How to calculate tax on voluntary retirement scheme or VRS

Voluntary retirement scheme or VRS is a technique used by organizations to reduce their existing workforce. Its applies to all employees who have completed 10 years of service or is above 40 years of age. VRS is generally used as an alternative to retrenchment process, which involved lots of legalities and complex procedures.

In general voluntary retirement scheme is used under the following circumstances;

  • Recession
  • Takeover or merger of the organisation
  • Reducing workforce due to intense competition

Amount received under Voluntary retirement scheme or VRS compensation falls within the meaning of profits in lieu of salary under section 17(3) of the income tax act, 1961. Therefore, it should always be taxable under the head income from salaries.

Exemption Limit for voluntary retirement scheme

As per section 10(10C) of the income tax act, 1961 amount received on voluntary retirement is exempted up to Rs 5,00,000. Balance amount left out after taking out the exempted amount will be taxable under the head salaries.

This means, as per section 10(10C), least of the following is exempted from VRS compensation.

  • Actual VRS compensation received
  • Rs 5,00,000

To whom exemption on VRS compensation is applicable

Exemption is applicable for the employees of;

  • A public sector company or any other company.
  • Any authority established under a state, central or provincial act.
  • A local authority.
  • Co-operative society.
  • University
  • Indian institute of technology
  • State government
  • Central government
  • Notified institute of management, i.e. IIMs at ahmedabad, lucknow, bangalore, calcutta and IIFT.
  • Notified institutes, having important throughout india or in any state or states.

Additional conditions to be satisfied to get exemption

Exemption under section 10(10C) is available only when conditions to rule 2BA of income tax rules 1962 are satisfied. Here are certain additional conditions to be satisfied as per the rules and section 10(10C) in addition to all the conditions discussed in this article;

  • Voluntary Retirement Scheme should be applicable to all employees except directors of the company.
  • The recipient has completed 10 years of service or 40 years of age.
  • VRS shall result in overall reduction of the organisation’s workforce.
  • The vacancy caused by Voluntary Retirement Scheme or VRS is not to be filled up.
  • Retired employee should not be employed in another company or concern belonging to the same management.
  • Compensation shall not exceed the higher of the following two;
    • Last drawn salary * 3 * number of fully completed years of service
    • Last drawn salary * balance number of months of salary left

As per the second proviso to section 10(10C) of the income tax act 1961, if you have claimed exemption in one previous year, then no exemption will be available thereafter in relation to VRS under section 10(10C). This means, exemption under section 10(10C) can be claimed once in employee’s lifetime if he/she has received any amount on voluntary retirement.

Exemption under section 10 (10C) shall not be allowed to the employee if relief under section 89(1) has been claimed in respect of VRS compensation . This means employees can either take benefits of exemption under section 10(10C) or relief under section 89(1).

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.