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Retirement Benefits
On the day of retirement, almost every employee smarts under a sense of injustice. He is
forced to make room for some half-baked professional just when he himself is ready for a
doctorate in competency. Be that as it may, it is necessary to plan for this eventuality and
hence every employee must know not only the quantum of the various terminal benefits
he would be getting, but also their tax implications. The employee may have higher
quantum of benefits by being fortunate in choosing a good employer but he has no choice
in respect of taxes. Within certain limits, the terminal benefits are exempt. Let us have a
good look at the terminal benefits.
Provident Fund
There are 3 types of Provident Funds:
1
Statutory Provident Fund under the Provident Fund Act, 1925 maintained by
government and semi-government organisations, local authorities, universities,
recognised educational institutions, railways, airlines etc. This is a blue-eyed
baby. Everything is exempt from tax, without any ifs and buts, including the
employer's contribution and the interest paid, even if it is over 12%.
2
Recognised Provident Fund (RPF) covered by Employee's Provident Fund and
Miscellaneous Provisions Act, 1952 applicable to establishments with 20 or more
employees. Those with fewer employees are also welcome to opt for it. The PF
Commissioner manages the funds. However, if the establishment desires to
manage its own funds, a trust approved by the IT Commissioner, has to be
created which will invest the funds in accordance with the PF Rules. Employee's
contributions are covered by Sec 88 and there is no ceiling on his voluntary
contribution. Employer's contribution in excess of 12% of employee's salary as
well as interest paid exceeding 9.5% p.a. is charged to tax. Payment of
accumulated balance in RPF is taxable under Rule 9(1) of Schedule IV(A) to the
ITA, unless the employee renders continuous service with his employer for 5
years or the discontinuance is due to causes beyond control of the employee. This
balance is also exempt if it is transferred to the employee's individual account in
any RPF maintained by his new employer or by the PF commissioner. Service
under his former employer or employers shall be included in computing the total
period of continuous service. Out of the total contribution of the employer (12%
of basic salary of the employee), 8.33% or Rs 542 whichever is less, is deposited
in the Employee Pension Fund and the balance to the Employee Provident Fund
as illustrated below:
Employer's
Basic
Total
Salary of
Contribution
Employee
(12% of Basic
Contribution
8.33%
Contribution
Rs Pension Fund
of
Provident
542 (Least of 'b' and
Salary
Fund (3.67%)
'c')
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Salary)
Rs
(a)
(b)
(c) (d)
(e) = (a - d)
4,600
Rs
552
Rs
383
Rs Rs
542 383
Rs
169
8,100
972
675
542 542
430
The current rate of interest on this Pension Fund Deposit is 9.5%, likely to be
reduced to 8% for the next fiscal.
3
Unrecognised Provident Fund, not approved by the IT Commissioner, is a bad
baby deserving heavy punishment. If the number of employees is less than 20,
the PF Commissioner finds it inconvenient to handle this small account. The
employer does not have the wherewithal to establish a trust and follow the
investment norms. Instead of coming to the rescue of such small organisations,
the punishment is heavy. Employee's contribution does not qualify for deduction
u/s 88! The employer's contribution and interest thereon are brought to tax as
profits in lieu of salary in the year when the payment is made. Interest on
employee's own contribution is taxable u/s 56 as Income from Other
Sources.This is a typical case of the lawmakers not being in contact with reality.
They have created a no-win situation for small entrepreneurs. They should have
forced the Commissioner to accept establishments having even one employee or
provided an alternative by allowing MFs or LIC to cater for such situations.Tax
Planning:Notification P592 F No. 142/27/94-TPL has empowered the trustees of
a provident fund to permit any time, within 12 months before the date of
retirement on superannuation of an employee, the withdrawal of up to 90% of the
amount standing to the credit of the employee. There is no limit on the quantum
of voluntary contributions made by an employee to his provident fund. It would
be a good idea to contribute up to your maximum capacity a few years prior to
the retirement. The funds can be made available by taking recourse to the
withdrawals, if necessary.
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Gratuity: Section 10(10 III)
Any death-cum-retirement gratuity received under the pension rules (or any similar
scheme) by employees of central or state government, any local authority or defence and
civil services is wholly exempt. Gratuity received under the Payment of Gratuity Act,
1972 is exempt up to a limit of gratuity paid at the rate of 15 days (last drawn) salary per
year of completed service or part thereof in excess of 6 months or Rs 3,50,000 whichever
is less, provided the employee has put in continuous service of 5 years. In the case of
employees of other statutory corporations and employees in the private sector to whom
the Payment of Gratuity Act is not applicable, the exempt amount would be the least of
the following:
1 Actual amount of gratuity.
2
Half month's salary for number of years of service calculated on the basis of average
salary for the last 10 months.
