To understand the import of VRS fully, it is necessary to have clarity on the issue of incidence of Income Tax on amounts payable to an employee in pursuance of Voluntary Retirement Schemes as, a ceiling of Rs 5,00,000/- has been placed by law on the amount beyond which, income tax shall become chargeable. Through the articles below, we shall attempt to explore this aspect;
Can exemption under section 10(10C) of the Income Tax Act be availed by an employee, in the event the voluntary retirement compensation is paid on the basis of ex-gratia amount and not the salary of the employee, with a ceiling of Rs. 5,00,000/-?
Section 10(10C) of the Income Tax Act exempts income tax on the amounts received by an employee in pursuance to the retirement schemes that are introduced by companies, societies, institutes etc. to the maximum ceiling amount of Rs. 5,00,000/- (Rupees Five Lakhs only). The first proviso to section 10 (10C) provides that for availing the benefit of the exemption, the schemes governing the payment of such voluntary retirement compensation/ amount are required to be framed in accordance with such guidelines as may be prescribed. (Section 10 (10C) of the Act has been provided below)
The Guidelines for the purposes of section 10 (10C) have been prescribed by rule 2BA of the Income Tax Rules, which amongst other conditions has provided that the amount receivable on account of voluntary retirement of the employee should not exceed the amount equivalent to three month’s 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 said Guideline further clarifies that the term “salary” shall have the same meaning as is assigned to it in clause (h) of rule 2 Part A of the Fourth Schedule, which definition is reproduced hereunder:
“Salary” includes dearness allowance, if the terms of the employment so provides but excludes all other allowances and perquisites”
(Rule 2BA of the Income Tax Rules has been mentioned below)
Therefore, for the purposes of seeking exemption on the compensation received under a VRS, the compensation would have to consists of the Basic and Dearness Allowance (DA) and has to be calculated on the basis of the service put in by the employee as well as the remaining service left of the employees.
The Board of Direct Taxes has vide its Circular No. 640, dated 26 November 1992 has issued clarifications on queries under section 10(10C). Some of these queries and answers are as follows –
“Question 6: Where the amount receivable on account of voluntary retirement exceeds rupees five lakhs in case of an employee, whether the entire amount receivable or only the excess of the amount above rupees five lakhs is to be subjected to income-tax?
Answer: Only the amount representing the excess above the limit of rupees five lakhs is to be subjected to income-tax.
Question 7: If the amount receivable on account of voluntary retirement is calculated on the basis of a formulation other than what has been specified in item (v) of rule 2BA and such amount does not exceed Rs. 5 lakhs, will such amount be entitled to income-tax exemption?
Answer: The amounts receivable on account of voluntary retirement of an employee which are not in accordance with the guidelines contained in rule 2BA are not entitled to income-tax exemption under section 10(10C) of the Income-tax Act.
Question 12: Whether income tax exemption on the amount of voluntary retirement is available when the amount payable is in addition to normal retirement benefits like provident fund, gratuity, pensions etc. payable under the terms governing the employment?
Answer: Yes. The provisions regarding income-tax exemption on the amount receivable on account of voluntary retirement are separate from the provisions, which govern taxation of provident fund, gratuity, pension etc.”
It is therefore clear that in order to avail the benefit of the exemption under section 10(10C), the amount on account of voluntary retirement has to be calculated in accordance with the guidelines contained in rule 2BA and necessarily has to be based on the basic salary and dearness allowance payable to an employee. A voluntary retirement compensation based on any other consideration not linked with the salary of the employee including any ex-gratia amount would not be exempted from section 10(10C) of the Income Tax Act. However, the employee/ worker will be entitled to take the benefit of tax exemption under any other section of the Income Tax Act, if the same is applicable to him. For example, a worker receiving compensation on account of voluntary retirement can claim relief under section 89(1) of the Income Tax Act, subject to the compliance of the condition in the said section.
