Tax on Retrenchment Compensation — Section 10(10B), VRS & Section 89(1) Relief

Updated: 3 June 2026 | Income-tax Act, 2025 (Section 10(10B) / 10(10C)) | Verified against CBDT circulars

Retrenchment compensation received by a workman is exempt under Section 10(10B) up to the lowest of: (a) ₹5,00,000, (b) compensation calculated under the Industrial Disputes Act 1947 formula (15 days' salary × years of service ÷ 26), or (c) actual compensation received. Any amount above the exemption is taxable as salary income. Section 89(1) relief can spread the tax burden — but Form 10E must be filed on the income tax portal before the ITR, or the relief is disallowed.

₹5,00,000

Maximum lifetime exemption under Section 10(10B) for retrenchment compensation
Same ₹5L cap applies to VRS under Section 10(10C). Both exemptions are mutually exclusive — only one can be claimed in a lifetime.

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File Form 10E before your ITR if claiming Section 89(1) relief on retrenchment compensation. Missing this step means the relief is rejected by CPC during ITR processing — even if you are otherwise eligible. Form 10E is available free at the income tax e-filing portal.

Section 10(10B) — Retrenchment Compensation Exemption

Section 10(10B) of the Income-tax Act (equivalent provision under the Income-tax Act, 2025) provides that retrenchment compensation received by a workman as defined under Section 2(s) of the Industrial Disputes Act, 1947 is exempt from income tax subject to the following conditions and limits:

EXEMPTION FORMULA

Three-Way Minimum Rule

Exempt amount = Minimum of:
(1) ₹5,00,000 (absolute ceiling as notified by the Central Government)
(2) 15 days' average pay × completed years of service ÷ 26 (ID Act formula; 26 = working days in a month)
(3) Actual retrenchment compensation received

Any amount exceeding the exemption limit is taxable under the head "Salaries" and the employer must deduct TDS accordingly.

ID ACT FORMULA EXAMPLE

Worked Example

Last drawn salary: ₹60,000/month → daily rate = ₹60,000 ÷ 26 = ₹2,307.69
15 days' pay = ₹2,307.69 × 15 = ₹34,615.38
Service: 8 years → ID Act formula = ₹34,615.38 × 8 = ₹2,76,923
Actual compensation received: ₹4,00,000
Exemption = Min(₹5,00,000, ₹2,76,923, ₹4,00,000) = ₹2,76,923
Taxable = ₹4,00,000 − ₹2,76,923 = ₹1,23,077 taxable as salary

VRS — Voluntary Retirement Scheme (Section 10(10C))

Where an employee voluntarily retires under a scheme that satisfies CBDT guidelines, the compensation received is exempt under Section 10(10C) subject to these conditions:

VRS EXEMPTION FORMULA

Section 10(10C) — Lower of Two Amounts

Exempt amount = Minimum of:
(1) ₹5,00,000 (absolute ceiling — lifetime limit)
(2) Lower of: (a) 3 months' salary × remaining months of service, or (b) last drawn salary × years of service

The VRS scheme must be framed in accordance with Rule 2BA of the Income Tax Rules — the employee must be aged 40+ or have completed 10+ years of service, and the vacated post should not be filled. Public sector companies, private sector companies, and co-operative societies are all eligible to offer CBDT-approved VRS.

IMPORTANT

Mutual Exclusivity of 10(10B) and 10(10C)

A person who has received exemption under Section 10(10C) (VRS) in any previous year is not eligible to claim Section 10(10B) (retrenchment) exemption in any subsequent year, and vice versa. The ₹5 lakh cap is effectively a combined lifetime cap across both sections — whichever you claim first uses up the pool.

Section 89(1) Relief — Spreading the Tax on Lump-Sum Receipt

When a large lump-sum payment (like retrenchment compensation) is received in one year, it may be taxed at a higher slab rate than if it had been received spread over the years to which it relates. Section 89(1) provides relief by computing tax as if the income had been received in the appropriate earlier years, effectively spreading the tax burden.

PROCEDURE

How to Claim Section 89(1) Relief

Step 1: Log in to the income tax e-filing portal (incometax.gov.in).
Step 2: Navigate to e-File → Income Tax Forms → File Income Tax Forms → Form 10E.
Step 3: Select Assessment Year and fill in the relevant schedule (Schedule A for arrears/advance salary; Schedule B for gratuity; Schedule D for compensation on termination).
Step 4: Submit Form 10E and obtain the acknowledgement.
Step 5: Only then file your ITR. Claim the Section 89(1) relief amount in your ITR under the Taxes Paid schedule.

