year and balance is received in next year or any subsequent year, it is taxed in this Previous year only, since it is accrued in the current previous year. In other words, the salary accrued or which becomes due need not be actually paid in order to make it taxable. What is relevant is whether the salary is due to an employee from an employer.
iii. exemption is available to the extent of Rs. 5,00,000/- on the lumpsum amount of VRS compensation.
iv. no other exemption/ rebate/ deduction can be taken availed if exemption u/S. 10(10C) is availed in respect of the amount of VRS Compensation. Proviso 3 to S. 10(10C) is inserted by Finance (No.2) Act, 2009 wef 01-04-2010 stating that exemption u/S 10(10C) cannot be availed if Rebate U/s 89 is already availed. Also similar proviso is inserted under Section 89 stating that if exemption u/S 10(10C) is availed already then rebate U/S 89 cannot be availed. So it's a welcome change for revenue department
Relevant case Laws:
1. Y.S.C. Babu Vs. CMD, Syndicate Bank, [2002] 253 ITR 1 (AP)
2. State Bank of Travavcore Vs. Central Board of Direct Taxes [2006]151 taxman 133 (Ker.)
So, it was advisable to the employees who were planning for compensation in two parts in two different years (as stated at the beginning) to rather get the agreement done for the payment of compensation in the beginning of next year so that such compensation would be the only income under the head Salary which would be chargeable to tax!
Whenever any employer organisation decides to introduce a scheme of Voluntary Retirement from the service, the main issue with employees' union, apart from consensus on VRS Compensation amount, is Taxability of that amount since the amount is a significantly huge sum of money and thus attract much more tax. So, just to reduce the tax burden, they try many ideas. Generally they know about Section 10 (10C) of the Income Tax Act that the VRS compensation is exempt to the extent of Rupees FIve Lakhs. So, One such "excellent" idea I recently came across was somewhat like this: "We will take the VRS compensation in two parts, half in this year, half in next year and so we can claim exemption upto Rs.5 Lakhs in both the years". Now, how fantastic was that!
However, the question remains as to the taxability of VRS Compensation. To study the taxability of VRS compensation, we have to consider several Sections and Rules of the Income Tax act together.
1. Section 5
This section explains about General scope of the phrase "Total Income", for chargeability under Section 4, which says that total income of the resident person includes all the income from whatever source derived which-
(a) is received or is deemed to be received in
(b) accrues or arises or is deemed to accrue or arise to him in
(c) accrues or arises to him outside
So, it is clear even from the plain reading of the section that not only the income actually received is considered as total income for the purpose of chargeability to tax but also the income which has accrued is also chargeable to the tax.
2. Section 15
This section gives what is chargeable to tax under the Head Salaries. It reads as follows,
The following income shall be chargeable to income-tax under the head
“Salaries”—
(a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not;
(b) any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him;
(c) any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.
[Explanation 1].—For the removal of doubts, it is hereby declared that where any salary paid in advance is included in the total income of any person for any previous year it shall not be included again in the total income of the person when the salary becomes due.
So, as per section 15, salary is charged to tax on the basis of Accrual or Receipt, whichever is earlier. i.e., Where the the salary is received in advance by the employee, it is charged to tax in the year of receipt. But, as per Explanation 1 to section 15, such salary which is received in advance, if taxed in the year of receipt, shall not be taxable again in the year in which it becomes due.
Likewise, any salary is due from the employer for the previous year, it will be charged to tax whether it is actually paid or not. Also, in case of arrears of salary, it becomes taxable in the year of receipt or accrual, whichever is earlier, if it is not taxed in any of the earlier years.
The intention of law behind this particular provision is ensuring the Revenue of the Government at as early stage as possible. If there is advance salary, Department doesn't want to wait till it becomes legally due since it will amount to deferment of revenue for the department. And whenever it becomes due but the employee has not actually received it, the Department books the revenue on an advance basis. The clear intention is not to defer the revenue in any case!
Now the question is, whether VRS Compensation can be considered under the head Salary? The answer to this question can be found out in Section 17.
3. Section 17 (1) and 17 (3)
17(1): For the purposes of sections 15 and 16 and of this section,—
(1) “salary” includes—
(i) wages;
(ii) any annuity or pension;
(iii) any gratuity;
(iv) any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages;
(v) any advance of salary; (va) any payment received by an employee in respect of any period of leave not availed of by him;]
(vi) the annual accretion to the balance at the credit of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under rule 6 of Part A of the Fourth Schedule;
(vii) the aggregate of all sums that are comprised in the transferred balance as referred to in sub-rule (2) of rule 11 of Part A of theFourth Schedule of an employee participating in a recognised provident fund, to the extent to which it is chargeable to tax under sub-rule (4) thereof; and
(viii) the contribution made by the Central Government [or any other employer in the previous year, to the account of an employee under a pension scheme referred to in section 80CCD;
17(3): “profits in lieu of salary” includes—
(i) the amount of any compensation due to or received by an assessee from his employer or former employer at or in connection with the termination of his employment or the modification of the terms and conditions relating thereto;
(ii) any payment (other than any payment referred to in clause (10) clause (10A), clause (10B), clause (11), clause (12), clause (13) or clause (13A) of section 10, due to or received by an assessee from an employer or a former employer or from a provident or other fund, to the extent to which it does not consist of contributions by the assessee or interest on such contributions or any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy.
Explanation.—For the purposes of this sub-clause, the expression “Keyman insurance policy” shall have the meaning assigned to it in clause (10D) of section 10;
(iii) any amount due to or received, whether in lump sum or otherwise, by any assessee from any person—
(A) before his joining any employment with that person; or
(B) after cessation of his employment with that person.
