Appuonline - Regulation

When an employee retires, he receives certain retirements/terminal benefits. Such benefits are taxable under the head "Salaries" as "Profits in Lieu of "Salaries" (see section 17(3) unless specifically exempted under any other provisions of the Income-tax Act. However, most of such receipts have been either wholly or partly exempted from tax under Section 10 and as such do not enter into the computation of total income.

The history of the Provident Fund legislation in India dates back to the year 1919. Various provident fund schemes were first framed u/s 96-B of the Government of India Act, 1919. Later, the Provident Fund Act, 1925 was enacted to amend and consolidate the laws relating to both Government and other Provident Funds. A statutory provident fund is set up under the provisions of the Provident Fund Act, 1925. This fund is maintained by Government and Semi Government organizations, local authorities, railways, universities and recognized educational institutions. Retired employees normally will not be concerned with such funds after their retirement.

The Finance Act, 1968 amended section 10(11) to provide for exemption of payments made from a notified fund also. The Central Government has notified the Public Provident Fund under the Public Provident Fund Scheme, 1968 (Notification No. SO 2430 dated 2.7.1968) as such a fund.

Any member of the Public whether a salaried employee, pensioner, a self employed person or businessman can participate in the Public Provident Fund by opening an account at any branch of the State Bank of India or its subsidiaries. Any amount in multiples of Rs. 5 (subject to a minimum of Rs. 100 and a maximum of Rs. 60000 in a year) can be deposited in this account. The accumulated balance is payable after 15 years. Withdrawals can however, be made to the extent indicated after every 5 year. The compound rate of interest on this account is now 9.5%. It was 12% upto 15.1.2000 and 11% from 15.4.2000 to 28.2.2001 (compounded interest).

The Income-tax Law relating to payments received from or made to such statutory provident funds or the Public Provident Fund can be summed up as under:

Payments made to subscriber/employee from such a fund are not liable to tax [Sec10(11)].
The annual contribution made by the employer to a statutory provident fund is not chargeable to tax in the hands of the employees while he is in service.
The employee's own contribution subject to fulfillment of certain conditions is eligible for tax rebate with effect from the assessment year 1991-92 under section 88 along with life insurance premia, contribution to the Unit Linked Insurance Plan, sums paid to effect or keep in force a contract for deferred annuity etc.
The interest credited to individual accounts of such statutory provident funds or the Public Provident Fund, from year to year, does not attract income tax.

This fund is one which is recognised by the Commissioner of Income-tax in accordance with the rules contained in Part A of the Fourth Schedule to the Income-tax Act. Such provident funds are generally maintained by the private sector organizations.

Under section 10(12), the accumulated balance due to an employee participating in a recognised provident fund is exempt to the extent indicated under Rule 8 of Part A of the Fourth Schedule to the Act. This rule specifies that to avail the exemption.

In so far as the employer's annual contribution to such a fund is concerned, it shall be deemed to be income and taxed under the head "salaries" in the hands of the employee.

The employee's own contributions to the extent of one-fifth of salary are eligible for tax relief u/s 88 with effect from the assessment year 1991-92 without any limit as to the amount of contribution. For these purposes (both for purposes of the employee's as well as the employer's contribution), the term 'salary' includes dearness allowance if the conditions of service so provide but excludes all other allowances and perquisites.

When an UNRECOGNISED Provident Fund obtains recognition for the first time, Rule 11(4) of Part A of the Fourth Schedule comes into operation. This stipulates that in the first instance, calculation should be made of the aggregate amount that would have been brought to tax, from year to year, had the fund been recognised from its inception. This aggregate amount is then to be brought to tax in the year of recognition. The law permits the Chief Commissioner or Commissioner to make a summary calculation of the aggregate of the amounts to be included in the total income, in case of serious accounting problems.