3 Rs 3,50,000.
Salary includes DA if the terms of employment so provide but excludes all other
allowances, bonuses, commissions and perks. The payment of gratuity, while the
employee is still in service, does not qualify for any exemption. Gratuity received from a
previous employer will be pooled with gratuity received from the present employer for
computation of the exempt limit.
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Superannuation Fund (SAF)
During the tenure of service, employees at higher income level would be required to pay
heavy taxes on their bonus income. Superannuation Fund (SAF) enables the employers as
well as employees to save income tax on such bonuses. The only restriction is that any
excess over 27% of salary contributed by the employer to PF and SAF put together will
not be allowed as deduction (Notification 10507 dated 16.1.98 w.r.e.f. 22.9.97).
The trustees of the fund shall enter into a scheme of insurance with any insurer of life
right from the start. Alternatively, they shall accumulate the contributions and interest
thereon. With this amount, they shall purchase an annuity from the insurance company at
the time of retirement (or prior death) of the employee, at or after a specified age, or on
his becoming incapacitated prior to such retirement.
At that juncture, the employee may be paid a commuted value not exceeding one-third of
the corpus where the employee receives gratuity and half otherwise. This commuted
amount is tax-free.
The freedom from income tax is not enjoyed if the employee resigns (not retires) or the
employee retires before the superannuation age. The escape route in such cases is to
purchase SAF-related annuity with the entire balance to the credit of SAF, without any
commutation.
For grant of exemption from tax, rule 89(ii) of ITA provides that annuities shall be
purchased from life insurance companies only. The employee has a wide choice between
different annuities.
Since this annuity has its nexus with salary of the employee, prior to his retirement, he
can claim the standard deduction thereon.
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Pension: Section 10(10A)
Any payment in commutation of pension received under the Civil Pension
(Commutation) Rules of the central government or under any similar scheme applicable
to the members of the civil services of the union, or civil posts under a state, or to the
members of the all India Services and defence services, or to the employees of a local
authority or a corporation established by a central, state or provincial Act, is exempt.
As regards any other employees, it is exempt up to one-third of the pension where the
employee receives any gratuity and one-half of such pension otherwise.
The standard deduction is available to pensioners as well.
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Leave Encashment: Section 10(10AA)
Encashment of privilege leave not availed of during the tenure of employment is taxed as
salary. However, leave salary paid to legal heirs of a deceased employee is not liable to
tax.
Cash equivalent of leave salary payable to a government employee in respect of leave to
his credit at the time of his retirement on superannuation or otherwise, is free from tax.
For other employees, this exemption is subject to the least ofa
10 months average salary (calculated on the basis of the salary during 10 months
preceding the employees' retirement on superannuation or otherwise).
b
Cash equivalent of leave salary in respect of the period of earned leave standing to
the credit of the employee. Earned leave cannot exceed 30 days for every year of
actual service rendered for the employer from whose service he has retired.
c
The amount of leave encashment actually received.
d
Rs 3 lakhs (Notification 123/2002 dated 31.5.02).
Where an employee has encashed leave in one or more years from more than one
employer, the total amount exempt in this regard is subject to the above ceiling.
The phrase 'retirement on superannuation or otherwise' has caused a lot of confusion and
consequent litigation. I hope the authorities define the meaning of or otherwise
unambiguously, or otherwise ITOs will continue to interpret the same differently.
In respect of leave encashment, CIT v Malhotra 142CTR325 (Bom) has observed, "On
acceptance of resignation, the employee stands retired from service. The word 'retirement'
has not been used in the restricted sense to mean 'retirement on superannuation'. On the
other hand it is clear that it has been used in the widest possible terms to mean and
include all cases of retirement, whether on superannuation or otherwise. What is relevant
is 'retirement'. How it took place is immaterial for the purpose of the clause. It is
therefore clear that on retirement, even on resignation, the employee will be entitled to
the benefit of the exemption."
Unfortunately, some of the ITOs adopt their own views wherever it is convenient for
them to do so.
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Retrenchment Compensation: Section 10(10B)
Compensation received by a workman is exempt up to the amount calculated in
accordance with Sec 25(b) of the Industrial Disputes Act 1947, or Rs 5 lakhs, whichever
is less.
