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Is it worth taking voluntary retirement?

A N Shanbhag

Is it worth taking voluntary retirement? The government has formulated tax rules for voluntary retirement schemes under Section 10(10C) of the Income Tax Act, which offers tax exemption up to Rs 5 lakh (Rs 500,000) if the scheme has the following structure.

Structure of VRS

The scheme - as it stands today - must be open only to companies, local authorities, co-operative societies, universities and the IITs. Any VRS must be in accordance with the following six requirements, laid down by rule 2BA. These are:

i) It applies to an employee who has completed 10 years of service or completed 40 years of age.

ii) It should apply to all employees (by whatever name called), including workers and executives of a company or of an authority or of a cooperative society excepting directors of a company or of a cooperative society.

iii) It has to result in overall reduction in the existing strength of the employees.

iv) The vacancy caused by the voluntary retirement is not to be filled up.

v) The retiring employee shall not be employed in another company or concern belonging to the same management.

vi) The amount receivable on account of voluntary retirement of the employee does not exceed the amount equivalent to three months' salary for each completed year of service, or salary at the time of retirement multiplied by the balance months of service left before the date of retirement on superannuation of the employee. It is the last salary drawn which is to form the basis for computing the amount of payment.

Note that the phrase, 'whichever is lower' (or higher) is absent.

People who accept VRS face two problems. One, saving tax on VRS and, two, investing the rest of the money earning the highest after-tax income.

Taxation

Compensation up to Rs 5 lakh is tax free but any amount over that is fully taxable, even if received in subsequent years and even if received by way of LIC annuity or a company pension plan.

Moreover, a person taking VRS may suddenly find that his normal salary earned up to the retirement, when added to the taxable portion of VRS makes his income under the head 'salaries' over Rs 5 lakh and, therefore, he is not eligible for standard deduction. Also, he is not eligible for the rebate under Section 88.

Is there any chance of saving this tax?

Solution-1: I have a suggestion which may (or may not) be acceptable to the department.

I rely on Gillanders Arbuthnot & Co Ltd Vs CIT [1964] 53 ITR 283 (SC), which laid down that any compensation received by an assessee for agreeing to refrain from carrying on a competitive business in respect of which an agency was terminated, or for loss of goodwill will prima facie be of the nature of a capital receipt and will not be taxed.

Could we apply the same rationale and say that if the employer offers a pension on the condition that the employee should not take employment with a competitor, the pension should not be taxed at all?

Solution-2: The following case, decided on March 10, 2001, is very interesting - 250ITR30 (Cal), 2001 Sail-DSP VR Employee's Association Vs Union of India - the VRS scheme consisted of part payment of lump sum and the rest in monthly payments.

The employees contended that standard deduction should be allowed on such monthly payments and subjected to tax annually as salary. The judge ruled for the employees.

The judge observed: "The privilege and/or right which has been given under Section 10(10C) of the Act cannot be termed to be an embargo or prohibition so as to render the contractual terms to be invalid and illegal and for which, such term is liable to be struck down. The payment has been received by each of the employees by way of monthly payment and in lieu of salary. The department and the concerned company are perfectly justified in deducting and/or releasing the taxes after giving due standard deduction."

In view of the above judgement, the employee can also claim relief under Section 89(1) and pay tax at the average rate over the years.

How and where to invest

Tax on normal income is levied at the rate of 10 per cent, 20 per cent or 30 per cent depending upon the assessee's income.

On the other hand, long-term capital gains are taxed at 10 per cent without indexation (or 20 per cent with indexation). Therefore, it makes sense to earn income through long-term capital gains for three reasons:

* Assume that the corpus grows at the rate of 9 per cent every year. You would like to strip only the growth leaving the corpus intact. Therefore, the tax will be 10 per cent of 9 per cent (= 0.9 per cent). Let me elaborate.

Suppose, the VRS take home corpus is Rs 10 lakh (Rs 1 million) and it grows by Rs 90,000. You withdraw Rs 90,000 after 366 days.

The capital gains portion of Rs 90,000 is only Rs 7,431. The tax at the rate of 10 per cent thereon is only Rs 743. In other words, you have Rs 90,000 for your day-to-day expenses. But the tax thereon is only Rs 743.

As I said earlier, it makes sense to pay tax at a little less than 1 per cent than at 10 per cent, 20 per cent, 30 per cent, as the case may be. It is obvious that even short-term will do for our purpose.

* Moreover, in most cases, after the VRS, the steady flow of salary income stops and the basic threshold of Rs 50,000 for levy of tax remains vacant.

Where the liability to tax arises in the case of individuals or HUFs only because of the inclusion of long-term capital gains in the total income, tax will be levied at the corresponding flat rates on the excess over the minimum taxable limit.

* Even this small tax can be saved by contributing the capital gains portion of the withdrawals to avenues under Section 54EC like Nabard (or the new NHB bonds).

The best parking place

Have a good look at pure-growth, open-ended, debt-based schemes of UTI/mutual funds.

* Being pure-growth, these are tax efficient and you can earn as much take-home (= tax-free) income as Rs 5 lakh on a corpus of Rs 50 lakh (Rs 5 million).

* Being debt-based, the safety of the capital as well as the income (around 10 per cent + at this juncture) is implicitly certain but not explicitly assured.

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