Tax on Retrenchment Compensation —
Rs 5 Lakh Exempt u/s 10(10B)
How a layoff / retrenchment payout is taxed: the Section 10(10B) exemption, the Industrial Disputes Act formula, VRS under 10(10C), gratuity & leave encashment, and Section 89(1) relief via Form 10E.
Retrenchment compensation is exempt under Section 10(10B) up to the lowest of: (a) Rs 5,00,000, (b) the Industrial Disputes Act, 1947 formula (15 days’ average pay × completed years of service ÷ 26), or (c) actual compensation received. Anything above that is taxable under the head “Salaries”. A voluntary exit (VRS) is exempt separately under Section 10(10C), also capped at Rs 5 lakh. Where the lump sum bumps you into a higher slab, Section 89(1) relief spreads the tax — but Form 10E must be filed before the ITR or the relief is disallowed.
The Rs 5 lakh caps under 10(10B) and 10(10C) are lifetime ceilings. If you have already used the VRS exemption under 10(10C) in an earlier year, you cannot claim 10(10B) later, and vice versa — whichever you claim first uses up the pool. Gratuity, leave encashment and pension have their own separate exemptions.
Retrenchment & Exit Payouts — Tax Treatment
Every component of an exit package sits under a different section with its own exemption. All figures are for non-government employees for FY 2025-26. See the income-tax slabs for the rate that applies to the taxable portion.
| Payout | Section | Exemption limit | Taxable portion | 89(1) relief |
|---|---|---|---|---|
| Retrenchment / layoff compensation | 10(10B) | Rs 5,00,000 or ID Act formula, whichever lower | Excess as salary | Yes |
| VRS / voluntary retirement | 10(10C) | Rs 5,00,000 (lifetime) | Excess as salary | Yes |
| Gratuity | 10(10) | Rs 20,00,000 (non-govt) | Excess as salary | Yes |
| Leave encashment on exit | 10(10AA) | Rs 25,00,000 (non-govt) | Excess as salary | Yes |
| Ex-gratia / “golden handshake” | 17(3) | Nil — fully taxable | Fully taxable | If lump sum |
Government employees get fuller exemptions on gratuity and leave encashment. Rs 20L (gratuity) and Rs 25L (leave encashment, raised from Rs 3L in 2023) are the non-government ceilings.
The Rs 5 Lakh Retrenchment Exemption & ID Act Formula
Retrenchment compensation received by a workman (as defined in Section 2(s) of the Industrial Disputes Act, 1947) is exempt under Section 10(10B) up to the least of three amounts. The compensation over that limit is taxed as salary, and the employer deducts TDS accordingly.
- Rs 5,00,000 — the absolute ceiling notified by the Central Government
- 15 days’ average pay × completed years of service ÷ 26 — the ID Act, 1947 formula (26 = working days in a month)
- Actual retrenchment compensation received
Worked example on a Rs 4,00,000 payout after 8 years of service at Rs 60,000/month:
ID Act formula amount
Exempt vs taxable
Any amount labelled ex-gratia, severance top-up or golden handshake — over and above statutory retrenchment compensation — is fully taxable as profit in lieu of salary under Section 17(3). Only the compensation that qualifies as retrenchment under the ID Act enjoys the 10(10B) exemption.
VRS (Section 10(10C)) vs Retrenchment (10(10B))
A voluntary exit under an approved scheme is exempt under Section 10(10C), while an involuntary layoff is exempt under 10(10B). Both cap at Rs 5 lakh, and you can use only one of them in your lifetime.
Retrenchment — involuntary
- Layoff, closure or downsizing by employer
- Exempt up to lower of Rs 5L or ID Act formula
- Only for a “workman” under the ID Act
- Excess taxed as salary; 89(1) relief available
VRS — voluntary
- Employee opts out under an approved scheme
- Exempt up to Rs 5L (lifetime)
- Scheme must satisfy Rule 2BA (age 40+ or 10+ yrs service)
- Cannot also claim 10(10B) — one per lifetime
A person who has claimed the VRS exemption under 10(10C) in any previous year cannot claim the retrenchment exemption under 10(10B) in a later year, and vice versa. The Rs 5 lakh is effectively a single combined lifetime pool across the two sections.
Received both a VRS payout and gratuity? Get every exemption computed correctly.
Talk to a Tax Expert →Section 89(1) Relief on a Lump-Sum Payout
A large one-time payout can push you into a higher slab in the year of receipt. Section 89(1) re-computes the tax as if the income had been spread over the years it relates to, and refunds the difference. To claim it you must file Form 10E on the e-filing portal before filing your ITR.
- Employer retrenchment / VRS letter
- Compensation break-up (statutory vs ex-gratia)
- ID Act formula computation
- Gratuity & leave-encashment statements
- Form 26AS / AIS showing TDS
- Form 10E filed before ITR
- Section 89(1) relief entered in ITR
- Old vs new regime compared
If Form 10E is not filed before the ITR, CPC disallows the Section 89(1) relief during processing — even when you are otherwise fully eligible. There is no window to file Form 10E after the return is processed, so always submit it first.
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Get ITR Filing Help →Retrenchment Compensation Tax — Frequently Asked Questions
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