A number of multinational companies have recently announced mass layoffs, affecting thousands of employees. Some of the top companies like Twitter, Meta (erstwhile Facebook), Google and Amazon are compensating their employees while terminating their services to save on rising operational expenses. The idea behind making this payment is to ensure that the employees have enough to survive on before they get employed at any other place. But, is the severance pay taxable? Find out.
There are different kinds of severance pay depending on the nature of layoffs. For example, people employed by the government and Public Sector Undertakings (PSUs) are asked to voluntary retire under the Voluntary Retirement Scheme (VRS). These employees are given handsome severance pay that they can use to earn a regular pension or venture into a new business idea. Though one may argue that severance pay is also like an income, Section 10(10C) of the Income Tax Act, 1961 lays down severance pay up to a maximum of ₹5 lakh would be exempt from tax. This means that if an employee has received ₹15 lakh as severance pay, he or she would be paying taxes on ₹10,00,000 after deducting ₹5 lakh from the total severance pay received.
Suresh Sadagopan, MD & Principal Officer, Ladder7 Wealth Planners, says, “The claim to tax exemption is based on compliance to provisions of Rule 2BA under this Section. Here, it is applicable to employees who have completed 10 years of service or 40 years of age, if the position vacated by voluntary retirement or separation is not filled up and other conditions.”
Also, the taxability of the severance pay would be determined on the basis of the assessee’s employment tenure. Section 89 of the Income Tax Act, 1961 reads, “An employee who rendered continuous service for three years or more before termination of his employment and unexpired portion of his term of employment is three years or more is eligible to claim relief under section 89 of the IT Act read with Rule 21A of the IT Rules. The employer while making payment of severance payment will deduct TDS in accordance with the provision of Section 192 of the Act.”
What if employees are not under the payroll of the company they are working for? This happens with many big companies like Accenture and others that hire workers through a third-party source. The employees’ pay would then be taxed under the heading “Income from Other Sources” in the income tax returns (ITRs) filed and not under “Salaries” since the same does not stem from an “employer-employee” association.
Calculating tax on severance pay
Income from severance pay is treated like salaries and, thereby, would be taxed like one. This means that employees laid off would have to declare their severance pay that would then be taxed under the tax regulations. Also, it is the duty of the employer companies to deduct tax at source (TDS) before handing over the severance pay cheque to their employees.