Valuation of Retirement Benefits – for Calculating Taxable Salary Income

Valuation of Retirement Benefits – for Calculating Taxable Salary Income

1.  Gratuity

Gratuity is a payment made by the employer to an employee in appreciation of the past services rendered by the employee. Gratuity can either be received by:

(a)      the employee himself at the time of his retirement; or

(b)     the legal heir on the event of the death of the employee.

Gratuity received by an employee on his retirement is taxable under the head “Salary” whereas gratuity received by the legal heir of the deceased employee shall be taxable under the head “Income from other sources”.

However, in both the above cases, according to section 10(10), gratuity is exempt upto a certain limit. Therefore, in case gratuity is received by employee, salary would include only that part of the gratuity which is not exempt under section 10(10).

Exemption of Gratuity under Section 10(10)

Government Employees & employees of local
authority
Employees covered under Gratuity Act Any other employee
Fully exempt Minimum of the following 3 limits:

(1) Actual gratuity received, or

(2) 15 days’ salary for every completed year, or part thereof exceeding six months 7 days’ salary for each season in case of employee in seasonal establishment; or

(3) Rs. 20,00,000

Meaning of Salary:

(i) Basic Salary plus dearness allowance.

(ii) Last drawn salary. Average salary for preceding 3 months in case of piece rates employees

(iii) No. of days in a month to be taken as 26

Minimum of the following 3 limits:

(1) Actual gratuity received

(2) Half months’ average salary of each completed year of service.

(3)  Rs. 20,00,000

Meaning of Salary:

(i) Basic salary plus D.A. to the extent the terms of employment so provide Commission, if fixed percentage of turnover.

(ii) Average salary of last 10 months preceding the month in which event occurs.

(iii) Only completed year of service is to be taken.

(i)      Where an assessee receives gratuity and part of it is taxable because it is not fully exempt under section 10(10), the employee can claim relief under section 89 on account of such gratuity.

(ii)     Where an employee had received gratuity in any earlier year(s) and had claimed exemptions under section 10(10) in respect of the gratuity received earlier also, he will still be entitled to this exemption but the limit which at present is Rs. 20,00,000 shall be reduced by the amount of exemption(s) availed in the earlier year(s). There will be no change in the other two limits.

(iii)    If gratuity is received from more than one employer in the same previous year, by an employee, the limit of Rs. 20,00,000 would apply to the aggregate of gratuity received from one or more employers.

(iv)    Gratuity is exempt. if the relationship of employer and employee exists between the payer and the payee. If such relationship does not exist, the exemption shall not be available, e.g., gratuity payable by the LIC of India to its Insurance Agents does not qualify for exemption as agents are not employees of the Corporation.

(v)     The words “completed service” occurring in section 10(10) should be interpreted to mean an employee’s total service under different employers including the employer other than the one from whose service he retired, for the purpose of calculation of period of years of his completed service, provided he was not paid gratuity by the former employer. [CIT v PM Mehra (1993) 201 ITR 930 (Born)].

(vi)    Any gratuity paid to an employee, while he continues to remain in service with the same employer is taxable under the head “Salaries” because gratuity is exempt only on retirement or on his becoming incapacitated or on termination of his employment or death of the employee. In this case, however the assessee can claim relief under section 89.

(vii)   The CBDT vide its instruction in F. No. 194/0/73-IT, dated 19.6.1973 has clarified that the expression “termination of employment” would cover an employee who has resigned from the service.

EXAMPLE :

R, who was employed with P Company Ltd. retired on 21.10.2021, received Rs. 3,60,000 as gratuity. He served the company for 26 years and 8 months. At the time of retirement, his salary was Rs. 15,000 p.m. However, the average salary for 10 months preceding the month of retirement is Rs. 14,400 p.m. He is not covered under the Payment of Gratuity Act, 1972.

(A)    Compute the taxable gratuity.

(B)     What amount of gratuity shall be taxable, if R, earlier to his appointment with P Company Ltd. had worked for 4 years with X Ltd. and was not entitled to gratuity from X Ltd.?

Solution :

(A)    The minimum of the following three amounts will be exempt:

(a)      Actual amount received, i.e., Rs. 3,60,0O0.

(b)     Half month’s salary for every completed year of service, i.e.,

Rs. 14400 /2  x 26 = Rs. 1,87,200

(c)      Rs. 20,00,000

Hence, Rs. 1,87,200 shall be exempt and the balance Rs. 1,72,800 would be included as gross salary.

(B)     The minimum of the following three amounts will be exempt:

(a)      Rs. 3,60,000

(b)     Rs. 14,400/2 x 30 = Rs. 2,16,000

(c)      Rs. 20,00,000

Hence, R. 2,16,000 shall be exempt and the balance Rs. 1,44,000 shall be taxable.

* Completed year of service will include the period of 4 years of earlier appointment as he was not entitled to gratuity at that time. [CIT v Mehra (P.M.) (1993) 201 ITR 930 (Born)]

2.  Treatment of Pension [Section 17(1)(ii)]

Pension is a payment made by the employer after the retirement/death of the employee as a reward for past service.

