Profits in Lieu of Salary – Section 17(3)
Retired with ₹15 lakh gratuity - full taxable? Encashed 30 days leave - all taxed? Not necessarily! Section 17(3) covers retirement benefits with special exemptions. Let's understand what's taxable and what's exempt.
What is "Profits in Lieu of Salary"?
Section 17(3): Payments received in lieu of (in place of) or in addition to salary
Key concept: Payments on termination/retirement or change in employment conditions
"In lieu" means: Instead of or because of employment ending
Items Covered under Section 17(3)
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1. Gratuity (Section 10(10))
Payment for past services on retirement/resignation
Exemption:
Government employees: Fully exempt
Private sector (covered under Payment of Gratuity Act): Least of:
- Actual gratuity received
- ₹20 lakh (increased from ₹10L in 2016)
- 15/26 × Last salary × Years of service
Not covered under Act: Least of:
- Actual gratuity
- ₹20 lakh
- Half month's salary × Years of service
Salary for calculation: Basic + DA (retirement benefits)
Example 1 - Covered under Act
Mr. Sharma (Private sector, 30 years service):
- Last drawn salary: ₹80,000/month (Basic + DA)
- Years of service: 30
- Gratuity received: ₹18,00,000
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Example 2 - Not Covered under Act
Mrs. Kapoor (worked 25 years):
- Last salary: ₹1,00,000/month
- Service: 25 years
- Gratuity: ₹15,00,000
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2. Leave Encashment (Section 10(10AA))
Payment for unutilized earned leave
During employment: Fully taxable
On retirement: Exemption available
Government: Fully exempt
Private sector: Least of:
- Actual leave encashment received
- ₹3,00,000
- Cash equivalent of unavailed leave (max 30 days per year)
- 10 months' average salary
Salary: Average of last 10 months (Basic + DA)
Example - Leave Encashment on Retirement
Mr. Verma (30 years service):
- Leave balance: 180 days
- Salary (last 10 months avg): ₹70,000/month
- Leave encashment received: ₹5,00,000
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₹3 lakh limit is the practical ceiling for most cases!
3. Commuted Pension (Section 10(10A))
Lump sum pension received instead of monthly pension
Government employees: Fully exempt
Private employees:
A. If receive gratuity:
- 1/2 of commuted value exempt
- Balance taxable
B. If don't receive gratuity:
- 1/3rd of total pension commuted value exempt
- Balance taxable
Example 1 - With Gratuity
Commuted pension: ₹10,00,000
- Exempt: ₹5,00,000 (1/2)
- Taxable: ₹5,00,000
Example 2 - Without Gratuity
Commuted pension: ₹12,00,000
- Exempt: ₹4,00,000 (1/3rd)
- Taxable: ₹8,00,000
4. Retrenchment Compensation (Section 10(10B))
Compensation for job loss (involuntary termination)
Exemption: Least of:
- Actual compensation
- ₹5,00,000
- Compensation under Industrial Disputes Act formula
Formula: 15 days' average salary × Years of service
Example
Job lost after 20 years:
- Compensation: ₹8,00,000
- Salary: ₹60,000/month
- Formula: (₹60k/26) × 15 days × 20 years = ₹6,92,308
Exempt: ₹5,00,000 (limit!) Taxable: ₹3,00,000
5. Voluntary Retirement (VRS) - Section 10(10C)
Voluntary retirement compensation
Exemption: ₹5,00,000 (flat)
Conditions:
- Company must have VRS scheme approved
- Employee voluntarily opts
- Can avail once in lifetime
Example:
VRS compensation: ₹12,00,000
- Exempt: ₹5,00,000
- Taxable: ₹7,00,000
6. Payment from Unrecognized Provident Fund
Employer's contribution to non-government recognized PF
Exemption at time of payment: Interest component taxable
Employer contribution + Interest: Taxable under Section 17(3)
Comparison of Retirement Benefits
| Benefit | Government | Private (Covered) | Private (Not Covered) |
|---|---|---|---|
| Gratuity | Fully exempt | Min of (Actual, ₹20L, formula) | Min of (Actual, ₹20L, half-month formula) |
| Leave encashment | Fully exempt | Min of (Actual, ₹3L, leave, 10 months) | Min of (Actual, ₹3L, leave, 10 months) |
| Commuted pension | Fully exempt | 50% OR 33% (with/without gratuity) | 50% OR 33% |
Complete Retirement Example
Mr. Joshi retires after 35 years (private sector):
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Total retirement benefits: ₹33 lakh Exempt: ₹23 lakh Taxable: ₹10 lakh (added to salary income for the year)
Key Points Summary
✅ Gratuity: ₹20L max exempt (formula-based for private)
✅ Leave encashment: ₹3L max exempt on retirement
✅ Commuted pension: 50% or 33% exempt (depends on gratuity receipt)
✅ VRS: ₹5L exempt (once in lifetime)
✅ Retrenchment: ₹5L max exempt
✅ Government employees: Most retirement benefits fully exempt!
Summary
- Section 17(3): Profits in lieu of salary - payments on retirement/termination in place of or addition to salary
- Gratuity: Private sector exempt up to ₹20 lakh (15/26 × salary × years formula), govt fully exempt
- Leave encashment: Retirement ₹3 lakh max exempt, during employment fully taxable
- Commuted pension: Govt exempt, private 50% exempt (with gratuity) or 33% (without gratuity)
- Retrenchment compensation: ₹5 lakh max exempt
- VRS: ₹5 lakh exempt (once in lifetime)
- During employment: Leave encashment, bonuses fully taxable
- Govt vs Private: Govt employees get full exemption on most retirement benefits
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