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VRS (Voluntary Retirement Scheme) Taxation Under Income Tax Act 2025: Rs 5 Lakh Exemption

VRS compensation taxation under ITA 2025 — Rs 5 lakh lifetime exemption (Schedule II), eligibility (40 years/10 years service), CBDT guidelines, excess taxable at slab, VRS vs retr...

Vikas Sharma Tax & Compliance Expert

March 26, 2026 2 min read 216 views Updated Jul 5, 2026

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Key Highlights

VRS compensation: exempt up to Rs 5 lakh under Schedule II of ITA 2025
Applies to employees of: any company or authority (public sector, private sector, PSU)
Eligibility: Employee must be 40 years old OR completed 10 years of service
VRS scheme must be in accordance with CBDT guidelines
Excess over Rs 5 lakh: taxable as salary income at slab rate
No simultaneous claim: if VRS exemption is claimed, Section 157 rebate still applies

Legal Reference

Schedule II (VRS exemption up to Rs 5 lakh), ITA 2025 | CBDT Circular No. 236/1996 (VRS guidelines) | Corresponds to Section 10(10C) of ITA 1961

1. What is VRS?

Voluntary Retirement Scheme (VRS) is an early retirement package offered by employers to reduce workforce numbers. An employee voluntarily retires before reaching the mandatory retirement age in exchange for a lump sum compensation. VRS is sometimes called the "golden handshake." Both public sector and private sector organisations offer VRS packages.

2. VRS Exemption Under Schedule II

Under Schedule II of the Income Tax Act, 2025, VRS compensation is exempt from tax subject to the following conditions:

The employee must be aged 40 years or above, OR must have completed 10 years of service
The amount must be received under a VRS scheme that follows CBDT guidelines
The VRS scheme must not apply to a director of a company or an authority
The exemption is limited to Rs 5,00,000 per employee in a lifetime
If the employee has already claimed VRS exemption from a previous employer, the balance available is reduced accordingly (lifetime limit)

3. Exemption Calculation

Under CBDT guidelines, the VRS amount must not exceed the lower of:

Three months salary (Basic + DA) for each completed year of service
Remaining months salary from VRS date to normal retirement date

The tax exemption is the lower of the amount computed above or Rs 5 lakh — the excess is fully taxable as salary.

4. VRS Example

Illustrative only. Suresh takes VRS at age 52, having completed 28 years of service. Last drawn monthly Basic + DA = Rs 60,000. Normal retirement at 60 — 8 years remaining (96 months). VRS compensation received = Rs 20 lakh.

3 months × Rs 60,000 × 28 years = Rs 50,40,000
96 months × Rs 60,000 = Rs 57,60,000
Lower of above: Rs 50,40,000 — so Rs 20 lakh is within the permitted amount
Exemption = lower of Rs 20L or Rs 5L = Rs 5 lakh
Taxable VRS = Rs 20L − Rs 5L = Rs 15 lakh (taxed at slab rates)

5. VRS vs Retrenchment: Difference

Feature	VRS	Retrenchment Compensation
Nature	Voluntary early retirement	Involuntary termination
Tax exemption	Rs 5 lakh (Schedule II)	Rs 5 lakh or 15 days pay per year (Industrial Disputes Act)
Employee choice	Employee opts in	Employer-initiated

6. Why TaxClue

VRS taxation requires verifying eligibility, calculating exemption, and reporting excess compensation correctly in the ITR. TaxClue guides employees through VRS tax computation and files the ITR with maximum exemptions claimed. Contact us for VRS tax advisory under ITA 2025.

Disclaimer

This article is for general informational and educational purposes only. It does not constitute legal, financial, or professional tax advice. Readers are advised to consult a qualified Chartered Accountant or tax professional before making any decisions. TaxClue Consultech Pvt Ltd accepts no liability. All case studies and examples in this article are illustrative only and do not represent actual persons or transactions.

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Frequently Asked Questions

How much VRS is tax free?

Under Schedule II of the Income Tax Act, 2025, VRS compensation is exempt from income tax up to Rs 5,00,000. This is a lifetime limit — if you have previously claimed VRS exemption from another employer, the balance available is reduced. Any VRS compensation received above Rs 5 lakh is taxable as salary income at your applicable slab rates in the year of receipt.

What are the conditions for VRS tax exemption?

To claim the Rs 5 lakh VRS tax exemption under Schedule II of ITA 2025, the following conditions must be met: the employee must be at least 40 years of age OR have completed at least 10 years of service; the VRS scheme must be in accordance with CBDT guidelines; it must not apply to directors; and the compensation must not exceed the lower of 3 months salary per year of service or salary for remaining months to retirement. The exemption is a lifetime limit across all employers.

Is VRS available to private sector employees?

Yes. The VRS tax exemption under Schedule II of the Income Tax Act, 2025 applies to employees of any company, authority, co-operative society, or other body — including private sector, public sector, PSUs, and government companies. The conditions (age 40+/10 years service and CBDT-compliant scheme) must be met regardless of the employer type.

What happens to the VRS amount above Rs 5 lakh?

VRS compensation received in excess of the Rs 5 lakh exemption limit is fully taxable as salary income in the year of receipt at the employee applicable slab rate. The employer deducts TDS on the taxable portion at the time of VRS payment. The taxable portion must be reported in the ITR in Schedule S (Salary) along with all other salary income for that Tax Year.

Can VRS and gratuity exemptions both be claimed?

Yes. VRS exemption (up to Rs 5 lakh under Schedule II) and gratuity exemption (up to Rs 20 lakh under Schedule II) are separate provisions — each with their own limit. If an employee receives both gratuity and VRS compensation on voluntary retirement, both exemptions can be claimed independently. They are not clubbed or shared — the Rs 5 lakh VRS cap and the Rs 20 lakh gratuity cap apply separately.