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Income tax rules in regard to severance pay that laid off employees should know

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Income tax on severance pay: Pushing some of the biggest economies into a lockdown to curb the spread of the pandemic, layoffs are inevitable in the current work scenario. If one does end up losing their job, the company is liable to let them go with a severance package – taxable in nature. Amid mass layoff news coming in from the office of recruiters like Twitter, Amazon, Meta, Google, etc., it is important to know that the severance pay that a laid-off employee receives is not a tax-free income. However, there are certain conditions under Section 10(10C) that enables a laid-off employee to claim income tax exemption on severance payment. But, the income tax exemption can only be claimed in the assessment year the compensation is received.

Speaking on income tax rules in regard to severance pay, Aarti Raote, Partner at Deloitte India said, “As a general rule, severance pay would be liable to tax in the hands of the employee. However, the tax provisions give exemptions from taxation to employees up to certain limits for payments received under the Provisions of the Industrial Disputes Act as retrenchment compensation or VRS payments that qualify for section 10(10C). For this the employee needs to have these schemes framed as per the guidelines mentioned in those sections and meetings conditions mentioned therein.”

Explaining the income tax rules in regard to severance pay, Vinit Khandare, CEO and Founder at MyFundBazaar said, “No exemption can be claimed under this section for the same annual year or any other if relief under Section 89 has been taken by an employee for compensation of voluntary retirement or separation or termination of services. However, an employee may claim relief under section 89 if they are liable to pay tax in respect of compensation received on termination of employment.”

On income tax rules that enables a laid-off employee to claim exemption on severance payment, Archit Gupta, Founder & CEO at Clear said, “Any compensation received on voluntary retirement or separation is exempt from tax as per the Section 10(10C).” However, Archit Gupta of Clear said that the following conditions must be fulfilled:

1] Compensation received is towards voluntary retirement or separation;

2] Maximum compensation received does not exceed 5 lakh;

3] 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 notified institute of importance throughout India or any state, PSU, company or a cooperative society; and

4] The receipts are in compliance with Rule 2BA.

No exemption can be claimed under this section for the same AY or any other if relief under Section 89 has been taken by an employee for compensation of voluntary retirement or separation or termination of services.

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