In so far as unrecognised provident funds are concerned, the employer's contribution thereto is not taxable from year to year nor is the employee entitled to tax rebate u/s 88 in respect of his own contribution thereto. The interest credited to such r. provident fund on year to year basis is not taxable because it will accrue to the employee only when he retires that is to say, the employee's entitlement to claim such interest arises only on retirement.

The payment received by him in respect of his own contributions will be exempt from tax, for the simple reason that his own contributions are from his income which has already been subjected to tax earlier.
Interest on his (the employee's) contribution is taxable under the head "income from other sources" [GIT v. G.Hyatt 80 ITR 177 (SC)].
The balance amount comprising the employer's contribution from year to year and interest thereon is taxable under the head "salaries" (CIT v. G. Hyatt, supra). However, the assessee is entitled to claim relief u/s 89(1).

A gratuity is not paid to an employee gratuitously as a kind of gift, bounty or boon. On the contrary, it is directly relatable to the past services which the employee has rendered to his employer as such. In appropriate cases, it can be claimed as a matter of right.

Like pension, a gratuity is also a compensation for past services. Like pension again, the liability to pay and the right to receive a gratuity is usually contractual. Both pension as well as gratuity arise out of a master servant or an employer-employee relationship. The only difference lies in the fact that whereas gratuity is a lump sum payment, pension consists of a series of periodical payments.

To the extent that a gratuity is not exempt u/s 10(10), it is chargeable to tax under the head "salaries". This is so because Section 17(1) specifically defines "salary" to include any gratuity. But even here, implicit is a master servant or an employer-employee relationship. Thus even section 17(1) will bring into the ambit of 'salary' not any gratuity received as a bounty and gift but only such gratuity as is paid by an employer to an employee.

In other words, in so far as (c) (supra) is concerned, the exemption limit could in fact be said to be the lowest of the following:

Salary includes dearness allowance if the terms of employment so provide but excludes all other allowances. If an employee received gratuity from more than one employer in the same previous year, the exemption shall not exceed the above limits.

Where the assessee received a gratuity in an earlier previous year which was not included in his total income, the exemption in respect of the gratuity received in the current year will be reduced by the amount.

Mr. X retired from Punjab Government Service on 30.11.2000. He received a gratuity of Rs. 1,00,000/-. This will not form part of his total income for the assessment year 2001-2002 (previous year 2000-2001) because he received the gratuity from the Government and Section 10(10)(i) specifically exempts such gratuity.
Mr. Y expired on 30.11.2000. His family received a gratuity for Rs. 65000/- from his employer ABC Private Ltd. The payment was made under the Payment of Gratuity Act, 1972. This is exempt in the hands of the employee's family u/s 10(10)(ii) for the assessment year 2001-2002 (previous year being 1.4.2000 to 31.3.2001).

Mr. Z superannuated from his company PQR Ltd. on 30.11.2000 after serving it for 35 years. M/s. PQR Limited paid him a gratuity of Rs. 3,00,0007-. During the 10 months preceding the month of his retirement, Mr. Z received an average salary of Rs. 10000/- p.m. In addition, in accordance with the terms and conditions of his service, he was also paid a dearness allowance of Rs. 5,000 p.m. favouring part of his salary.
The exemption available to Mr. Z in respect of the gratuity received by him during the previous year 2000-2001, relevant to the assessment year 2001-2002 will be the lower of the following:

Rs. 35000/-; or
1/2 month's salary (including dearness allowance) for each completed year of service on the basis of average salary of 10 months preceding the month of retirement.

Gratuity actually received

	One month's salary (including DA being average salary of preceding 10 months)	Rs. 15,000
	1/2 month's salary	Rs. 7,500
	No. of completed year of service	35
	1/2 month's salary for each completed year of service	35 x Rs. 7,500
	Gratuity exempt by this method	Rs. 2,62,500

Rs. 3,00,000 gratuity received.
Gratuity exempt will be Rs.2,62,500/- as it is the lowest of Rs.3,50,000/-, Rs.2,62,500/- and Rs.3,00,000/-.
In this particular case as Mr. Z received a total gratuity of Rs.3,00,000/-, Rs.37,500/- will be includible in his total income under the head "salaries". Mr. Z however can claim relief u/s 89(1) in respect thereof.

