To meet soaring costs and high-interest rates, companies are forced to undertake coercive measures such as layoffs, retrenchments and issue of voluntary retirement schemes to employees. The benefits of the packages and compensations come with complex income tax implications.
The employees who receive such compensatory payments are often left wondering about the income tax implications. To complicate things further, companies often call their pays, packages and compensation by different names.
These transactions are often lump sum and non-recurring in nature, which caused the Income Tax Departments to categorize them under the head āCapital Receiptsā or exclude them from taxability upon dispute, both from the department and the aggrieved employees alike.
According to Section 17(3)(i) of the Income Tax Act of 1961, payments received in this manner were taxed as “Profits in lieu of salary” under the category of “Salaries.” The Assessing Officer, however, was unable to prove the employer-employee relationship in some instances, which resulted in the decision that the revenues could not be taxed under the head “Salaries.”
In some circumstances, the appellate authority determined that the received contributions were not taxable since they were of “capital nature.”
Most of these scenarios are not in favour of the employee. However, certain benefits are available under the Income Tax Act itself to the aid of the taxpayer.
If the employee receives compensation for availing Voluntary Retirement Schemes (VRS) or Separation upto a maximum of Five Lakh Rupees, if received in compliance with Rule 2BA of the Income Tax Rules, then such income is exempt from taxation in accordance with Section 10(10C) of the Income Tax Act.
If the employee was not working in a managerial, administrative or supervisory position, then upon receiving compensation or severance as per the provisions of the Industrial Disputes Act, 1947 he/she can claim tax exemption upto Rupees Five Lakhs according to the Section 10(10B) of the Income Tax Act. It is pertinent to note that no one employed under Army Act, Navy Act or Airforce Act is entitled to this benefit. In addition, this provision is not applicable to policemen or employees of prisons.
Unfortunately, no pandemic or recession specific reliefs have been made available by the Government to taxpayers who had to forgo their employment. The Section 89 of the Income Tax comes to the rescue of the employee in this regard.
As per Section 89(1), tax relief is provided by recalculating tax for the year in which arrears are received and the year to which the arrears pertain; and the taxes are adjusted in the year in which they were due. It is available for salary paid as arrears and advances for upto three years from the present assessment year.
In cases where compensation is received but there is no employer-employee relation, the amount drawn shall be taxed as āincome from other sourcesā under the Section 56 of Income Tax Act.
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