Relevant provisions under Income Tax Act –
Section 10 (10C) of the Income Tax Act
10 (10C) any amount received or receivable by an employee of –
- a public sector company; or
- any other company; or
- an authority established under a Central, State or Provincial Act; or
- a local authority; or
- a co-operative society; or
- a University established or incorporated by or under a Central, State or Provincial Act and an institution declared to be a University under section 3 of the University Grants Commission Act, 1956 (3 of 1956); or
- an Indian Institute of Technology within the meaning of clause (g) of section 3 of the Instituted of Technology Act, 1961 (59 of 1961); or
(7 a) any State Government; or
(7 b) the Central Government; or
(7 c) an institution, having importance throughout India or in any State or States, as the Central Government may, by notification in the Official Gazette, specify in this behalf; or
8. such institute of management as the Central Government may, by notification in the Official Gazette, specify in this behalf;
on his voluntary retirement or termination of his service, in accordance with any scheme or schemes of voluntary retirement or in the case of a public sector company referred to in sub-clause (i), a scheme of voluntary separation, to the extent such amount does not exceed five lakhs rupees:
Provided that the schemes of the said companies or authorities or societies or Universities or the Institutes referred to in sub-clause (vii) and (viii), as the case may be, governing the payment of such amount are framed in accordance with such guidelines (including inter alia criteria of economic viability) as may be prescribed:
Provided further that where exemption has been allowed to an employee under this clause for any assessment year, no exemption thereunder shall be allowed to him in relation to any other assessment year;
Rule 2BA of the Income Tax Rules
Guidelines for the purposes of section 10 (10C)
2BA The amount received or receivable by an employee of –
(i) a public sector company; or
(ii) any other company; or
(iii) an authority established under a Central, State or Provincial Act; or
(iv) a local authority; or
(v) a co-operative society; or
(vi) a University established or incorporated by or under a Central, State or Provincial Act and an institution declared to be a University under section 3 of the University Grants Commission Act, 1956 (3 of 1956); or
(vii) an Indian Institute of Technology within the meaning of clause (g) of section 3 of the Instituted of Technology Act, 1961 (59 of 1961); or
(viia) an institution, having importance throughout India or in any State or States, as the Central Government may, by notification in the Official Gazette, specify in this behalf; or
(viii) such institute of management as the Central Government may, by notification in the Official Gazette, specify in this behalf;
at the time of his voluntary retirement or voluntary separation shall be exempt under clause (10C) of section 10 if the scheme of voluntary retirement framed by the aforesaid company or authority or co-operative society or University or Institutes, as the case may be or if the scheme of voluntary separation framed by a public section company, is in accordance with the following requirements, namely:-
(i) it applies to an employee who has completed 10 years of service or completed 40 years of age;
(ii) it applies to all employees (by whatever name called)including workers and executives of a company or of an authority or of a co-operative society as the case mat be, excepting directors of a company or of a co-operative society;
(iii) the scheme of voluntary retirement or voluntary separation has been drawn to result in overall reduction in the existing strength of the employees;
(iv) the vacancy caused by the voluntary retirement or voluntary separation is not to be filled up;
(v) the retiring employee of a company shall not be employed in another company or concern belonging to the same management
(vi) the amount receivable on account of voluntary retirement or voluntary separation of the employee 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;
Provided that requirement of (i) above would not be applicable in case of amount received by an employee of a public sector company under the scheme of voluntary separation framed by such public section company.
Explanation: In this rule, the expression “salary: shall have the same meaning as is assigned to it in clause (h) of rule 2 Part A of the Fourth Schedule.
With regard to VRS, is an employer liable to deduct tax at source, in a situation where income tax is payable?
As per the Income Tax Act, when VRS is paid in accordance with Section 10(10C) of the Act, the benefit is available up to the ceiling of Rs 5,00,000/-. Any amount payable as VRS over and above this amount is not exempted under IT Act. In such circumstances, the question that arises is whether TDS will be charged on the amount over and above the ceiling limit of Rs 5,00,000/-;
Section 192 of the Income Tax Act imposes an obligation upon any person responsible for paying any income chargeable under the head “Salaries” to deduct Tax at Source on the basis of the rates in force for the financial year in which the payment is made.
Now, Clause 5.2 of Circular No. 11/2006 dated 16-11-2006 in respect of the Income-Tax Deduction from Salaries during the Financial Year 2006-07 under section 192 of the Income-Tax Act, 1961, specifies the incomes which shall not be included in computing the income from salaries for the purpose of section 192 of the Act. The said circular under sub-clause 6 includes any payment received or receivable (even if received in installments) by an employee under section 10 (10C) to the extent that such amount does not exceed five lakh rupees. Therefore, till the voluntary retirement compensation is up to five lakh rupees the tax on the same shall not be required to be deducted at source.