If, in the above case, Mr. Z had received a gratuity of Rs. 20,000/- from a previous employer in an earlier previous year in respect of which he was allowed exemption u/s 10(10), the gratuity exempt in the assessment year 2001-2002 will be Rs.242500/- (Rs.262500/- minus Rs.20000/-).
Gratuity would remain exempted even if the person receiving it joins another concern on payment of salary after retirement.

In so far as approved superannuation funds are concerned, in the hands of the employee, the employer's annual contribution to such a fund is exempt from tax.¹⁴

The employees' own contribution, on the other hand, qualifies for rebate u/s 88 from the assessment year 1991-92.

Interest on the amount of balance accumulated to the credit of an employee is exempt from tax in the hands of the latter.

Under section 10(13), the following payments made from an approved superannuation fund are exempt from tax:

Amounts paid to legal heirs of a beneficiary; or
Amounts paid to an employee in lieu of or in commutation of an annuity on retirement at or after a specified age or on his incapacitation prior to such retirement; or
Amounts paid by way of refund of contributions on the death of a beneficiary;
Amounts paid by way of refund of contributions to an employee on his leaving service in circumstances other than those indicated in (b) above, to the extent to which such payments does not exceed the contribution made prior to April 1, 1962. For instance, where the payment received by an employee does not include any contribution made prior to April, 1962, the whole amount would be taxable.

The cash equivalent of unutilised earned leave will not form part of total income if received on retirement in one of the following circumstances.

In respect of payment received by an employee of the Central Government or State Government as the cash equivalent of the leave salary in respect of the period of earned leave at his credit at the time of his retirement whether on superannuation or otherwise.
In the case of others, concerning the category of leave specified at (a) above, the exemption is limited to the cash equivalent of leave salary related to unutilised leave of upto 10 months, calculated on the average salary of the 10 months preceding the month of retirement, or Rs. 2,40,000/- whichever is lower.

Entitlement of leave for the purposes of this provision shall be deemed to be limited to 30 days' leave for each year of actual service.

Where an employee receives such payments from more than one employer in the same previous year, the aggregate amount exempted will be subject to the limit indicated above.

Where he has received such a payment for an earlier previous years also, the amount exempt during the current year will be reduced by the amount which was not included in the total income earlier as cash equivalent of unutilised earned leave.

Mr. X working in the Finance Ministry retired from ^ervice on 30.11.2000. He received a sum of Rs. 40000/- as leave encashment.

The amount of Rs. 40000/- is exempt from tax in the hands of Mr. X during the assessment year 2001-2002 because section 10(10AA)(i) specifically exempts such receipt of leave encashment from taxation.
Mr. Y, an employee of a private limited company M/s. ABC (P) Ltd. retired from service on 30th November, 2000. At the time of his retirement, unutilised leave of 6 months was credited in the account of Mr. Y.

The employer of Mr. Y decided to pay him Rs. 50,0007-for the unavailed leave. During the 10 month period preceding November, 2000, the month of his retirement, Mr. Y received an average salary of Rs. 7500/- per month.

The exemption available to Mr. Y in respect of the cash equivalent of unutilised leave by him during the previous year 2000-2001 relevant to assessment year 2001-2002 will be the lower of the following:
1. Leave salary for the unutilised leave of 6 months calculated on the average salary of 10 preceding months i.e. 45,000/-.
2. Rs. 2,40,000 being the maximum amount notified as exempt.
3. Rs. 50,0007- i.e. amount actually received.
The exemption will be limited to Rs. 45,0007- being the least of the two amounts.

Any compensation received by a workman under the Industrial Disputes Act, 1947 or under any other Act, or rules, orders, notifications issued thereunder or under any award, contract of service or otherwise, at the time of his retrenchment shall be exempt to the extent of:

However, the monetary limit as prescribed above shall not apply in cases where the compensation is received under any scheme approved by the Central Government.

