How to calculate tax exemption on retrenchment compensation

Retrenchment compensation received by the workmen under the Industrial Disputes Act, 1947 or any other act, rules, notification, order, award, contract of service or otherwise is exempted under section 10(10B) of the Income tax act, 1961. In general, its paid by employer to employees when an undertaking is closed or employees are transferred due to agreement or compulsory acquisition.

Exemption on retrenchment compensation

As per section 10(10B) of the income tax act, 1961, least of the following is exempted:

• Actual retrenchment compensation received
• Rs 5,00,000
• 15 days average pay for every completed year of service or part thereof in excess of 6 months.

Retrenchment compensation received in excess of the aforesaid limit is taxable and would therefore be included in gross salary.

For the purpose of above exemption calculation, you need to understand how to calculate average pay.

Calculation of average pay

As the name suggests, average pay means the average of the last three months wages payable to a workman.

Average salary = (15/30) * average salary of last 3 months * number of completed years of service or part thereof in excess of 6 months

If the retrenchment compensation is received due to a scheme approved by the central government, the whole amount is exempted from tax.

Assessee can claim relief under section 89.

Illustration

Mr X received retrenchment compensation of Rs 15,00,000 after working for 32 years and 4 months with a private limited company. Average basic salary at the time of leaving the organization was Rs 30,000 and dearness allowance was Rs 5,000.

Computation:-

In addition to it you are also allowed exemption on pension, gratuity and on other retirement benefits.