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Sudhakar Rao, an employee with a large private sector firm is due to retire in two months and is planning his post-retirement life. His finances are in order. He has no liabilities since his home loan has been paid off. His children were earning and would repay the education loans taken for their higher studies. Rao is expecting to receive a sizeable amount at the time of retirement by way of gratuity, employee provident fund and unused leave. He wants to know what are the taxes that he will be liable to pay, so that he can plan how to invest the rest of amount accordingly.
Generally, benefits received at the time of retirement are taxable under the Indian Income tax law as profits in lieu of salary in terms of section 17(3) of the Income Tax Act ('Act'). However, one can avail various tax benefits on the amounts received on retirement from the employer, subject to provisions contained in the Act.
Let us take a look at some of the provisions that can help retirees claim tax benefits.
Gratuity
Gratuity is a part of salary that is received by an employee from his/her employer in gratitude for the services offered by the employee in the company. Gratuity is paid when an employee completes five or more years of full time service with the employer. Taxability of gratuity depends on the recipient.
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In case of government employees there is no tax on the gratuity
- In case of private sector employees, if they are covered under the Payment of Gratuity Act, 1972, then the gratuity is exempt from tax subject to a maximum of Rs 10 lakh or 15 days salary for each completed year of service (or part thereof)
Commuted Pension
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Pension received by government employees, is exempt from tax.
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In case of private sector employees, if he/she receives gratuity, the commuted value of one third of the pension is exempt. Otherwise, the commuted value of half of the pension is exempt
- Pension received from LIC pension fund is entirely exempt
Leave encashment during service is fully taxable in all cases. However, such payment received by government employees at the time of retirement is fully exempt. In case of other employees (including employees of local authority and public sector undertakings), leave encashment at the time of retirement, whether on superannuation or otherwise, is exempt from tax to the extent of least of the following amounts:
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Actual leave encashment received;
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10 months of leave encashment, based on last 10 months average salary;
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Cash equivalent of unavailed leave calculated on the basis of maximum 30 days leave for every year of actual service rendered. The cash equivalent is calculated on the basis of average salary;
- Rs 3 lakh
Voluntary retirement payments
Payment received on voluntary retirement, by employee of a public sector undertaking is exempt from income tax subject to a limit of Rs 5 lakh. Such an exemption is available only when such compensation is received in accordance with the scheme of voluntary retirement or in the case of a public sector company, under a scheme of voluntary separation.
The scheme governing the voluntary retirement payment should be framed in accordance with guidelines as prescribed in Rule 2BA of the Income Tax Rules. The benefit is also available to employees of authority established under State, Central or Provincial Act; Local Authority; Co-operative Societies; Universities; IITs and Notified Institutes of Management.
It may be noted that such an exemption is available to an employee only once and if it has been availed for any assessment year, it shall not be allowed to him for any other assessment year. Further, if relief is availed by an employee under section 89 of the Act in respect of any payment on voluntary retirement, termination or voluntary separation, no exemption can be availed by him further.
Superannuation funds
In terms of section 10(13) of the Act, any payment received by an employee from an approved superannuation fund is exempt from tax, if it is made in lieu of or in commutation of an annuity on his retirement at or after a specified age.
Provident funds
Any payment made to an employee from a provident fund to which Provident Fund Act, 1925 applies or from any other provident fund set up by the central government and notified by it in this behalf, is exempt from tax. The Public Provident Fund (PPF) established under the PPF Scheme, 1968 has been notified for this purpose.
Other than these exemptions, employees can also invest in any of the instruments under Section 80 C to the extent of Rs 1.5 lakh to save on tax. These include senior citizen deposit schemes, PPF, National Savings Schemes, National Savings Certificate, National Pension System, life insurance policies and Equity Linked Saving Scheme of mutual funds.
The author is Managing Partner, Nangia & Company. With inputs from Neha Malhotra of Nangia & Company