I have intentionally taken up these two sub-sections together.
Under Sec 17(1), the act has defined "Salary" and it mentions in 17(1)(iv) that profits in lieu of salary is also included in the term Salary. Further, Sec 17(3) states what does profits in lieu of salary mean and include. In here, very first clause [17(3)(i)] says that any compensation due to or received by an assessee, at or in connection with the termination of his employment. This wording clearly suggests that Voluntary Retirement Compensation is a part of Salary and taxable under the same head of Income.
Now let us look at the exemption Section i.e. Section 10(10C). It reads as follows:
10 (10C): any amount received or receivable by an employee of—
(i) a public sector company ; or
(ii) any other company ; or
(iii) an authority established under a Central, State or Provincial Act ; or
(iv) a local authority ; or
(v) a co-operative society ; or
(vi) a University established or incorporated by or under a Central, State or Provincial Act and an institution declared to be a University under section 3 of the University Grants Commission Act, 1956 (3 of 1956) ; or
(vii) an Indian Institute of Technology within the meaning of clause (g) of section 375 of the Institutes of Technology Act, 1961 (59 of 1961) ; or
(viia) any State Government; or
(viib) the Central Government; or
(viic) an institution, having importance throughout
(viii) such institute of management as the Central Government may, by notification80 in the Official Gazette, specify in this behalf, on his voluntary retirement or termination of his service, in accordance with any scheme or schemes of voluntary retirement or in the case of a public sector company referred to in sub-clause (i), a scheme of voluntary separation, to the extent such amount does not exceed five lakh rupees :
Provided that the schemes of the said companies or authorities or societies or Universities or the Institutes referred to in sub-clauses (vii) and (viii)], as the case may be, governing the payment of such amount are framed in accordance with such guidelines (including inter alia criteria of economic viability) as may be prescribed
Provided further that where exemption has been allowed to an employee under this clause for any assessment year, no exemption thereunder shall be allowed to him in relation to any other assessment year :]
Provided also that where any relief has been allowed to an assessee under section 89 for any assessment year in respect of any amount received or receivable on his voluntary retirement or termination of service or voluntary separation, no exemption under this clause shall be allowed to him in relation to such, or any other, assessment year;
It's a big section now, isn't it? Let me sum it up for you. It says that any amount received or receivable by an employee from the employer (the list of employers given and it is exhaustive; not inclusive- see the last one) on voluntary retirement or termination is exempt upto Rs. 5,00,000/-. However, proviso 1 to the section says that to avail this exemption, a few conditions need to be satisfied by the companies. These guidelines are given in Rule 2BA of the Income tax Rules which are as follows
Rule 2BA
At the time of his voluntary retirement [or voluntary separation] shall be exempt under clause (10C) of section 10 only if the scheme of voluntary retirement framed by the aforesaid company or authority [or co-operative society or University or institute], as the case may be [or if the scheme of voluntary separation framed by a public sector company,] is in accordance with the following requirements, namely :—
(i) it applies to an employee who has completed 10 years of service or completed 40 years of age;
(ii) it applies to all employees (by whatever name called) including workers and executives of a company or of an authority or of a co-operative society, as the case may be, excepting directors of a company or of a co-operative society;
(iii) the scheme of voluntary retirement [or voluntary separation] has been drawn to result in overall reduction in the existing strength of the employees;
(iv) the vacancy caused by the voluntary retirement [or voluntary separation] is not to be filled up;
(v) the retiring employee of a company shall not be employed in another company or concern belonging to the same management;
(vi) the amount receivable on account of voluntary retirement [or voluntary separation] of the employee does not exceed the amount equivalent to three months salary for each completed year of service or salary at the time of retirement multiplied by the balance months of service left before the date of his retirement on superannuation :
Provided that requirement of (i) above would not be applicable in case of amount received by an employee of a public sector company under the scheme of voluntary separation framed by such public sector company.
So, after going through the rule cum guidelines, it is advised that before claiming the exemption, such employees should make sure that the VRS Agreement made between them and the Management meets all the conditions for claiming the exemption!
Now, a combined reading and interpretation of Sections 15, 17 and clause 10C of Section 10 states that
i. compensation received under VRS is taxable as salary
ii. it is taxable in the year of accrual or receipt, whichever is earlier (i.e. whether paid or not). So, even if
part of the compenstion is received in this year and balance is received in next year or any subsequent year, it is taxed in this Previous year only, since it is accrued in the current previous year. In other words, the salary accrued or which becomes due need not be actually paid in order to make it taxable. What is relevant is whether the salary is due to an employee from an employer.
iii. exemption is available to the extent of Rs. 5,00,000/- on the lumpsum amount of VRS compensation.
iv. no other exemption/ rebate/ deduction can be taken availed if exemption u/S. 10(10C) is availed in respect of the amount of VRS Compensation. Proviso 3 to S. 10(10C) is inserted by Finance (No.2) Act, 2009 wef
Relevant case Laws:
1. Y.S.C. Babu Vs. CMD, Syndicate Bank, [2002] 253 ITR 1 (AP)
2. State Bank of Travavcore Vs. Central Board of Direct Taxes [2006]151 taxman 133 (Ker.)
So, it was advisable to the employees who were planning for compensation in two parts in two different years (as stated at the beginning) to rather get the agreement done for the payment of compensation in the beginning of next year so that such compensation would be the only income under the head Salary which would be chargeable to tax!
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