The Board of Direct Taxes vide its Circular No. 640, dated 26 November 1992 in Question no. 13, had also clarified the liability of the employer for deducting of tax at source. The relevant portion of the said Circular is reproduced hereunder:
“Question 13: Whether any tax needs to be deducted at source by the employer from the amount of voluntary retirement when all the conditions specified in section 10(10C) and rule 2BA are satisfied?
Answer: No. If all the conditions specified in section 10(10C) read with rule 2BA are satisfied, the employer need not deduct tax at source from the amount of voluntary retirement to an employee”
However in cases where the amount received is in excess of the ceiling limit prescribed by section 10(10C) i.e. Rs. 5,00,000/- (Rupees Five Lakhs only) or where the amount received by an employee at the time of retirement is not calculated on the basis of a formulation other than what has been specified in item (v) of rule 2BA, the same is treated as “profits in lieu of salary” as defined under section 17 (3) of the Income Tax Act and hence chargeable to the under the head of income “Salaries” for the relevant financial year.
In the case of Commissioner of Income Tax vs. G. V. Venugopal ([2005] 273 ITR 307 (Mad)), the Hon’ble Madras High Court, while dealing with the question whether an employee will be allowed to claim benefit under section 89(1) on the amount received by him under the voluntary retirement scheme as reduced by the exemption under section 10(10C), held as follows;
“19. The word ‘salary’ as defined in section 17 of the Act includes any profit in lieu of salary, which has been defined in section 17(3) of the Act to include any amount of compensation due or received by the assessee from his employer or former employer in connection with the termination of his employment. Hence, payment under the voluntary retirement scheme is covered by the word ‘salary’, which has been given very wide definition in section 17. Since the assessee is covered by section 89, he will get both the benefits, which he has claimed for”
The aforesaid judgment has been relied upon several times thereafter by both the High Courts and the ITAT.
Therefore, in view of the above, an employer will have to deduct at source the income tax or the taxable income for the relevant financial year after excluding five lakhs under section 10(10C) of the Income Tax Act.
Whether the payment made by an employer to an employee under a voluntary retirement scheme be considered as expenses under the Income Tax Act?
Section 35DDA of the Income Tax Act provides that the expenditure incurred by way of payment of any sum to an employee at the time of his voluntary retirement, in accordance with any of the scheme of voluntary retirement, would be allowable as deduction over a period of five years.
The Central Board of Direct Taxes vide its Circular dated 23rd January 2001 reported at (2001) 248 ITR (St) 257 has clarified that ex-gratia payments at the time of voluntary retirement is to be treated as capital expenditure and section 35DDA would, however, allow the same on staggered basis. (Section 35DDA has been provided below)
In the matter of Commissioner of Income-tax vs. Simpson & Company Ltd. ([1998] 230 ITR 794 (Mad)], the Hon’ble Madras High Court held that;
“Insofar as question No. 3, is concerned, it relates to assessment of 1974-75 and 1975-76 in the matter of payments made to the employees under the Voluntary Retirement Scheme. The point for consideration is whether such payment is admissible as deduction in computing the total income of the assesse for the assessment years under consideration. Similar consideration came up before this Court, in the case of CIT vs. George Oakes Ltd. (1992) 197 ITR 288 (Mad) wherein this Court held that when the payment is made for the purpose of retrenchment of workers it was for the purpose of reducing the staff and to bring about a reduction in the wage bill as well. Therefore, these were matters of management pertaining to business considerations and expediency and the expenditure incurred by the assessee in this regard was for purpose of business and also with a view to maintain good relationship with the labour and that expenditure had to be considered as having been laid out wholly and exclusively for business purposes of the assessee. Therefore, it is deductible. A similar view was also taken by this Court in a decision reported in CIT vs. Sri Ramvilas Service Ltd. A similar view was also taken by this Court while rendering its decision in T.C. No. 267/1983(CIT v. Simpson and Co. Ltd. (no. 1) (1998) 230 ITR 703 in the case of the same assesse, dated. 10th June, 1996. Accordingly we answer the question No. 3 in the affirmative and against the Department.”
Therefore, payments made by a Company to its workers under a voluntary retirement scheme shall be deductible as expenditure over a period of 5 years.
Section 35DDA of the Income Tax Act
“Amortisation of expenditure incurred under voluntary retirement scheme.
35DDA. (1) Where an assessee incurs expenditure in any previous year by way of payment of any sum to an employee in connection with his voluntary retirement, in accordance with any scheme or schemes of voluntary retirement, one-fifth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year and the balance shall be deducted in equal installments for each of the four immediately succeeding previous year. ..”
