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Retirement benefits and tax applicable under certain circumstances
January, 21st 2008

Employees receive certain retirement benefits from the employer. Some of these are fully taxable , some are partly taxable and others are exempt from tax. Under Section 17(3) of the Income Tax Act, such benefits are taxable under the head 'Salaries' as 'profits in lieu of salaries'. However, in case of some, exemption from tax is granted under Section 10 of the Income Tax Act, either wholly or partly.

Here are some benefits and tax rules applicable:

Gratuity

Under the IT Act, any death-cum-retirement gratuity received by Central and State Government employees , defence employees and employees of a local authority will be exempt. Any gratuity received by persons covered under the Payment of Gratuity Act, 1972, is exempt subject to two limits.

One, for every completed year of service or part thereof , gratuity should be paid at the rate of 15 days wages based on the rate of wages last drawn by the employee concerned.

Two, the amount of gratuity as calculated above should not exceed Rs 3.5 lakhs. In case of other employees, gratuity received will be exempt. The exemption is limited to half month's salary (based on last 10 months' average) for each completed year of service or Rs 3.5 lakhs, whichever is lesser. In case the gratuity was received in any one or more earlier previous years also and any exemption was allowed towards it, the exemption to be allowed during the year gets reduced to the extent of exemption already allowed, the overall limit being Rs 3.5 lakhs. The exemption in respect of gratuity is permissible even in cases of termination of employment due to resignation .

The gratuity amount will qualify for relief under Section 89(1). Gratuity payment to a widow or other legal heirs of any employee who dies in active service is exempt from income tax. Commutation of pension Under the IT Act, in case of employees of central and state government, a local authority, defence services and corporation established under central or state acts, the entire commuted value of pension is exempt.


For other employees, if the employee receives gratuity , the commuted value of one-third of the pension is exempt. Otherwise, the commuted value of half the pension is exempt.

Leave encashment

As per the IT Act, leave encashment during service is fully taxable in all cases. Payment towards leave encashment received by central and state government employees at the time of retirement in respect of the period of earned leave at credit is fully exempt. The limit on the maximum amount receivable by employees of the central government has been specified at Rs 2.4 lakhs for employees retiring whether on superannuation or otherwise . In case of other employees, the exemption is to be limited to a maximum of 10 months of leave encashment, based on last 10 months' average salary. This is further subject to a limit of Rs 2.4 lakhs.

Leave salary paid to legal heirs of a deceased employee in respect of privilege leave standing to his credit at the time of death is not taxable.

Compensation on voluntary retirement


Payment received by an employee at the time of voluntary retirement, or termination of service is exempt to the extent of Rs 5 lakhs. The employee must be employed with a public sector company or any other company or authority establishment under the state, central or provincial act. He may also be employed with a local authority, cooperative society , university, any notified institute of management or any state or central government .

The voluntary retirement scheme under which the payment is being made must be framed in accordance with the guidelines prescribed in the Income Tax Rules. Where exemption has been allowed in any assessment year, another exemption will not be allowed in any other assessment year.

Payment from approved superannuation fund


As per the Act, payment from an approved superannuation fund will be exempt provided the payment is made in the circumstances specified in the Section ie, death, retirement or incapacitation of the employee.

Payment from provident fund


Any payment received from a statutory provident fund is exempt. Any payment from any other provident fund notified by the central government is also exempt. The Public Provident Fund (PPF) has been notified for this purpose . Moreover, the accumulated balance due and becoming payable to an employee participating in a recognised provident fund is also exempt as per specified limits.


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