Section 18 of the Income-tax Act, 2025 defines profits in lieu of salary: compensation on termination or modification of employment terms, amounts received before joining or after leaving, and payments from an employer or a fund, including Keyman insurance sums.
What section 18 does
Section 18 catches the payments that are not salary in the ordinary sense but arise out of the employment relationship — severance, joining bonuses paid before employment starts, and money received after it ends. Under the 1961 Act this was section 17(3); the Income-tax Act, 2025 gives it a section of its own.
The reach is deliberately wide. Sub-section (1)(b) covers amounts received from any person before joining employment with that person or after cessation of employment with them, which is how sign-on payments and post-exit settlements are brought to tax under the salary head rather than escaping into the residuary head.
Sub-section (2) then carves out specific entries by pointing to the exemption Schedules, so the section and the exemption lists have to be read together.
The Income-tax Act, 2025 takes effect from 1 April 2026 and applies from tax year 2026-27. The Income-tax Act, 1961 continues to govern every year up to 31 March 2026, including assessments, appeals and penalties for those years, because of the repeal and savings provision in section 536. Figures quoted here are the amounts written into the Act as enacted (with the Gazette corrigenda of 3 September 2025); the annual Finance Act can change rates and thresholds.
Old Act and new Act, side by side
The table below shows what the Income-tax Act, 1961 did and where the same ground is covered in the Income-tax Act, 2025.
| Income-tax Act, 1961 | What it did | Income-tax Act, 2025 |
|---|---|---|
| 17(3) | Definition of profits in lieu of salary | 18 |
| 17(3)(i) | Termination or modification compensation | 18(1)(a) |
| 17(3)(ii) | Payments from employer or a fund, Keyman insurance | 18(1)(c) |
| 17(3)(iii) | Amounts before joining or after cessation | 18(1)(b) |
| 10(10B), 10(10C) | Retrenchment and voluntary retirement exclusions | Schedule entries read with section 19 |
Section 18 sub-section by sub-section
Read this alongside the bare text — each heading below is a sub-section of the section as enacted.
Sub-section (1)(a) — compensation on termination or change of terms
Any compensation due to or received by an employee from an employer or former employer, at or in connection with the termination of employment or the modification of its terms and conditions, is profits in lieu of salary. Both limbs matter: a payment for accepting a worse contract is caught just as a severance payment is.
Sub-section (1)(b) — money before joining and after leaving
Any amount due to or received by an assessee from any person, whether in a lump sum or otherwise, before joining employment with that person or after cessation of employment with them, is profits in lieu of salary. This is the clause that taxes joining bonuses paid in advance and settlements negotiated after an exit.
Sub-section (1)(c) — payments from an employer or a fund
Three categories are covered: payments from an employer or former employer; payments from a provident or other fund, but only to the extent they do not consist of the employee's own contributions or interest on them; and any sum received under a Keyman insurance policy as defined in Schedule II (Note 1), including bonus allocated on such a policy.
Sub-section (2) — the carve-outs
The payments referred to in sub-section (1)(c) do not include payments referred to in Schedule II (Table: serial numbers 3, 4 and 8) and Schedule III (Table: serial number 11). In other words, amounts that the exemption Schedules already take out of total income are not pulled back in as profits in lieu of salary.
Worked example
An employee is retrenched in tax year 2026-27 after eleven years of service and receives the following.
| Payment | Amount | Treatment |
|---|---|---|
| Severance compensation on termination | ₹12,00,000 | Profits in lieu of salary — section 18(1)(a) |
| Payment for accepting reduced notice period terms | ₹1,00,000 | Profits in lieu of salary — modification limb of section 18(1)(a) |
| Employer's share and interest from an unrecognised fund | ₹4,00,000 | Profits in lieu of salary — section 18(1)(c), employer portion only |
| Employee's own contributions returned from that fund | ₹3,00,000 | Not profits in lieu — expressly excluded by section 18(1)(c) |
| Sum received under a Keyman insurance policy | ₹5,00,000 | Profits in lieu of salary — section 18(1)(c) |
Profits in lieu of salary come to ₹22,00,000. The ₹3,00,000 representing the employee's own contributions is outside the clause. Against the severance element, the deduction for compensation received by a workman is available from the section 19 table, and where the amounts relate to earlier years, relief under section 157 should be examined.
Compliance checklist and due dates
- Split any fund payout between the employee's own contributions (outside section 18) and the employer's contribution plus interest on it (inside section 18).
- Check Schedule II serial numbers 3, 4 and 8 and Schedule III serial number 11 before treating a fund receipt as taxable.
- For retrenchment and voluntary retirement, claim the deductions available in the section 19 table rather than assuming a blanket exemption.
- Where a severance package spans more than one year of service, evaluate relief under section 157.
- Employers must deduct tax on these payments under section 392.
Common mistakes
- Treating a joining bonus received before employment starts as a casual receipt. Section 18(1)(b) puts it in the salary head.
- Taxing the entire fund payout, including the employee's own contributions, which the clause expressly excludes.
- Assuming voluntary retirement receipts are wholly exempt. The deduction has a ceiling in the section 19 table.
- Overlooking the modification limb — compensation for a change in employment terms is caught even where employment continues.
This is an explanatory guide, not tax advice, and it does not reproduce the section in full. Read the bare text of the section before you rely on it, and check for later amendments, the Income-tax Rules made under the new Act, and CBDT circulars and notifications.