Treatment of Amounts received on retirement forming part of salaries

No matter which country you opt to move for your employment, everywhere it is expected from the employees that they will get additional benefits and privileges upon completing their employment tenure or upon their retirement. In India, retirement benefits are governed by specific provisions in the Income Tax Act. In the Indian context, the Income Tax Act provides certain tax benefits and exemptions on retirement benefits to encourage savings for retirement and provide financial security to individuals post-retirement. Let us analyse in detail what are these different types of retirement benefits and their tax treatments.

Provident Fund:

PF is a mandatory contribution made by both employers and employees towards a retirement savings scheme governed by the government of India. It is a retirement scheme that is maintained throughout the employment period of the employees to ensure that there are enough savings at the time of retirement. Contributions to recognized provident funds are eligible for tax deductions under Section 80C of the Income Tax Act. Additionally, the interest earned on PF accumulations is tax-exempt subject to certain conditions.

Gratuity:

Gratuity is a retirement benefit provided to employee upon completion of his tenure of employment. Gratuity is given on either Superannuation, on retirement or resignation or upon death or disablement due to accident or disease. A full time wages- drawing employee in a continuous service for more than 5 years is eligible to get gratuity. However, the 5 years condition is not applicable in case of death, accident or disease. Earlier, it was not mandatory to pay gratuities to employees. However, with the introduction of the Payment of Gratuity Act 1972, certain employees are mandatorily paid the amount of gratuity. It is not required to be paid as a part of regular salary but shall be mandatorily paid on occurrence of the events mentioned above.

If any employee receives gratuity during his service, then it is fully taxable as income in his hands under the Income Tax Act, 1961 (‘the Act’). However, if gratuity is received in case of death, retirement, or resignation and certain other cases, then tax exemption is provided under section 10(10) of the Act.

Let us understand the amount exempt from tax.

Central or state government employees:

Entire amount of gratuity received upon retirement is exempt from tax.

Other employees to whom POGA,1972 applies:

gratuity is exempt from tax to the extent of the least of the following:

Rs. 20 lakhs (increased from Rs. 10 Lakh as per the amendment)
Actual gratuity amount received
Last salary (basic + DA)* number of years of employment* 15/26

Other employees to whom POGA,1972 does not apply:

Same provisions as mentioned in above point (ii) except the fact that there are restrictions on gratuity payments and amount of Rs.20lakhs is restricted to Rs.10lakhs only and for salary part the formula is 1/2x(last 10 months average salary)/10 x number of years of employment

Pension:

Pension received by an individual is taxable as salary income. However, there are certain exemptions available, especially for government employees and specified employees, under various sections of the Income Tax Act.

There are multiple other types of retirement benefits available to an individual like Superannuation fund, contribution to EPF or to NPS and all such benefits attract different types of tax benefits as mentioned in the provisions of income tax act.

Conclusion:

In conclusion, the Income Tax Act of India provides various provisions for tax benefits related to retirement benefits received from salaries. These benefits include deductions for contributions to schemes like the Employee Provident Fund (EPF), Public Provident Fund (PPF), and the National Pension System (NPS) under Section 80C and 80CCD. Additionally, gratuity received upon retirement or termination of employment is often tax-exempt up to certain limits as mentioned above. These retirement benefits helps an individual to make desired tax planning decisions and investment decisions.

About Author:

CA Chinmay Shirish Agate

Chinmay Agate is a Practicing Chartered Accountant having 4+ years of experience and expertise in the field of Direct Taxation and Auditing compliances. In the past, he worked in various CA firms and comes with wide industry experience from services, retail to manufacturing to trading where he has handled various complex assignments. He has keen interest in Forex and Derivative knowledge as well as fundamental analysis.