Whether the total amount of voluntary retirement compensation can be paid in installments?
The Parliament, vide Circular No. 7/2003, dated 5-9-2003 issued explanatory notes on provisions relating to Direct Taxes. Clause 9 of the said Circular clarifies that the receivables under the voluntary retirement scheme by an employee, means compensation received in installments. The said clause 9 is reproduced hereunder:
“Exemption of amount received under VRS Compensation allowable even if it is receivable or received in installments…”
9.1 Under the existing provision contained in clause (10C) of section 10, any amount received by an employee of a public sector company or any other company or an authority established under a Central, State or Provincial Act or a local authority or a co-operative society, or a University, or Indian Institute of Technology, or State or Central Government, or an institution having national/state level importance, or a institute of management, notified by the Central Government, etc., at the time of voluntary retirement or termination of his service in accordance with any scheme or schemes of voluntary retirement, or in the case of a public sector company, a scheme of voluntary separation, to the extent such amount does not exceed five lakh rupees, is not included in computing the total income of such employee. However, some of the employees availing VRS were facing problems in case the amount was given to them in installments, over a number of years.
9.2 To solve this problem, clause (10C) of section 10 has been amended by the Finance Act, 2003 to provide that any amount not exceeding five lakh rupees received or receivable (i.e., even if received in installments) by an employee on his voluntary retirement or termination of his service will not be included in computing the total income of such employee. Other conditions, as well as the overall limit shall, however, remain unchanged.
9.3 This amendment will take effect from 1st April, 2004, and will, accordingly, apply in relation to the assessment year 2004-05 and subsequent years.”
In the matter of Sri V. G. Ramachandiron vs. Income-tax Officer ([2006] 284 ITR 53 (AT)), the Hon’ble Income Tax Appellate Tribunal (ITAT), while dealing with the issue of whether the sum paid on voluntary retirement scheme subject to a limit of Rs. 5 Lakhs are exempt from being charged to tax under section 10 (10C) of the Income Tax Act, when the payment is made in installments, held as under:
“7. Admittedly, the amount receivable in these cases is on account of compensation of voluntary retirement scheme which is well within the maximum permissible limit of Rs. 5,00,000/- lakhs under Section 10(10C) of the Act. The sum received under voluntary retirement scheme to the extent of Rs. 5,00,000/- are to be exempt under Section 10(10C). Even if the payment is spread over a period of two years, since, it has been received from the same employer and the proviso to Section 10(10C) does not spell out restriction on this account. This view has been clarified in the case law of Hon’ble Calcutta High Court cited above. Even otherwise, the payment of benefit arising at the time of retirement from the same employer and from the same scheme, the treatment of employees of the same organization coming out on voluntary retirement scheme without discriminating on the ground, receipt should have been received in full or to avail full limit of Rs. 5, 00,000/- as prescribed under Section 10(10C) is the intention of the legislature. If we go by the intention of the legislature which has amended the proviso to Section 10(10C) as, “or receivable” has been inserted w.e.f. 1.4.2004 by the Finance Act, 2003. Even if we go by the memo explaining the provisions and circular issued by CBDT 263 ITR 62 (Statutes) (page 72) (supra) where it is mentioned even if received in instalments, this clearly means it is clarificatory in nature and it is curative. The memo explaining the provisions of the Finance Act’ 2003 and the CBDT Circular cited above was clearly aimed at solving the problem of retired employees that those persons who received the compensation in instalments spread over to many years then, subject to other conditions as well as overall limit of exemption of Rs. 5,00,000/- as provided under Section 10(10C) of the Act, this was inserted. A similar view while interpreting the provisions of Section 43B, the Hon’ble Apex Court in Allied Motors (P) Ltd. has taken a similar view that the reasons given for insertion to Section 43B was-
“As is evident from the Budget Speech of the Finance Minister for the year 1983-84 see (1983) 140 ITR (St.) 31-32 and the Memorandum explaining the provisions in the Finance Bill, 1983 see (1983) 140 ITR (St.) 160 that Section 43B was clearly aimed at curbing the activities of those tax-payers, who did not discharge their statutory liability of payment of excise duty, employer’s contribution to provident fund, etc., for long periods of time but claimed deductions in that regard from their income on the ground that the liability to pay these amounts had been incurred by them in the relevant previous year. It was to stop this mischief that Section 43B was inserted”
Respectfully following the Hon’ble Apex Court cited above and the judgment of Hon’ble Calcutta High Court, (supra), on identical facts, we hold that the installments received by retired employee on account of voluntary retirement scheme compensation is exempt under Section 10(10C) subject to the overall exemption limit of Rs. 5,00,000/-, even though, it is spread over for several years but the same should come out of the same scheme as formulated by the company concerned. In view of this, we allow the claim of the assessee and accordingly the orders of the lower authorities are reversed”.
