Retirement Benefits – Know tax computation thereof

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Retirement Benefits

When you reach the age of retirement, your regular income is going to be stopped and you may be entitled for retirement benefits viz. gratuity, leave encashment, pension. In this article we will understand the tax treatment of each such benefits.

Gratuity

Sec. 10(10) of the Income-tax Act deals with the exemption of gratuity received by employee. Broadly, it is divided into following:
Gratuity Chart

A. Gratuity received during continuation of service

Gratuity received during continuation of service is fully taxable in the hands of all employee (whether Government or non-Government employee).

B. Gratuity received at the time of termination of service by Government employee

Gratuity received at the time of termination of service by Government employee is fully exempt from tax u/s 10(10)(i).

C. Gratuity received at the time of termination of service by non–government employee, covered by the Payment of Gratuity Act

In such case, minimum of the following shall be exempted from tax u/s 10(10)(ii):

  1. Actual Gratuity received;
  2. ₹ 10,00,000; or
  3. 15 working days salary for every completed year of service
    [Arithmetically, 15/26 * Completed year of service * Salary p.m.]

Completed year of service includes any fraction in excess of 6 months. (e.g. 7 years 9 months will be treated as 8 years; 7 years 5 months will be treated as 7 years and 7 years 6 months will be treated as 7 years).

Salary here means Basic + DA, last drawn

D. Gratuity received at the time of termination of service by non-government employee not covered under the Payment of Gratuity Act

Gratuity received at the time of termination of service by non-government employee being not covered under the Payment of Gratuity Act shall be exempted from tax u/s 10(10)(iii) to the extent of lower of the following:

  1. Actual Gratuity received;
  2. ₹ 10,00,000; and
  3. 1/2 * Completed year of service * Average Salary p.m.
Also Read  35th GST Council Meeting Decision

While calculating completed year of service ignore any fraction of the year. (e.g. 7 years 9 months will be treated as 7 years only)

Average Salary here means, Basic + DA# + Commission (being a fixed percentage on turnover) being last 10 months average salary, immediately preceding the month of retirement.

E. Gratuity received after death of employee

The Act is silent on treatment of gratuity received after death of employee. However, on the following grounds, it can be concluded that gratuity received by a legal heir shall not be taxable in the hands of the recipient –

  • A lump sum payment made gratuitously to widow or legal heir of employee, who dies while in service, by way of compensation or otherwise is not taxable under the head “Salaries”. [Circular No.573, Dated 21.08.1990]
  • Unutilised deposit under the capital gains deposit account scheme shall not be taxable in the hands of legal heir. [Circular No.743 dated 6/5/1996]
  • Legal representative is not liable for payment of tax on income that has not accrued to the deceased till his death.
  • Leave salary paid to the legal heir of deceased employee is not taxable as salary. [Circulars Letter No. F.35/1/65-IT(B), dated 5/11/1965]. Further, leave salary by a legal heir of the Government employee who died in harness is not taxable in the hands of the recipient [Circulars No.309, dated 3/7/1981].

Leave Encashment

Leave Encashment

A: Leave salary received during continuation of service

Leave salary during continuation of service is fully taxable in the case of the Government employee as well as other employees [Sec. 17(1)(va)].

Case B: Leave salary received by Government employee on termination of service

Also Read  Reverse Charge under GST

At the time of termination of service, leave salary received by the Central or State Government employee is fully exempted u/s 10(10AA)(i).

Case C: Leave salary received by non-Government employee on termination of service

At the time of termination of service, leave salary received by a non-Government employee (including employee of foreign Government, local authority, public sector undertaking) is exempted to the minimum of the following u/s 10(10AA)(ii):

  1. Actual amount received as leave salary
  2. 3,00,000/-
  3. 10 * Average salary p.m.
  4. To the maximum of 30 days (normally taken as 1 month) average salary for every completed year of service, subject to deduction for actual leave availed during the tenure of service.
    i.e., [{(1 * completed year of service) – leave actually taken in terms of month} * average salary p.m.]

Average salary means Basic + DA + Commission (as a fixed percentage on turnover) being last 10 months average salary ending on the date of retirement or superannuation.

While calculating completed year of service, ignore any fraction of the year.

D: Leave salary paid to the legal heir

Leave salary paid to the legal heir of deceased employee is not taxable. [Circulars Letter No. F.35/1/65-IT(B), dated 5/11/1965]. Further, leave salary received by a legal heir of the Government employee who died in harness is not taxable in the hands of the recipient [Circulars No.309, dated 3/7/1981].

Pension

Pension means a periodical payment received by an employee after his retirement. On certain occasions, employer allows to withdraw a lump sum amount as the present value of periodical pension. When pension is received periodically by employee, it is known as Uncommuted pension. On the other hand, pension received in lump sum is known as Commuted pension. Such lump sum amount is determined considering factors like the age and health of the recipient, rate of interest, etc.
Pension

Also Read  Income from Other Sources

A: Uncommuted pension

Uncommuted pension is fully taxable in the hands of all employees whether Government or Non –Government employee.

B: Commuted pension received by a Government employee

Commuted pension received by a Government employee is fully exempt from tax u/s 10(10A)(i).

C: Commuted pension received by an employee who also received gratuity

One third of total pension (which assessee is normally entitled for) commuted shall be exempted u/s 10(10A)(ii).

It is immaterial whether the employee is covered by the Payment of Gratuity Act or not.

D: Commuted pension received by an employee who does not receive gratuity

One half of total pension (which assessee is normally entitled for) commuted shall be exempted u/s 10(10A)(ii).

Retrenchment Compensation

Meaning

Retrenchment means cancellation of contract of service by employer.

Tax Treatment [Sec. 10(10B)]

Any compensation received by a worker at the time of retrenchment is exempted to the extent of minimum of the following:

  1. Actual amount received;
  2. ₹ 5,00,000; or
  3. An amount calculated in accordance with the provisions of sec. 25F(b) of Industrial Dispute Act, 1947 (Under the said Act a workman is entitled to retrenchment compensation equivalent to 15 days’ average pay, for every completed year of service or any part thereof in excess of 6 months).

Notes

  1. In case, where the compensation is paid under any scheme approved by the Central Government nothing shall be taxable.
  2. Compensation received by a workman at the time of closing down of the undertaking in which he is employed is treated as compensation received at the time of his retrenchment.
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