Under Voluntary Retirement Scheme (VRS), an employee is offered to voluntarily retire from his services before his retirement falls due. It is an excellent method used by companies to reduce surplus staff. It is also known as the Golden Handshake. But it involves certain conditions, as mentioned below.
- The scheme is applied to all employees, including workers & executives of a concern, excluding directors of a company or a co-operative society.
- The recipient is an employee of an authority established under the central or state act, local authority, university, IIT, state government or central government, notified institute of management, or a notified institute with importance throughout India or any state, PSU, company or cooperative society and must have completed 10 years of service or 40 years of age (not applicable to employees of a PSU).
- The scheme shall result in overall reduction of the existing strength of the employees of the company.
- The vacancy caused by voluntary retirement is not to be filled up, and the retiring employee must not be employed in another company or concern belonging to the same management.
- As per the Income Tax Act, any compensation received upon voluntary retirement is exempt from tax up to least of the following:
- Actual amount received.
- Three months’ salary for every completed year of service.
- Salary for number of months remaining service [i.e. number of months to be counted from the month of voluntary retirement to the month of actual retirement]
- ₹5,00,000 (Maximum Limit)
- Here, Salary includes basic pay, dearness allowance (if it forms part of the retirement benefits) and percentage wise fixed commission on turnover or sales.
- Exemption when allowed for an assessment year, will not be allowed for any other assessment year.
- Where relief under section 89 has been taken by an employee for compensation for voluntary retirement or separation or termination of services – no exemption shall be available under this section for the same assessment year or any other assessment year.
Let us understand the tax treatment of the compensation received on voluntary retirement with the help of an example:
Mr. X aged 55 years has put in 17 years of service in ABC limited, voluntarily resigns from his job under the Voluntary Retirement Scheme. He has 5 years and 2 months of service left. His last drawn salary was ₹25,000, which includes basic pay, dearness allowance, forming part of the retirement benefits and commission on turnover or sales. He received ₹12,00,000 as compensation. Out of this amount, least of the following is exempt from tax:
- ₹12,00,000 (amount actually received)
- ₹12,75,000 (3*25000*17)
- ₹15,50,000 (5 years and 2 months i.e. 62 months*25000)
- ₹5,00,000 (Maximum Limit)
Therefore, out of the compensation received ₹5,00,000 will be exempt from tax and remaining ₹7,00,000 will be taxable.