Critical: If Form 10E is not filed before the ITR, the relief will be disallowed by CPC during processing. There is no provision to file Form 10E after the ITR has been processed.

Retrenchment & VRS — Tax Treatment at a Glance

Type	Section	Exemption Limit	Taxable Portion	89(1) Relief
Retrenchment Compensation	10(10B)	Min of ₹5L, ID Act formula, or actual — whichever is lowest	Excess taxable as Salary	Available (File Form 10E first)
VRS Compensation	10(10C)	Min of ₹5L or (3 months salary × remaining months OR salary × service years)	Excess taxable as Salary	Available (File Form 10E first)
Gratuity on Retrenchment	10(10)	Up to ₹20L for private sector (Payment of Gratuity Act employees)	Excess taxable as Salary	Available
Leave Encashment on Retrenchment	10(10AA)	Up to ₹25L for non-government employees (revised in Budget 2023)	Excess taxable as Salary	Available
Ex-Gratia / Golden Handshake	17(3)	Nil — fully taxable as profit in lieu of salary	Fully taxable as Salary	Available if lump-sum

Act mapping note: Section 10(10B) and 10(10C) under the Income Tax Act, 1961 correspond to equivalent exemption provisions in Chapter III (Incomes Not Included in Total Income) of the Income-tax Act, 2025. The Industrial Disputes Act, 1947 formula for retrenchment compensation remains the benchmark. CBDT has not changed the ₹5L ceiling via notification since 2001 — verify if any Budget changes apply for the relevant Tax Year.

Frequently Asked Questions

Is tax treatment different for layoff vs VRS (Voluntary Retirement Scheme)?

Yes, different sections apply. Involuntary retrenchment / layoff compensation is governed by Section 10(10B) — exempt up to ₹5,00,000 or compensation calculated under the Industrial Disputes Act (15 days × service years / 26), whichever is lower. VRS (Voluntary Retirement Scheme) compensation is governed by Section 10(10C) — exempt up to ₹5,00,000 (calculated as lower of 3 months' salary × remaining months of service, or salary × years of service). Both exemptions are mutually exclusive — if you receive both, only one exemption can be claimed in a lifetime. The excess over the exemption limit is taxable as salary income in both cases.

Can I claim Section 89(1) relief on retrenchment compensation?

Yes. Section 89(1) relief is available on retrenchment compensation if a large lump-sum amount pushes you into a higher tax bracket in the year of receipt than what you would have paid had the amount been spread over the preceding years. To claim this relief, you must file Form 10E on the income tax portal before filing your ITR. If Form 10E is not filed before the ITR, the relief will be disallowed even if you are otherwise eligible. The AO or CPC will compute the relief across the relevant previous years as per Rule 21A of the Income Tax Rules.

How is retrenchment compensation taxed when a company closes down?

Compensation received due to company closure is still treated as retrenchment compensation under the Industrial Disputes Act, 1947. The same Section 10(10B) exemption applies — exempt up to ₹5,00,000 or the ID Act formula amount, whichever is lower. The compensation is taxed as salary income above the exemption limit. If the employer deducts TDS on the taxable portion, the same will reflect in Form 26AS. The employee should disclose the full amount in the salary head in ITR, claim the Section 10(10B) exemption, and additionally claim Section 89(1) relief via Form 10E if applicable.

What happens to pension or gratuity received after retrenchment?

Gratuity received on retrenchment is taxed separately under Section 10(10) — not under Section 10(10B). Section 10(10) provides a separate gratuity exemption: for government employees, the full gratuity is exempt. For private sector employees covered under the Payment of Gratuity Act, exemption is the least of (a) actual gratuity received, (b) ₹20,00,000, or (c) 15 days' salary × years of service (calculated on last drawn salary). Pension received after retrenchment is taxed under the Salaries head as a continuing income. Each component — retrenchment compensation, gratuity, leave encashment — has a separate exemption and should be reported separately in ITR.

Does the ₹5 lakh exemption under Section 10(10B) apply to each employer or once in a lifetime?

The ₹5,00,000 exemption under Section 10(10B) is a lifetime exemption. If you claim the full ₹5 lakh exemption from one employer, you cannot claim it again from a subsequent employer. The same restriction applies to Section 10(10C) for VRS. If the exemption was partially claimed from a prior employer, only the remaining balance can be claimed later. The employer is required to obtain a declaration from the employee in this regard before granting the exemption. There is no restriction on the number of retrenchments — only on the cumulative exemption limit across a lifetime.

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