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Voluntary Retirement Scheme: Section 10(10C)
VRS compensation received by an employee at the time of his voluntary retirement in
accordance with prescribed guidelines is exempt up to Rs 5 lakhs. Different schemes can
be framed for different classes of employees but within the guidelines.
Now comes a peculiar problem. A candidate accepting VRS may suddenly find that his
normal salary earned up to the retirement, when added to the taxable portion of VRS
makes his income under the head Salaries over Rs 5 lakhs and therefore, he loses the
rebate u/s 88. The standard deduction also goes down from Rs 30,000 to Rs 20,000.
Following are the guidelines:
1
It applies to all employees, including workers and executives (but not directors),
who have completed 10 years of service or completed 40 years of age.
2
Where such exemption has been allowed any time in the past, no exemption shall
be allowed in any other subsequent year.
3
The vacancy caused is not to be filled up, nor is the retiring employee to be
employed in another company or concern belonging to the same management.
VRS should result in overall reduction in the existing strength of the employees.
4
VRS benefit should not exceed either (i) 3 months' last drawn salary for each
completed year of service or (ii) salary at the time of retirement multiplied by the
balance months of service left before the date of his retirement on
superannuation. Note the absence of 'whichever is more' or 'whichever is less'.
One of the two conditions should be satisfied for the eligibility of the exemption.
Salary includes DA, if the terms of employment so provide, but excludes all
other allowances and perquisites.
5
Where this exemption has been allowed to any employee for any year, it shall not
be allowed to him for any other year.
6
The exemption up to Rs 5 lakhs is available on the entire VRS amount, even if
paid in instalments in different years.
Under such a situationU/s 15, the entire compensation paid or accrued under the VRS becomes chargeable to
tax during the very first year.
U/s 192, "TDS on income under the head 'Salaries' at the average rate of income tax
computed on the basis of the rates in force for the FY in which the payment is made, on
the estimated income of the assessee under this head for that FY."
Yes, Sec 192 requires TDS to be computed on payment made for the year whereas Sec 15
makes the entire compensation paid or accrued as an income chargeable to tax.
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There appears to be an apparent contradiction between the two sections. The issue is
resolved by YSC Babu & Another v Chairman & Managing Director, Syndicate Bank &
Others (2002) 173CTR151 (AP). The learned judge correctly observed, "The intention of
the legislation is that it is necessary to arrive at the average of the income tax payable on
the estimated income for the FY during which the first instalment is paid on the basis of
the rates in force and thereafter, deduct the tax payable only on the amount paid during
the year.
"As provided u/s 192, the income of every employee has to be estimated under the head
Salaries for the FY in question and thereafter, give effect to the exemptions that are
available not only u/s 10(10C) but also under any other provisions of the Act, such as the
standard deduction and rebate u/s 88, etc. Several exemptions provided under the Act
have to be cumulatively applied while computing the annual income and not with
reference to a particular payment. Thereafter, one has to compute the average income tax
on the basis of the rates in force for the FY. TDS has to be effected at that rate on the
amount actually paid under the VRS and the other income chargeable to tax under the
head Salaries, at the time of such payment.
"Consequently, as and when the subsequent instalments are paid, tax on these incomes
has to be computed by applying the rate of tax thus arrived at. Exemptions, deductions
and rebates can be claimed thereon as provided by the Act."
U/s 35DDA(1), amortisation of expenditure incurred under VRS is allowable to the
employer in five equal instalments in respect of the amount paid (including payable, as
per strict interpretation). Therefore, the employers will find it useful to spread the cash
outflow arising out of VRS over a period of 5 years. Any interest paid to the employee on
the periodical instalments received subsequently, will be directly a charge to profits and
gains of the business for the previous year during which the interest is paid.
The employee will also find this arrangement useful because of two distinct reasons. The
first is that he does not have to suffer the entire tax upfront at the prevailing rates but be
subjected to TDS as and when the instalments are paid. Moreover, he gets rewarded by
way of interest at a rate much higher than the market rate and from a very safe source, his
erstwhile employer.
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Miscellaneous
Besides the above benefits, some employers give retirement benefits in the form of:
1
Insurance annuity policy in appreciation of outstanding services rendered. The
annuity payments are payable to the employee or his heirs. The payments commence
after retirement or prior death of the employee.
2
Medical assistance to the retired employee and his wife as well as dependent
children.
3
Any ex-gratia received on termination of service need not be treated as profit in lieu
of salary within the meaning of Sec 17(3), if the employer was under no obligation to
make the payment.
