When PSUs, banks, and large companies offer Voluntary Retirement Scheme (VRS) packages to reduce headcount, the compensation can run into tens of lakhs - but only the first Rs 5 lakh is tax-free, and even that exemption comes with strict eligibility conditions that many employees overlook.
What is VRS Compensation?
A Voluntary Retirement Scheme (VRS), sometimes called a 'golden handshake', is an offer by an employer for employees to retire early in exchange for a lump-sum compensation package, typically calculated based on years of remaining service or a multiple of salary. VRS has historically been used by public sector banks, PSUs, and large private companies during restructuring.
Section 10(10C): The Rs 5 Lakh Exemption
Section 10(10C) of the Income Tax Act exempts VRS compensation up to a maximum of Rs 5,00,000 from tax, once in a lifetime - meaning if you've claimed this exemption for a VRS payout from one employer, you cannot claim it again for a VRS payout from a subsequent employer.
| Particulars | Details |
|---|
| Maximum exemption | Rs 5,00,000 (one-time, lifetime limit across all employers) |
| Amount above Rs 5 lakh | Fully taxable as 'Salary' income (specifically, 'Profits in lieu of salary' under Section 17(3)) |
| Eligibility conditions | Must satisfy conditions prescribed under Rule 2BA of the Income Tax Rules |
| Applicable to | Employees of authorities established under central/state Acts, public sector companies, universities, IITs/IIMs, local authorities, cooperative societies, and certain notified companies |
Rule 2BA: Conditions for Exemption
To qualify for the Section 10(10C) exemption, the VRS scheme must satisfy conditions laid down in Rule 2BA, which include:
- The scheme applies to employees who have completed 10 years of service or 40 years of age
- The scheme applies uniformly to all employees of a category, regardless of designation
- The retiring employee will not be subsequently employed in another company or concern belonging to the same management
- The amount receivable does not exceed the equivalent of: (a) 3 months' salary for each completed year of service, or (b) salary at the time of retirement multiplied by the balance months of service left until normal retirement - whichever is less
Critical check: If the VRS scheme offered by your employer does not meet ALL the conditions under Rule 2BA - even if your employer calls it a 'VRS' - the Section 10(10C) exemption will be denied, and the entire compensation becomes taxable as salary. Employees should verify with HR/finance whether the scheme has been structured to comply with Rule 2BA before assuming the Rs 5 lakh exemption applies.
VRS vs Section 89 Relief
If the taxable portion of VRS compensation (the amount above Rs 5 lakh, or the entire amount if Rule 2BA conditions aren't met) pushes you into a higher tax bracket in the year of receipt due to the lump-sum nature of the payment, you may be eligible for relief under Section 89(1) using Form 10E. This relief spreads the tax impact by recalculating tax as if the compensation were received over multiple years, reducing the 'bunching' effect of a large one-time receipt.
Important: You cannot claim both the Section 10(10C) exemption AND Section 89 relief on the same VRS amount for the portion that's exempt. Section 89 relief, where applicable, applies only to the taxable portion of the compensation (above Rs 5 lakh, or the full amount if 10(10C) doesn't apply).
Bank VRS Schemes (2000, 2010, 2020)
Public sector banks have periodically offered VRS schemes to employees - notable ones included schemes around 2000, 2010, and a larger one in 2020 involving multiple PSU banks following mergers. Employees who opted for these schemes typically received compensation calculations based on the Rule 2BA formula (3 months' salary per year of service, or salary x remaining months to retirement, whichever is lower), with the first Rs 5 lakh exempt under Section 10(10C).
How to Report VRS Compensation in ITR
- Report the exempt portion (up to Rs 5 lakh, subject to Rule 2BA conditions) under the 'Exempt Income' schedule, citing Section 10(10C)
- Report the taxable portion under 'Income from Salary' as 'Profits in lieu of salary'
- If claiming Section 89 relief on the taxable portion, file Form 10E before submitting the ITR - the relief cannot be claimed without it
- Check Form 16 issued by the employer to see how they've already classified the exempt vs taxable portions
Frequently Asked Questions
How much of my VRS compensation is tax-free? ▼
Up to Rs 5,00,000 of VRS compensation is exempt under Section 10(10C), but this is a one-time, lifetime limit - if you've claimed it for a VRS payout from one employer, you cannot claim it again for a later VRS from another employer. Any amount above Rs 5 lakh is fully taxable as salary.
What is Rule 2BA and why does it matter for VRS exemption? ▼
Rule 2BA lays down the conditions a VRS scheme must satisfy for the Section 10(10C) exemption to apply - including minimum service/age criteria, uniform application to employee categories, and a cap on the compensation amount based on remaining service or years completed. If the scheme doesn't meet these conditions, the entire VRS compensation becomes taxable, even if your employer calls it a 'VRS'.
Can I claim Section 89 relief on my VRS compensation in addition to the Section 10(10C) exemption? ▼
You can claim both, but on different portions. Section 10(10C) exempts up to Rs 5 lakh. Section 89(1) relief (via Form 10E) can then be claimed on the remaining taxable portion of the VRS compensation to reduce the impact of receiving a large lump sum in one year.