Pension is normally paid as a periodical payment on monthly basis but certain employers may also allow an employee to forego a portion of the pension and receive a lump sum amount by surrendering such portion of pension. This is known as commutation of pension. The pension may be fully or partly commuted i.e. in lieu of the pension, a lump sum payment is made to the employee. The treatment of these two kinds of pension is as under:

Uncommuted pension i.e. the periodical pension:

It is fully taxable in the hands of all employees, whether government or non-government.

Commuted pension:

Exemption of commuted pension u/s 10(10A)

Govt. employees, employees of local authorities and employees of statutory corporations Any other employee

 

Fully exempt (a) If gratuity is not received Commuted value of half (1/2) of  pension which he is normally entitled to receive.

(b) If gratuity is also received Commuted value of 1/3rd of pension which he is normally entitled to receive.

Pension received by the employee is taxable under the head “Salaries”. However, the family pension received by the legal heirs after the death of the employee is taxable in the hands of the legal heir under the head “Income from other sources” because in this case there is no relationship of employer and employee. Treatment of family pension is discussed in detail under the head “Income from other sources”.

Example :

A retired on 15.4.2021 from B Company Ltd. He was entitled to a pension of Rs. 8,000 p.m. At the time of retirement, he got 75% of the pension commuted and received Rs. 2,40,000 as commuted pension. Compute the taxable portion of the commuted pension if—

(i)      He is also entitled to gratuity.

(ii)     He is not entitled to gratuity.

Solution :

  1. 75% of Commuted Pension is equal to Rs. 2,40,000.

Hence commuted value of 1/3 of the pension would amount to  Rs. 2,40,000 x 100/75 x 1/3 = Rs. 1,06,667;

Rs. 1,06,667 would, therefore, be exempt and balance Rs. 1,33,333 would be taxable.

  1. 75% of commuted pension is equal to Rs. 2,40,000.

Hence commuted value of 50% of pension would amount to Rs. 2,40,000 x 100/75 x ½ = Rs. 1,60,000.

Therefore, Rs. 1,60,000 would be exempt and Rs. 80,000 would be taxable.

3.  Treatment of Leave Salary

Exemption of leave encashment at the time of retirement u/s 10(10AA)

Govt. employee i.e. Central and State Govt. employees Any other Employee
Fully exempt

 

Minimum of the following four limits:

(i)      Leave encashment actually received; or

(ii)     10 month’s average salary; or

(iii)    Cash equivalent of unavailed leave calculated on the basis of maximum 30 days leave for every year of actual service rendered;
or

(iv)     Rs. 3,00,000

  Meaning of salary

(i)      Basic salary plus D.A. to the extent the terms of employment so provide plus Commission, if fixed percentage of turnover.

(ii)     Average salary of last 10 months immediately preceding the date of retirement.

Amount specified by the Government from time to time is given in the table below:

Date of Retirement Rs.
Between 1-1-1988 and 3 1-3-1995 79,920
Between 1-4-1995 and 30-6-1995 1,30,320
Between 1-7-1995 and 1-7-1997 1,35,360
After 1-7-1997 and upto 1-4-1998 2,40,000
After 1-4-1998 3,00,000

 

1.       If the employee had received leave encashment in any one or more earlier previous year(s) also and had availed of the exemption in respect of such amount, then the limit given in clause (d), specified above, shall be reduced by the amount of exemption(s) availed earlier.

2.       Where the leave encashment is received by the employee from more than one employer in the same previous year, the specified limit given in clause (d) above would apply to the aggregate of leave encashment received from one or more employers.

3.       Leave salary received by the family of a government servant, who died in harness, is not taxable in the hands of the recipient. [Circular Wo. 309, dated 3.7.1981].

4.       Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to the credit of such employee at the time of his/her death is an ex-gratia payment on compassionate grounds in the nature of gifts. Thus the payment is not in the nature of salary. [Letter No. 35/1/65, dated 5.11.1965].

5. The assessee can claim relief from tax under section 89 in respect of leave encashment.

 Example :

E, an employee of XYZ Pvt. Ltd. retired from the company on 30.11.2021. At the time of his retirement, he received 2,88,000 as leave salary from his employer. The following information is provided by the employee:

    Rs.
(1) Salary at the time of retirement (p.m.) 18,000
(2) Period of Service 20 years & 8 months
(3) Leave encashment 2,88,000
(4) Leave availed while in service 14 months
(5) Balance unavailed leave at the time of retirement 16 months
(6) Average salary for the months of February, 2021 to November, 2021 17,600
(7) Leave entitlement 11/2 month for every completed year of service

Compute the amount of taxable leave encashment.

Solution:

The minimum of the following four amounts will be exempt:

(a)      Leave encashment actually received =  Rs.  2,88,000

(b)    10 months’ average salary, i.e., Rs. 17,600 x 10 = Rs. 1,76,000

(c)      Leave encashment for 6 months @ Rs. 17,600 p.m. = Rs. 1,05,600.

