Taxability of Retrenchment Compensation

“Retrenchment” means termination by the employer of service of a work man for any reason other than as a punishment inflicted by a disciplinary action. There are times when an organization or a company is forced to close down its operations due to various reasons such as – lack of sufficient funds to continue the operation in its existing shape and form, death of the proprietor, inability to survive in the competitive environment and many more reasons. In such cases the “Indian Industrial Dispute Act of 1947”, stipulates that the workers who have been working in such organization are adequately compensated to take care of their immediate future. This is where “retrenchment” of workers comes into picture.

Retrenchment compensation received by a workman under the “Indian Industrial Dispute Act of 1947” or any other Act or Rules is exempt subject to the following limits:

    • an amount calculated in accordance with the provisions of Section 25F(b) of the “Indian Industrial Dispute Act of 1947”; or
    • Such amount, not being less than Rs. 5,00,000/- as the Central Government may specify in this behalf.
    • The amount received whichever is the least.

In simple terms all the amounts upto Rs. 5Lacs received as retrenchment compensation is fully exempt from Income Tax of India. The said limit of the tax exempt amount may be relaxed by the Central Government in case where the workers deserve special protection.

How to calculate amount under Section 25F(b) of the “Indian Industrial Dispute Act of 1947”?

Section 25F(b) of “Indian Industrial Dispute Act of 1947” provides for payment of retrenchment compensation equivalent to 15 days average pay for every completed year of continuous service or any part thereof in excess of six months.

For this purpose, average pay will be calculated as under:

    • if the workman is getting monthly salary, then on the basis of the salary of last three calendar months; or
    • if the workman is getting weekly wages, then on the basis of wages of last four completed weeks; or
    • if the workman is getting daily wages, then on the basis of wages of last twelve full working days.

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