Income Tax on VRS – Voluntary Retirement Scheme

Income economy is now in a dynamic stage. It is under constant evolution, betterment, upgradation and getting rid of old and moribund ways of conducting business.

As a byproduct (Can also be called as consequence) the old days when a person started and remained an employee until retirement in the same organization has become a thing of the past.

Multiple jobs across a person’s working span of life, is the order of the day. So it would be no surprise to see people in their 50s and 40s who have already changed over half a dozen jobs, and may be even changed their line of profession.

The companies and businesses are also facing equally daunting situation due to global competition, better technologies being made available in India at much cheaper costs, newer technological innovations from foreign shores making the existing product lines of Indian Companies unattractive and redundant to the Indian consumers.

Under such a severe onslaught, the Indian Companies have to either perform or perish. So, they are making drastic changes to their products, infrastructures, Human Capital (Man Power) and at the same time taking variety of measures to cut costs on all fronts. One of the major areas where the companies have found that they can cut cost is to reduce the man power. In effect, what 1000 people use to produce, is now being done with half or less than half of the same. This is very widely prevalent in the manufacturing sector. Now how does a company reduce man power? They can’t be asked to leave overnight, after having worked for many years in a particular organization.

Hence the Indian Industry came up with the idea of VRS or Voluntary Retirement Scheme, whereby the employees are offered a onetime lump-sum amount. Many employees in their 50s have opted for this scheme. This is also called as “Golden Handshake” Scheme. What we are now going to analyze is how does the Income Tax Department interprets money received in this manner. The same is being presented in an easy to understand Question & Answer format for the readers.

Taxation of amounts received under VRS

Is compensation receiver in connection with the termination of employment taxable?

Normally, it is taxable as profit-in-lieu-of-salary. However, Under the existing provisions contained in clause (IO c) of section 10, any amount received by an employee of a public sector company- 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 an Indian Institute of Technology or a notified institute of management, at the time of his voluntary retirement is not included in computing his total income. The exemption is available for amounts upto Rs 5 Lacs, but only if the payment is in accordance with a voluntary retirement scheme as per the prescribed guidelines. The guidelines are discussed separately in one of the following Question & Answers.

Has the exemption of amount received under VRS now been extended to central and state government employees?

Yes. The exemption of amount received under V.R.S. is extended to employees of the Central Government w.e.f. Assessment Year 2002-2003 and for State Government employees w.e.f. Assessment Year 2001-2002.

If this exemption has been allowed to any employee for any assessment year can it be allowed in another assessment year also?

No. It shall be allowed to him only once in a life time.

What are the guidelines for exemption from tax of compensation received or golden handshake (VRS) given to an employee under a scheme of voluntary retirement?

The guidelines for the exemption from tax on the Golden Handshake (VRS) are explained underneath.

  1. VRS applies to an employee of the company who has completed 10 years of service or 40 years
  2. It applies to all employees and executives (excluding directors).
  3. It has been drawn to result in overall reduction in the existing strength of the employees of the company.
  4. Vacancy caused by the VRS is not to be filled up.
  5. The retiring employee is not to be employed in other business belonging to the same management.
  6. The amount should not exceed Rs. 5 lacs.
  7. The employee has not Availed in the past the benefit of any other voluntary scheme.

The above guidelines are to be strictly followed, and in case, the payments on account of voluntary retirements are not strictly made as per the prescribed guidelines, the payment will not be exempt.

In the amount of VRS, whether the entire amount receivable or only the excess of the amount above Rs. 5 lacs, is to be subjected to income-tax?

Only the amount representing the excess and above the limit of Rs. 5 lacs is to be subjected to Income-tax.

Is the VRS receivable by an employee of a company which has been set up less than 10 years ago, exempt?

No. The scheme is applicable to the employees who have completed 10 years of service with a company, so it will not be exempt.

Can such scheme only be drawn by loss making companies?

The guidelines require that the scheme should result in overall reduction in the existing strength of the employees of the company. Therefore, the Scheme can be drawn even by the profit making companies, but the company should be older than 10 years.

Whether income tax exemption of VRS is available when the amount payable is in addition to normal retirement benefits like PF., gratuity, pension etc. under the terms governing employment?

Yes. The provisions governing exemption of VRS are separate from the provisions which govern taxation of provident Fund, Gratuity, and Pension etc.

Whether any TDS has to be made from VRS amount?

No. If all specified conditions are satisfied the employer need not deduct the TDS from the VRS Amount.

Has there been any recent change in the VRS scheme?

Yes. The words “termination of his service” have been added to the word Voluntary retirement’ and in the case of a public sector company ‘a scheme of voluntary separation’ have been added.