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RELIEF U/S 89(1)
The various terminal benefits received by an employee are bound to push the income
onto a substantially higher tax slab. A similar situation arises when the salary is paid in
arrears or in advance. To mitigate the hardships caused to the assessee by such situations,
ITOs are empowered to grant appropriate relief u/s 89(1), on receipt of an application
from the assessee. However, u/s 192(2A), government servants or employees in
companies, co-operative societies, local authorities, universities, institutions, associations
or bodies may furnish the particulars in Form 10E and get the relief directly from the
employer.
If leave encashment is received during employment, it is chargeable to tax, irrespective of
whether the employee is in government or private service. The employee can, however,
claim relief in terms of section 89 (Circular 431, dated 12.9.85).
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Salary in Arrears or in Advance [Rule 21A(2)]
The relief on salary received in arrears or in advance is computed in the manner laid
down in rules 21A and 21AA as follows:
a
Calculate the difference between the taxes payable of the relevant previous year in
which the additional salary is received on the total income, excluding the additional
salary and including it.
b
Calculate the difference between the taxes payable on the total income after
excluding the additional salary and including it in the previous year to which such
salary relates.
c
The amount of relief admissible u/s 89 = A - B. No relief is admissible if 'A - B' is
negative. If the additional salary relates to more than one previous year, salary would
be spread over the previous years to which it pertains in the manner explained above.
All these computations are to be carried out by taking cognisance of the rebate u/s 88,
88B or 88C to the extent applicable. The fact that the assessee would have contributed
additional money to such avenues has to be ignored. Surcharge has to be applied on the
tax payable after rebates for respective years.
Family pension received in arrears by family members of a deceased employee is also
eligible for benefit of Sec 89(1) w.e.f. FY 95-96.
Finally, application of Sec 89(1) to VRS.
Madras high court in the case of CIT v M. Raman, Abdul Hadi and NV Balasubramanian
JJ, (ITR vol 245, 2000) decided on 4.3.1997 that- The amount received by the employee
at the time of voluntary retirement of service would be regarded as salary and the relief
under section 89 of the Income Tax Act, 1961, would be admissible in respect of such
sum.
"The assessee has taken voluntary retirement from the service and received an amount of
compensation at the time of his voluntary retirement. The question that arises is whether
the compensation received by the assessee at the time of voluntary retirement would fall
within the provisions of section 17(3)(i) of the Income Tax Act, 1961, that is, whether it
can be regarded as salary and the assessee would be entitled to the relief provided u/s 89
of the Income Tax Act, 1961. This court in the case reported in CIT v. J Visalakshi
(1994) 206 ITR 531, held that if an employee receives at the time of resignation, the
amount could be regarded as salary and the assessee would be entitled to the relief
provided u/s 89 of the Income Tax Act, 1961. The said principle rendered by this court in
the case of resignation would equally apply to the case of voluntary retirement of an
employee from service."
The method of computing the relief is described under the subhead, 'Compensation on
Termination' subsequently.
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Gratuity [Rule 21A(3)]
Relief can be claimed u/s 89(1), if gratuity is received in excess of the limits specified in
the Act. However, no relief is admissible if taxable gratuity is in respect of services
rendered for less than 5 years. How relief is computed is discussed below.
If service is for 15 years or morea Compute average rate of tax on the total income, including the gratuity in the year of
receipt.
b Compute tax on gratuity at this rate.
c Compute average rate of tax by adding one-third of the gratuity to the other income
of each of the 3 preceding years.
d Take average of the 3 rates computed in the manner specified in 'C' above and
compute the tax on gratuity at that rate.
The relief admissible u/s 89(1) = B - D.
If service is for 5 years or more but less than 15 yearsThe relief is computed on similar lines. The only difference is that instead of average of
the average rates of the preceding 3 years, the average of the rates of the preceding 2
years is computed by adding half of the gratuity to the other income of each of the
preceding 2 years.
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Compensation on Termination [Rule 21A(4)]
If the service is continuous for not less than 3 years and the unexpired term of
employment is not less than 3 years, the relief offered is as if the gratuity was for service
of 15 or more years.
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Commutation of Pension [Rule 21A(5)]
Relief can be claimed in respect of payment in commutation of pension in excess of the
limits mentioned in the Act. Such relief is computed in the same manner as if the gratuity
was paid to the employee for service of 15 years or more.
Author: AN Shanbhag is a best selling author and a very widely syndicated columnist on
personal finance and taxation.