Compensation in excess of the aforesaid limits is taxable as salary or profit in lieu of salary which is however eligible for relief under Section 89(1) read with I.T. Rule 21A.

Section 25F(b) of Industrial Disputes Act provides for payment of retrenchment compensation equivalent to 15 days average pay for every completed year of continuous service or any part thereof in excess of six months.

Under the Industrial Disputes Act, for this purpose salary or wages mean all remuneration capable of being expressed in terms of money, which would be payable to a workman in respect of the his employment or work done in such employment, including the value of benefits mentiioned in the Explanation to such Act.

Compensation received by a workman at the time of the closing down of the undertaken in which he is employed is treated as compensation received at the time of his retrenchment. If ownership or management of the undertaking in which the workman is employed is transferred and he takes up employment with the transferee, the consideration received by him at the time of transfer of ownership or management will also qualify for the aforesaid tax exemption if;

the service of the workman has been interrupted by such transfer;
the terms and conditions of service applicable to the workman after such transfer are in any way less favourable to the workman than those applicable to him immediately before the transfer; or
new employer is under the terms of such transfer or otherwise, legally not liable to pay to the workman, in the event of his retrenchment, compensation on the basis that his service had been continuous and had not been interrupted by the transfer.

Mr. Z is a workman working with M/s. PQR Limited. HE is retrenched from service by the management and paid a compensation of Rs. 36,0007- under the Industrial Disputes Act, 1947. The receipt of Rs. 36,0007- will be exempt from tax in the hands of Mr. Z.

Compensation received at the time of voluntary retirement is exempt from tax if the following conditions are satisfied:

The guidelines for the purposes of section 10(10C) have been laid down by rule 2BA. The scheme of voluntary retirement framed by a company or authority should be in accordance with the following requirements, namely:

if applies to an employee who has completed ten years of service or completed 40 years of age;
it applies all employees (by whatever name called), including workers and executives of the company or authority or of a cooperative society excepting directors of company or of a cooperative society.
the scheme of voluntary retirement has been drawn to result in overall reduction in the existing strength of the employees;
the vacancy caused by voluntary retirement is not to be filled up, nor the retiring employee is to be employed in another company or concern belonging to the same management; and
the amount receivable on account of voluntary retirement of the employees does not exceed the amount equivalent to three months' salary for each completed year of service or salary at the time of retirement multiplied by the balance months of service left before the date of his retirement on superannuation.

The following aspects also need to be kept in view in the context of VRS-Golden Hand Shake.

Taxpayers can frame different schemes of voluntary retirement for different classes of their employees. However, these schemes has to conform to the aforesaid guidelines prescribed in rule 2BA of the Income-tax Rules.

It is the last salary drawn which is to form the basis for computing the amount of payment.

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 or authority who has completed ten years of service or forty years of age. Since the employee of a company or concern (presuming that he is less than forty years of age) which has been set up less than ten years ago, cannot satisfy the aforesaid requirement, the amount receivable by him shall not be entitled to income-tax exemption under section 10(10C).

The scheme of voluntary retirement should be drawn to result in overall reduction in the existing strength of the employees of a company or authority. This requirement reflects the criterion of economic viability for framing the schemes of voluntary retirement. The scheme which does not result in overall reduction in the existing strength of the employees of a company or concern will not be in accordance with the guidelines for the purposes of section l0(l0C),.

The requirement in the guidelines which reflects the economic criterion is to the effect that the scheme of voluntary retirement has been drawn to result in overall reduction in the existing strength of the employees of the company or concern. Therefore, schemes can be drawn even by profit making companies or concerns.

The Benefit of section 10(10C) has been vide section 5(a) of the Finance Act, 2001 extended to the employees of the Central and State Government Employee from 1.4.2001 i.e. from the assessment year 2001-2002.