Tax Treatment of “Retrenchment Compensation” [Section 10(10B)]

Retrenchment compensation received by an employee due to termination of employment is partially exempt from tax under Section 10(10B) of the Income Tax Act, 1961. Below is a detailed breakdown of the exemption rules, calculations, and key conditions.

1. Eligibility & Conditions for Exemption

• Applies to:
  • Workers retrenched under the Industrial Disputes Act, 1947.
  • Employees terminated due to business closure, restructuring, or downsizing.
• Does NOT apply to:
  • Voluntary retirement schemes (VRS) (covered under Section 10(10C)).
  • Resignations or dismissals due to misconduct.

2. Exemption Calculation

The exempt amount is the least of the following:

1. ₹5,00,000(statutory limit).
2. Actual retrenchment compensation received.
3. 15 days’ average salaryfor each completed year of service (or part >6 months).

Formula:

Exempt Amount = Least of (₹5L, Actual Compensation, 15 Days’ Salary × Years of Service) 

Taxable Amount = Total Compensation – Exempt Amount 

Example:

• Years of service:12 years (including 7 months = rounded to 12).
• Last drawn salary (Basic + DA):₹40,000/month.
• Retrenchment compensation received:₹6,00,000.

Exemption Calculation:

1. ₹5,00,000 (statutory limit).
2. ₹6,00,000 (actual compensation).
3. 15 days’ salary per year:

Exempt Amount: ₹2,76,923 (least of above).

Taxable Amount: ₹6,00,000 – ₹2,76,923 = ₹3,23,077.

3. Key Points

1. Salary Definition:Includes Basic + DA (if part of retirement benefits).
2. Lifetime Limit:The ₹5L exemption is per retrenchment (not cumulative).
3. Legal Compliance:Retrenchment must follow Industrial Disputes Act
4. Tax Regime:Exemption applies in both old and new tax regimes.

4. Comparison with VRS Compensation [Section 10(10C)]

5. Reporting in ITR

• Taxable portionmust be reported under “Income from Salaries” in ITR-1/ITR-2.
• Form 10Emust be filed to claim relief under Section 89 (if applicable).