Retrenchment compensation is the amount paid to a workman (employee) at the time of termination of employment due to retrenchment (layoff) or closure of the business. The tax treatment of retrenchment compensation is governed by Section 10(10B) of the Income Tax Act, 1961, which provides exemptions for such payments.
Eligibility for Exemption:
- The exemption applies to workmenas defined under the Industrial Disputes Act, 1947.
- A workman is an employee (excluding managerial or administrative personnel) engaged in manual, unskilled, skilled, technical, operational, or clerical work.
Exemption Limit:
The exemption is limited to the least of the following:
- ₹5,00,000(maximum limit as per the Income Tax Act).
- Amount calculated as per the Industrial Disputes Act, 1947:
- 15 days’ average pay for every completed year of service or part thereof in excess of 6 months.
- Actual retrenchment compensation received.
Summary of Exemptions:
| Employee Type | Exemption |
| Workmen Employees | Least of …
1. ₹5,00,000, 2. Amount as per Industrial Disputes Act, or 3. Actual compensation received |
| Non-Workmen Employees | Fully taxable |
Average Pay Calculation:
- Average pay is calculated based on the last 3 months’ salarybefore retrenchment.
- Salary includes basic wages, dearness allowance, and cash value of any concessions(e.g., food, accommodation).
Taxability of Excess Amount:
Any amount exceeding the exempted limit is taxable under the head “Income from Salaries”.
Conditions for Exemption:
- The retrenchment compensation must be paid in accordance with the provisions of the Industrial Disputes Act, 1947.
- The exemption is available only for compensation received due to retrenchment or closure of the business.
Example Calculation:
Case 1: Retrenchment Compensation within Exemption Limit
- Average pay: ₹50,000 per month
- Years of service: 10 years
- Retrenchment compensation received: ₹4,00,000
Exemption Calculation:
- Amount as per Industrial Disputes Act: (15/26) × ₹50,000 × 10 = ₹2,88,461
- Maximum exemption limit: ₹5,00,000
- Actual compensation received: ₹4,00,000
Exempted amount: Least of the above = ₹2,88,461
Taxable compensation: ₹4,00,000 – ₹2,88,461 = ₹1,11,539
Case 2: Retrenchment Compensation Exceeding Exemption Limit
- Average pay: ₹60,000 per month
- Years of service: 15 years
- Retrenchment compensation received: ₹6,00,000
Exemption Calculation:
- Amount as per Industrial Disputes Act: (15/26) × ₹60,000 × 15 = ₹5,19,231
- Maximum exemption limit: ₹5,00,000
- Actual compensation received: ₹6,00,000
Exempted amount: Least of the above = ₹5,00,000
Taxable compensation: ₹6,00,000 – ₹5,00,000 = ₹1,00,000
Notes:1. Maximum Exemption Limit: o The maximum exemption limit for retrenchment compensation is ₹5,00,000. This limit applies to the total compensation received during the employee’s entire career. 2. Voluntary Retirement Scheme (VRS): o Compensation received under a Voluntary Retirement Scheme (VRS) is covered under Section 10(10C) and has a separate exemption limit of ₹5,00,000. 3. Non-Workmen Employees: o Retrenchment compensation received by non-workmen employees (e.g., managerial or administrative personnel) is fully taxable and does not qualify for exemption under Section 10(10B). 4. Multiple Employers: o If an employee has worked with multiple employers, the exemption limit of ₹5,00,000 applies to the aggregate retrenchment compensation received from all employers. |