(d)    Amount specified by the Government, i.e., Rs. 3,00,000

Hence Rs. 1,05,600 would be exempt and the balance of Rs. 1,82,400 would form part of gross salary.

Although he is entitled to 1 1/2 month’s leave for every completed year of service, for the purpose of calculating limit for clause (c) above, the calculation will be done on the basis of maximum 30 days’ leave for every completed year of service. Therefore, the maximum leave allowable for purpose of clause (c), i.e., 30 days x 20 =  600 days, i.e., 20 months. Leave already availed by employee is 14 months. Therefore, the unavailed leave calculated on basis of 30 days leave for every completed year of service is 6 months (20 – 14).

4.  Retrenchment Compensation [Section 10(10B)]

Any compensation received by a workman at the time of his retrenchment, under the Industrial Disputes Act, 1947 or under:

(a)      any other Act or rules or any order or notification issued there-under; or

(b)     any standing order; or

(c)     any award, contract of service or otherwise,

shall be exempt to the extent of minimum of the following limits:

(i)      Actual amount received;

(ii)     15 days’ average pay for every completed year of service or part thereof in excess of 6 months;

(iii)    Amount specified by the Central Government, i.e. Rs. 5,00,000

Compensation received in excess of the aforesaid limit is taxable and would, therefore, form part of Gross Salary. However, the assessee shall be eligible for relief under section 89 read with rule 21A.

1.     Where retirement compensation is received by a workman in accordance with any scheme which the Central Government having regard to the need for extending special protection to the workman in the undertaking to which such scheme applies, has approved in this behalf, the entire amount of compensation so received shall be exempt under section 10(10B).

2.     Where retrenchment compensation received by a workman exceeds the amount which qualifies for exemption under the new clause, he will be entitled to relief under section 89 read with rule 21A of the Income-tax Rules, in respect of such excess.

5.  Compensation received on Voluntary Retirement [Section 10(10C)]

The compensation received or receivable by the employee of the following, on voluntary retirement, under the Golden Hand Shake Scheme, is exempt under section 10(10C):

(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; or

(vii)     an Indian Institute of Technology within the meaning of clause (g) of section 3 of the Institutes of Technology Act, 1961; or

(viii)    such institute of management as the Central Government may, by notification in the Official Gazette, specify in this behalf;

(ix)      State Government;

(x)       Central Government;

(xi)      Institutions having importance throughout India or in any State or States as may be notified.

Exemption shall be available, subject to the following conditions:

(a)       The compensation is received only at the time of voluntary retirement or termination of his services in accordance with any scheme or schemes of voluntary retirement or in the case of public sector company, a scheme of voluntary separation. Even if the compensation is received in instalments, the exemption shall be allowed.

(b)     Further, the scheme of the said companies or authorities or societies or universities or the institutes referred to in clauses (vii) and (viii) above, 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. In the case of public sector companies, if there is a scheme of voluntary separation, it shall also be according to the said prescribed guidelines.

Quantum of Exemption:

The amount of exemption is

  • the actual amount of compensation received or
  • 5,00,000,

whichever is less.

1.     The exemption is available to an employee only once and if it has been availed for an assessment year it shall not be allowed to him for any other assessment year.

2.      The assessee shall not be eligible for relief under section 89 in case he has claimed exemption under section 10(10C). On the other hand, if he claims relief under section 89, he cannot claim exemption under section 10(10C).

Guidelines [Rule 2BA] – for claiming Exemption

The guidelines of the government for bestowing the exemption from tax on the Golden Handshake Scheme are given herein below:

(i)      it applies to an employee, who has completed 10 years of service or completed 40 years of age;

(ii)     it should apply 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 should have 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:

(a)      the amount equivalent to 3 month’s salary for each completed year of service; or

(b)     salary at the time of retirement multiplied by the balance months of service left before the date of his retirement on superannuation.

However, the 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.

This rule does not require that the amount representing the lower of the aforesaid two limits is to be allowed under the scheme of voluntary retirement. The amount receivable by an employee on account of his voluntary retirement can be either of the aforesaid two amounts. However, the amount which will qualify for exemption under section 10(10C) will be upto Rs. 5,00,000.

Salary for this purpose includes dearness allowance, if the terms of employment so provide, but excludes all other allowances and perquisites. However, if a fixed percentage of commission on turnover is given, it will be included due to the Supreme Court’s decision in the case of Gestetner Duplicators (P) Ltd. v CIT(1979) 117 ITR 1 (SC). Further, salary will be the last salary drawn.

One of the requirements in the guidelines prescribed for schemes of voluntary retirement is that the scheme should apply to an employee of a company who has completed 10 years of service or 40 years of age. Since the employee of a company (presuming that he is less than 40 years of age) which has been set up less than 10 years ago, cannot satisfy the aforesaid requirement, the amount receivable by him shall not be entitled to income-tax exemption under section 10(10C).

6.  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.

7.  Interest credited to Recognised Provident Fund

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

8.  Amount comprised in the Transferred Balance

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

See also  [Section 44AA and Rule 6F]- Maintenance of Accounts by Certain Persons carrying on Business and Profession
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