I am retiring. How much of my gratuity, leave encashment, commuted pension and VRS money is tax-free?
Government employees get gratuity, leave encashment and commuted pension fully exempt. Everyone else works to ceilings: Rs 20 lakh for gratuity (since 2018-19), Rs 25 lakh for leave encashment (raised from Rs 3 lakh by CBDT Notification 31/2023, in force from 1 April 2023), one-third or one-half of the commuted pension, and Rs 5 lakh for VRS. All four exemptions survive under the new regime.
Four different clauses of section 10 cover four different retirement receipts, and each one splits the world into government employees and everybody else. If you retired from the Central Government, a State Government, a local authority or (for pension) a statutory corporation, the gratuity, the leave encashment and the commuted pension are exempt without any monetary cap. The rest of this explainer is about the rest of us.
Gratuity under s.10(10) has a formula and a ceiling. If your employer is covered by the Payment of Gratuity Act, 1972, the exempt amount is the least of: 15/26 of your last drawn basic plus dearness allowance multiplied by completed years of service; the gratuity you actually received; and Rs 20,00,000. If your employer is not covered by that Act, the formula changes to half a month's average salary of the last ten months multiplied by completed years, but the Rs 20,00,000 ceiling is the same. The Income Tax Department's own FAQ records how the ceiling got there: S.O. 1420(E) dated 29 March 2018 from the Ministry of Labour lifted it for covered employees, and S.O. 1213(E) dated 8 March 2019 lifted it to Rs 20,00,000 for employees not covered by the Act. Some commentary still prints Rs 10 lakh for the non-covered category; that is stale.
Leave encashment under s.10(10AA) got the most recent change. CBDT Notification No. 31/2023 dated 24 May 2023 raised the ceiling for non-government employees from Rs 3,00,000 to Rs 25,00,000, deemed to be in force from 1 April 2023. The exempt amount is the least of four numbers: what you actually got; ten months' average salary; the cash value of unused earned leave counted at no more than 30 days for each completed year of service; and Rs 25,00,000. Leave encashed while you are still working is fully taxable — the clause only covers encashment at retirement or resignation.
Commuted pension under s.10(10A) does not have a rupee ceiling at all; it has a fraction. A non-government pensioner who also received gratuity gets the commuted value of one-third of the pension exempt. A non-government pensioner who did not receive gratuity gets one-half. Commuted pension out of a fund set up under s.10(23AAB) by LIC or another insurer is fully exempt whoever you are. Your monthly uncommuted pension is always taxable salary.
VRS under s.10(10C) is capped at Rs 5,00,000 and, unlike the others, is a once-in-a-lifetime benefit: if the exemption is allowed in one assessment year, it cannot be allowed in any other. The scheme itself must satisfy Rule 2BA — the employee must have completed 10 years of service or be 40 years old, the scheme must apply to all employees other than directors, it must produce an actual reduction in headcount, the vacancies must not be refilled, the retiree must not be re-employed by the same management, and the payment must not exceed three months' salary per completed year or the salary he would have earned to superannuation. You also cannot take both the s.10(10C) exemption and s.89 relief on the same VRS money in different years.
The most useful thing to know is that none of this is lost by choosing the new regime. HRA and LTA go away under s.115BAC; gratuity, leave encashment, commuted pension and VRS exemptions do not. A retiree on the default new regime keeps all four.
These are one-off receipts, often the largest single credit a person will ever see in a bank account, and the exemption is computed once and cannot easily be redone. Employers commonly deduct TDS on the gross figure or on a stale ceiling. Getting the least-of computation right at the deduction stage saves a refund fight later.
My client resigned; he did not superannuate. The officer says s.10(10AA) is only for retirement, so his leave encashment is fully taxable. Is that right?
I took VRS from a bank and claimed the Rs 5 lakh exemption under section 10(10C). Can I also claim spread-over relief under section 89(1) on the balance?
My employer's early retirement scheme does not spell out every condition in Rule 2BA. Does that destroy the s.10(10C) exemption?
I took voluntary retirement. Can I claim both the s.10(10C) exemption and s.89 relief on the balance?
My VRS does not satisfy Rule 2BA. The Commissioner says that kills my s.35DDA deduction as employer. Does it?
My client retired from a public sector undertaking a few weeks before 29 March 2018 and was paid twenty lakhs of gratuity, but tax was deducted on ten lakhs of it. Central Government employees had already been given the twenty-lakh ceiling from 1 January 2016. Can I get the higher exemption on Article 14 grounds?
My clients settled a wage dispute and took VRS and compensation for loss of future salary in two instalments. The company deducted TDS on the whole amount without giving s.89 relief. Can we make the employer refund it?
For the s.10(10) gratuity and s.10(10AA) leave encashment limits, can I compute 'salary' on the pay my employer actually used — basic plus all the allowances that went into provident fund pay?
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