Synopsis

You can claim full tax exemption on VRS if the scheme was launched under special framework; Know how it works for employees claiming VRS.

Recently there was a case in ITAT Chennai where Smt Govindarajulu who was a former employee of BSNL and who had opted for the BSNL VRS-2019 Scheme and received ex-gratia compensation upon separation from service paid tax on the money she received after claiming only Rs 5 lakh tax exemption. The issue is she could have got Section 10(10B) tax exemption on VRS but she mistakenly claimed only Rs 5 lakh.



While filing her income tax returns for AYs 2020-21 and 2021-22, she claimed exemption of only Rs 5 lakh under Section 10(10C), treating the payment as compensation received under a voluntary retirement scheme, and offered the balance ex-gratia amount to tax.



Subsequently, after she became aware of favourable judicial precedents holding that compensation received under the BSNL VRS-2019 Scheme was eligible for tax exemption under Section 10(10B), she filed appeals seeking exemption of the entire amount. Ultimately ITAT Chennai ruled in her favour and gave her relief. A similar ruling was also made by ITAT Chandigarh in another case between Harish Kumar vs ITO.

ITAT Chennai said that the BSNL VRS-2019 Scheme was introduced as part of the Government-approved revival package for BSNL and MTNL and was approved by the Union Cabinet on October 23, 2019. So the compensation payable under the scheme was funded through Government budgetary support.



Thus ITAT Chennai held that the BSNL-2019 VRS scheme was not merely an ordinary voluntary retirement scheme but had the characteristics of a Government-approved retrenchment compensation scheme. Accordingly, the ex-gratia compensation received under the scheme qualified for exemption under Section 10(10B) of the Income-tax Act, which grants tax exemption in respect of retrenchment compensation.



Chartered Accountant Suresh Surana says that Smt Govindarajulu succeeded because ITAT Chennai accepted the argument that the BSNL VRS-2019 compensation was, in substance, retrenchment compensation and not merely compensation under a conventional VRS.



However, the ruling should not be interpreted to mean that every compensation received by employees under any such Scheme is automatically exempt from tax.



Also read: Senior citizen mistakenly paid tax on tax-free VRS compensation; wins complete relief from ITAT Chennai on this ground



Read below to know how tax treatment of VRS is determined for govt and private sector employees.

How much tax exemption can govt and private sector employees claim for VRS

Surana says that the tax treatment of compensation received under a Voluntary Retirement Scheme (VRS) depends on the nature of the employer, the scheme under which the payment is made, and the specific tax exemption provisions of the Income-tax Act, 1961.



Under Section 10(10C) of the Income Tax Act, 1961 (corresponding to Section 19(1) Sl. No, 12, a tax exemption of up to Rs 5 lakh is available in respect of amounts received by an employee at the time of voluntary retirement or voluntary separation from a public sector company, any other company, an authority established under a Central or State Act, a local authority, a co-operative society, a university, an Indian Institute of Technology, a State Government, the Central Government, or notified institutions. This Rs 5 lakh tax exemption for VRS is subject to the VRS scheme satisfying the conditions prescribed under Rule 2BA of the Income-tax Rules, 1962 (corresponding to Section 19(2)(h) of the Income Tax Act, 2025).



The exemption can be claimed only once during the employee's lifetime, and any amount exceeding Rs 5 lakh is generally taxable under the heads of income "Salaries."



In the case of Government as well as private-sector employees, therefore, the general rule is that VRS compensation is eligible for exemption under Section 10(10C), subject to fulfilment of the prescribed conditions.



Surana says: “However, where the payment is characterised not as voluntary retirement compensation but as retrenchment compensation, exemption may instead be available under Section 10(10B), which provides exemption in respect of retrenchment compensation received under the Industrial Disputes Act, 1947, or any other law, to the extent prescribed therein.”



Section 10(10B) of the Income-tax Act 1961 provides an exemption in respect of retrenchment compensation received by a workman. The exemption is available up to the least of the following amounts:

• The amount of compensation calculated in accordance with Section 25F(b) of the Industrial Disputes Act, 1947
• Rs 5,00,000 (the amount notified by the Central Government); or
• The actual retrenchment compensation received.

The Central Government has notified Rs 5 lakh as the monetary ceiling for retrenchments taking place on or after 1 January 1997 through Notification No. 10969 [F. No. 200/21/97-IT(A-I)], dated 25 June 1999. Therefore, under the 1961 Act, the ordinary exemption is the lowest of the actual compensation, the statutory service-based amount and Rs 5 lakh.



Under the Income-tax Act, 2025, the corresponding benefit is provided as a deduction under section 19(1), Table, Sl No. 10. The deduction is the minimum of:

• the compensation received;
• the amount calculated under section 25F(b) of the Industrial Disputes Act, 1947; and
• such amount, not being less than Rs. 50,000, as may be notified by the Central Government.

The reference to Rs 50,000 does not prescribe Rs 50,000 as the exemption ceiling. It merely provides that the amount notified by the Central Government cannot be lower than Rs. 50,000. The existing notification prescribing a ceiling of Rs 5 lakh continues to remain relevant under section 536(2)(j) of the Income-tax Act, 2025, which preserves notifications issued under the corresponding provisions of the repealed 1961 Act, provided they are not inconsistent with the new Act. Accordingly, unless a fresh notification changes the amount, the applicable monetary ceiling continues to be Rs 5 lakh under section 19 as well.

What are the key tests to determine whether a scheme is a VRS or a retrenchment scheme?

The distinction between a VRS and a retrenchment scheme depends primarily on the nature, purpose and legal framework governing the separation from employment.



Surana says that a key test is whether the employee has voluntarily opted to separate from service under a scheme formulated by the employer. If the separation is at the employee’s option and the scheme satisfies the conditions prescribed under Section 10(10C) of the Income Tax Act, 1961 read with Rule 2BA of the Income-tax Rules, 1962, the payment is generally regarded as VRS compensation.



On the other hand, retrenchment typically involves termination of service by the employer for reasons which may include redundancy, restructuring or reduction in workforce, and is generally governed by the provisions of the Industrial Disputes Act, 1947.



In such cases, Surana says that the employee does not voluntarily seek separation; rather, the employment is terminated by the employer, subject to statutory safeguards and compensation requirements. Compensation received in such circumstances may qualify for exemption under Section 10(10B), subject to the prescribed limits and conditions.



Therefore, the principal tests include:

• (i) whether the separation is voluntary or employer-driven;
• (ii)whether the scheme complies with the conditions prescribed under Rule 2BA for VRS;
• (iii)whether the payment is made following a workforce reduction/retrenchment exercise under labour laws; and
• (iv) the terms and documentation governing the employee’s exit.

Can an employee claim both Sections 10(10B) and 10(10C), or must one exclude the other?

An employee cannot generally claim exemption under both Section 10(10B) and Section 10(10C) in respect of the same compensation amount, as the two provisions apply to different types of payments.



Surana says that Section 10(10B) provides exemption for retrenchment compensation received by a workman in accordance with the Industrial Disputes Act, 1947 or any other applicable law, subject to the prescribed limits.



On the other hand, Section 10(10C) grants exemption in respect of amounts received under an approved Voluntary Retirement Scheme (VRS) or voluntary separation scheme, subject to the specified conditions and a monetary ceiling of Rs 5 lakh.

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