The Hindu Business Line : Holding on to relief

SALARIES are taxable in the year in which they are due or are paid. Where salary is paid in arrears or in advance, or where a retirement benefit or salary for more than 12 months is received in any one financial year, the income for that year may be liable to assessment at a rate higher than that at which it would otherwise have been assessed.

In such cases, Section 89 of the Income-Tax Act, 1961 comes to the rescue of the salaried taxpayer and allows relief by spreading the amount over a three-year period. Encashment of leave by an employee on his retirement is exempt from tax to the extent provided in Section 10 (10AA). Such encashment while in service will enjoy relief under Section 89, which applies to payments made under Section 17(3) as `profit in lieu of salary'. Ex gratia compensation received by an assessee consequent to his resignation, or any payment made on the termination of his services by dismissal, compulsory retirement or on attaining superannuation would be covered by this Section.

Section 10(10C)

This Section was inserted by the Finance Act, 1997 with effect from April 1, 1987, and provides exemption for compensation of up to Rs 5 lakh received under the voluntary retirement scheme. The section applies both to public and private sector companies if the scheme is framed as per Rule 2BA.

The second proviso bars relief for the second year, and this means that the exemption can be claimed only once. This is to prevent misuse of the provision by employees who shift from one employer to another merely to get Section 10(10C) benefit.

If the compensation exceeds Rs 5 lakh, is it open to the employee to seek relief under Section 89? The Revenue has been contending that VRS compensation is a composite package and anything over Rs 5 lakh is nothing but ex gratia payment not entitled to relief under Section 89.

The legislative intent, it is argued, is to provide deduction from tax liability only for one assessment year, and giving relief under Section 89 by spreading the income over the earlier three assessment years with consequential tax relief; this is in addition to what is under Section 10(10C). The claim goes against the spirit of tax relief granted under Section 10(10C). It is also argued that Rule 21A does not provides for relief under Section 89 for ex gratia payments.

Armed with these arguments, the assessing officer (AO) initiated proceedings under Section 201 against Canara Bank for not deducting tax at source on VRS payment made in excess of Rs 5 lakh.

In CIT vs P. Surendra Prabhu (279 ITR 402), the Karnataka High Court went into this issue in-depth.

It held that `salary' as defined in Section 17(1) of the Act covered any kind of remuneration received by or due to an employee irrespective of whether the payment was received during the period or at the termination of employment.

Section 17(3) of the Act provides an inclusive definition of `profits in lieu of salary'. Termination from service would mean by way of compulsory retirement, voluntary retirement, resignation and superannuation.

In the Canara Bank case, the employee was not only entitled to the benefit of exemption under Section 10(10C) to the extent prescribed in the provision itself but also for any amount over and above the prescribed limit. He was also entitled to relief under Section 89 read with Rule 21A. The bank could not be treated as an assessee in default in granting relief under Section 89.

The Madras High Court held that the second proviso to Section 10(10C) only refers to exemption claimed in any other year. Every assessment year is a self-contained unit and the mere fact that relief under Section 89 had been spread over several years did not mean that the relief was not in respect of a particular assessment year.

There was no prohibition to the twin benefits in respect of the amount received under the VRS. The relief contemplated under Section 89 is aimed at mitigating hardship that may be caused on account of the high incidence of tax due to progressive increase in tax rates. Payment under VRS is covered by the word `salary' which has been given a wide definition in Section 17. Since the assesee was covered by Section 89, he would get both the benefits (CIT vs G.V. Venugopal 273 ITR 307).

At the same time, arrears of salary credited to provident fund cannot be spread over under Section 89 even if such additional salary received as arrears related to more than one previous year.

The additional salary relating to each such previous year will have to be ascertained and taxed in respect of such previous years (Kerala Electricity Officers Federation vs Central Board of Direct Taxes 279 ITR 482 Kerala). It is unfortunate that court rulings on Section 10(10C) vis-à-vis Section 89 have not been accepted by the Revenue. After all, the tax effect may not be large enough to warrant appeal to the Supreme Court.

(The author is a former Chief Commissioner of Income-Tax.)