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Severance pay is given as compensation to the employees at the time of lay off (termination of service) or on account of voluntarily retirement. This helps in bridging the gap between one job and the next. But how is it taxed? Check here
A large number of employees have recently received the pink slip from big tech companies such as Meta, Google, Amazon, startups, and so on. They have been fired reportedly on grounds of commercial shutdowns, mass layoffs, and business re-establishments. Usually, ex-employees receive a severance pay at the time of such layoffs. However, many are not aware that severance pay is taxable.
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Why is severance pay given?
Severance pay is given as compensation to the employees at the time of lay off (termination of service) or on account of voluntarily retirement. This helps in bridging the gap between one job and the next.
On average, severance-paying organisations provide terminated employees between one and two weeks' pay for each year of service.
How is it taxable?
Such amount received is taxable in the hands of the employee as a part of salary income under the provisions of Section 17(3)(i) of the Income-tax Act 1961 (the Act), said Sandeep Sehgal, Partner-Tax, AKM Global while talking to CNBC-TV18.com.
“Further, when the payment of the severance package is made to the employee by a third party, then such income is taxable as income from other sources under the provisions of Section 56(xi) of the Act,” he explained.
What are the exemptions available?
Certain exemptions are provided by the Act subject to prescribed limits and conditions.
Exemption under Section 10(10C) for Voluntary Retirement Scheme (VRS) and Termination
Exemption is available to employee up to a maximum limit of Rs 5 lakh under VRS or termination of employment.
“However, such exemption shall be subject to certain guidelines prescribed under Rule 2BA of the Income Tax Rules, 1962 such as the employee has completed 10 years of service or completed 40 years of age. The retiring employee of a company shall not be employed in another company or concern belonging to the same management etc,” Sehgal told CNBCTV-18.com.
Exemption under Section 10(10B) for Retrenchment of the Employee
Any compensation received by the employee under the Industrial Disputes Act, 1947 shall be eligible for the exemption restricted to lower of the amount received, the amount specified in the Industrial Disputes Act, 1947, and the amount specified by the government i.e., INR 5,00,000.
Relief under Section 89 of the Act for arrears and advances with respect to salary
Salary received in arrears or advance or profit in lieu of salary would be eligible for the relief under Section 89 of the Act. Such relief shall be in line with conditions prescribed in Rule 21A of the Income-tax Rules 1962 such as employee should have provided continuous service for at least 3 years and the unexpired portion of the term of employment should not be less than 3 years, Sehgal said.
Further, in case the employee seeks the exemption of Section 10(10C) then such an employee would also be ineligible to seek the benefit of section 89.