Retrenchment Compensation Taxability -Section 10(10B)
Retrenchment Compensation means any payment received by an employee on termination of his contract of service either due to his professional misconduct, violation of Company policies, or due to incapability of the company to continue any of its units further.
Whatever be the reason for closure, the Indian Industrial Disputes Act of 1947, stipulates that the workers who have been working in such organization are adequately compensated to take care of their immediate future. This is where retrenchment of workers comes into picture.
Taxability on Retrenchment Compensation
Retrenchment Compensation received by a workman/employee under the Industrial Disputes Act 1947 or any other Act is exempted to the extent of the lower of the following:
- Amount actually received.
- 15 days average pay for every completed year of continuous service or part thereof in excess of 6 months (calculated in accordance with the provisions of Section 25F(b) of the Industrial Disputes Act, 1947)
- Basic exemption limit of 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 simple words all the amount received upto Rs 5 Lacs as Retrenchment Compensation by employee/workman is fully exempt from Income Tax.
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 i.e. if an employee has worked for 5 years 7 months than number of year served shall be taken as 6 years and if he has worked 5 years 5 months than it will be 5 years.
For this purpose, average pay will be calculated as under:
- if the employee is entitled to monthly salary, then on the basis of the salary of last three calendar months; or
- if the employee is entitled to weekly wages, then on the basis of wages of last four completed weeks; or
- if the employee is entitled to daily wages, then on the basis of wages of last twelve full working days.
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 person in respect of the his employment or work done in such employment, including the value of benefits mentioned in the Explanation to such Act.
Compensation received by a person at the time of the closing down of the Organization in which she / he is employed is treated as compensation received at the time of his retrenchment. If ownership or management of the undertaking in which the person 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 it meets criteria cited underneath.
- If the service of the person has been interrupted by such transfers of the managements; or
- If the terms and conditions of service applicable to the employee after such transfer are in any way less favorable to the person, than those that were applicable to him immediately before the transfer of the management; or
- If the new employer under the terms of such transfer, is legally not liable to pay to the retrenched employee in the event of her / his retrenchment, Retrenchment compensation on the basis that her / his service had been continuous and had not been interrupted by the transfer.
In simple words what this condition means is, if the new management has entered into agreement of the old management that only the old management is liable to pay the retrenchment compensations.
Example of Calculation of Exempt Amount/Taxable Amount of Retrenchment Compensation Received
Mr. A is an employee of ABC Ltd. Due to his Professional Incompatibility, he is retrenched from the services after serving 7 years 7 months. He received an amount of Rs 4, 00,000 as Retrenchment Compensation. During his employment he was getting a monthly salary of Rs 50,000.
|Least of the following is exempt:||Amount|
|Amount actually received15 days average pay x no.of yrs served|
Maximum exemption limit
|Exempted amountTaxable Amount||2,00,0002,00,000|