The Hon’ble ITAT in the aforesaid judgment relied on the judgment of the Hon’ble Calcutta High Court (DB) in the matter of SAIL DSP VR Employees Association 1998 vs. Union of India and Ors. ([2003] 181 CTR 367 (Cal)). The relevant portion of the said judgment is reproduced hereunder:
“15. Once we have found that the amounts payable come under Section 10(10C) and the same is being paid in accordance with the scheme framed for voluntary retirement, now we are to examine whether it would be hit by the second proviso to Section 10(10C). The second proviso provides that exemption to Clause (10C) to the extent that the benefit of exemption is available only in one assessment year and would not be available for any other assessment year, once availed of. According to Mr. Some and echoed by Mr. Banerjee, the payment having stretched over to a longer period than one assessment year, the payments made in subsequent assessment years are hit by the said proviso.
Admittedly, the provisos are exemptions carved out of the principal section. But, this question had to be dealt with having regard to Section 15 and 17, read with Section 43(2) of the Income-tax Act.
16. Section 43(2) defines the expression “pay” which includes the incurring of the liability as well. Whereas Section 15(a) provides chargeability of salary to tax as soon it becomes due, though not paid. As soon the salary becomes due, the incurring of the liability is complete. As soon the liability is incurred, it becomes a deemed payment in view of the definition of “pay” defined under Section 43(2). In the present case, though the amount of monthly benefit paid under Clause 4.1(i) of the voluntary retirement scheme consists of salary or benefit in lieu of salary as defined in Section 17(1) or (3), read with Section 43(2), but the same is exempted from tax by reason of Section 10(10C). This amount became chargeable under Section 15 (a) as soon as it became due, though not paid. Under the scheme the liability to pay was incurred and the amount became payable at the time when the employee was released having opted for the voluntary retirement under the scheme. Therefore, this is an amount, which is receivable by the employee at the time of voluntary retirement according to the scheme and became chargeable to tax under Clause (a) of Section 15, even though not paid. Therefore, to the extent of rupees five lakhs, the said amount is exempted from being charged to tax by reason of Section 10(10C). Even, if the payment is stretched over a period of years, the same would not become chargeable to tax in any subsequent assessment year. An amount becomes chargeable once it is earned whether it is received or not. Since the employee was not in service, therefore, the deferred payment will not continue and it would not be a salary from service, neither a deferred payment of salary nor arrear payment of salary, since the scheme postulates an one time payment in consideration of voluntary retirement spread over to a period of ten years or till the age of 58 years, whichever is earlier, in quarterly payment in advance. It is a deferred payment of the benefit receivable under the voluntary retirement scheme. Therefore, it would not be a payment of salary outside the scope of Section 10(10C). The characteristic cannot be changed because of stretching over the period of payment of dues under the scheme.”
Therefore in light of the Circular No. 7 of 2003 and the aforesaid judgments an employer can pay part of the amount out of the total voluntary retirement compensation as an advance to enable the workers/ employees to invest money in Tax Saving Bonds and subsequently pay remaining amount.
Some important points to remember on Voluntary Retirement Scheme;
- A compensation under voluntary retirement scheme can be paid by an employer under any nomenclature, however for the worker to take the benefit of the exemption under section 10(10C) the compensation has to be calculated in accordance with Rule 2AB and therefore it has to be necessarily based on Basic and Dearness Allowance (DA) and linked with the years of service of the worker/ employee.
- In the event the voluntary retirement compensation is paid on the basis of ex-gratia amount and not on the basis of years of service, the same will be treated as “profits in lieu of salary” under section 17(3) of the Income Tax Act and the Employer would be liable to deduct tax on the same under section 192 of the Income Tax Act. However, the workers/ employers would be entitled to take benefits of deductions available under any other provision of the Income Tax Act.
- Payments made by an employer to its workers under a voluntary retirement scheme shall be deductible as expenditure over a period of 5 years.
- It is permissible for an employer to pay the voluntary retirement compensation in installments to enable the workers/ employees to invest money in Tax Saving Bonds.