Amidst the news of layoffs in big companies like PayPal, Oracle and Volkswagen in India, there has been a lot of discussion on the severance packages that employees get after losing their jobs. PayPal has cut about 220 jobs in India, while Oracle is reported to have affected about 3000 employees. Volkswagen Group’s Indian unit is also planning to reduce its workforce by about 12 percent. At the same time, severance pay certainly provides financial support for some time after leaving the job, but it is also very important to understand the tax rules on this amount.
Generally, in India, compensation received from the employer due to termination of employment or change in terms of employment is considered as ‘Profits in lieu of salary’. This amount is taxable under the ‘salary head’ as per the employee’s income tax slab rate. However, the same rules do not apply to all types of severance payments.
However, in some cases, exemption may be available under the law. For example, Retrenchment Compensation paid to eligible employees under the Labour Act can be exempted from tax under Section 10(B) of the Income Tax Act subject to certain conditions.
In addition, there is a tax exemption of up to Rs. 5 lakh under Section 10(C) on the money received under the Voluntary Retirement Scheme (VRS). Compensation which does not come under the salary head is taxable under ‘Income from Other Sources’, depending on the circumstances.
It is also important to report severance payments correctly while filing ITR. According to tax experts, the employee should first get the full and final settlement statement and Form-16 from the company and see how the company has categorized the severance payment, the part that is taxable, is usually shown in the income tax return (ITR) as income from salary.
Apart from severance, full and final settlement also includes gratuity and salary arrears. While tax exemption is available on gratuity up to a certain limit, relief can be claimed under Section 89 for salary arrears. It is important to keep documents like termination letter, employment agreement, settlement statement, service period certificate, TDS and Form 10E for Section 89 relief.
