Rajkumar11 (Director) 23 October 2014

Itax for compensation arising from mutual separation aggreme

Dear Experts,

I am confused on the treatment of tax deduction for a compensation arising out of mutual separation agreement. The employer has deducted tax on the entire amount paid and they claim that it was paid as salary hence all of it is taxable. However, i have found a separate article which states the following:

Severance is the compensation that an employer provides to an employee who has been laid off, whose job has been eliminated, who through mutual agreement has decided to leave the company, or who has parted ways with the company for other reasons.

Retrenchment compensations are classified under the Indian Income Tax Act as Retrenchment Compensation u/s 10 (Sub Section 10B). However it has a lot of conditions, which needs to be met in order to qualify for the compensation. Let us understand those conditions, as well as what is the amount that is exempt from Income Tax of India, under retrenchment compensation.

Any compensation received by a person due to the Retrenchment shall be exempt to the extent as stipulated underneath.

a. an amount calculated in accordance with the provisions of Section 25F(b) of the Industrial Disputes Act, 1947

b. Such amount, not being more than Rs. 5,00,000 as the Central Government has specified in this matter, if the management has not filed for insolvency / bankruptcy to the Board for Industrial & Financial Reconstruction (in Short it is called as BIFR).

c. The amount received whichever is the least. In simple terms all the amounts upto Rs 5 Lacs received as Retrenchment Compensation is fully exempt from Income Tax of India. Compensations in excess of the above mentioned limits is taxable as salary or profit in lieu of salary which is however eligible for relief under Section 89(1) read along with Indian Income Tax Rule 21A.

My legal advisor is also in agreement with the article, however, i want a second opinion from this panel before making the legal move. Kindly advise as soon as possible as the deducted amount is considerably high.

with Warm Regards,

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1 Replies

T. Kalaiselvan, Advocate (Advocate) 24 October 2014

RETRENCHMENT COMPENSATION – SECTION 10 (10B) :

The retrenchment compensation received by a workman is exempt provided that in general it does not exceed the sum calculated on the basis provided in Section 25F(b) of Industrial Disputes Act, 1947 or any such amount as is specified by the Central Govt. by a Notification, whichever is less. The maximum exemption is Rs. 5 lakhs where retrenchment is on or after 1-1-1997.

You have a perfect answer in your query itself which is right and proper. Further Severance pay means the compensation that an employer provides to an employee who has been laid off, whose job has been eliminated, who through mutual agreement has decided to leave the company, or who has parted ways with the company for other reasons.

Such amount, not being more than Rs. 5,00,000 as the Central Government has specified in this matter, if the management has not filed for insolvency / bankruptcy to the Board for Industrial & Financial Reconstruction (in Short it is called as BIFR).

Compensations in excess of the above mentioned limits is taxable as salary or profit in lieu of salary which is however eligible for relief under Section 89(1) read along with Indian Income Tax Rule 21A. The 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.

You can find more information in the CA club website.