Retirement Benefits: Gratuity, Leave Salary and Pension
by Retirement Benefits are payments or benefits provided to an employee on retirement, resignation, termination or completion of service. They provide financial support to employees after their employment ends. Under Indian Income Tax law, important retirement benefits include gratuity, leave salary and pension. The tax treatment of these benefits depends on the nature of employment, the circumstances in which the payment is received and the applicable statutory provisions. Some retirement benefits may be fully exempt, while others may receive exemption subject to specified conditions and limits. Understanding the tax treatment of retirement benefits is important for correctly determining an employee’s taxable salary income and the amount of exemption available under the Income Tax law.
1. Gratuity
Gratuity is a retirement benefit paid by an employer to an employee as a reward for long and continuous service. It is generally received on retirement, resignation, termination or on certain other specified events. The tax treatment of gratuity depends upon whether the employee is covered by the Payment of Gratuity Act, 1972 and the nature of employment.
For employees covered by the Payment of Gratuity Act, exemption is available subject to the prescribed conditions and statutory limits. The exempt amount is generally based on the prescribed formula involving the employee’s last drawn salary and completed years of service, subject to the applicable overall limit.
For employees not covered by the Act, exemption is calculated using the prescribed formula based on salary and completed years of service, subject to the applicable monetary ceiling.
In the case of Government employees, gratuity received under the applicable rules is generally exempt, subject to the conditions of the Income Tax law. Any amount of gratuity that does not qualify for exemption is included in taxable salary.
2. Leave Salary
Leave salary, also known as leave encashment, is the amount received by an employee for unutilised leave accumulated during the period of employment. It may be received during service or at the time of retirement, resignation or termination.
Under the Income Tax law, the tax treatment depends upon the nature of employment and the time of receipt. Leave encashment received by a Government employee at the time of retirement is generally fully exempt, subject to applicable provisions.
For a non Government employee, exemption is available subject to prescribed conditions and the applicable monetary limit. The exemption is generally determined by considering specified factors such as average salary, unutilised earned leave and the period of service.
Leave encashment received while the employee is still in service is generally taxable. The amount qualifying for exemption is excluded from taxable salary, while the balance amount is taxable under the head Salaries.
3. Pension
Pension is a regular payment received by an employee after retirement as a benefit for past services. It may be received as a periodical pension or converted partly into a lump sum, known as commuted pension.
Periodical or uncommuted pension is generally taxable under the head Salaries in the hands of the employee. The tax treatment of commuted pension differs according to the nature of employment.
For a Government employee, commuted pension received in accordance with the applicable rules is generally fully exempt. For other employees, the exemption depends on whether the employee receives gratuity and is subject to the prescribed conditions.
A family pension received by the family of a deceased employee is generally taxable under the head Income from Other Sources, subject to the deductions and exemptions permitted under the Income Tax law. Thus, the form and recipient of pension are important for determining its tax treatment.