TCS layoffs: The big severance, and the bigger tax surprise

TCS: How is severance package taxed

When news broke of Tata Consultancy Services (TCS) parting ways with senior employees and offering generous severance packages ranging from six months to two years, depending upon the tenure, it stirred both shock and speculation.

Layoffs in India’s IT sector are not new, but the scale and nature of the payouts at TCS have renewed focus on how such severance payments are treated under tax law and the fine print that employees must understand before signing on the dotted line.

A layoff, unlike a termination for poor performance, happens when an employer decides to reduce staff due to restructuring, cost-cutting, or shutting down certain operations. “It’s purely a business decision taken by the company, and the employees are not at fault,” says Sujit Bangar, Founder, Taxbuddy.com. To cushion the financial blow, companies offer a severance package typically including salary for the notice period, compensation for loss of employment, and pay for unused leave.

But the relief of a hefty payout often fades once taxes come into play.

Fully taxable — unless exemptions apply

From a tax perspective, severance pay is classified as “profits in lieu of salary” under Section 17(3)(i) of the Income Tax Act, 1961. “Any payment linked to the termination of employment is deemed income from salary and taxed accordingly,” explains Itesh Dodhi, Director, Nangia & Co LLP. “Employers are also required to deduct TDS on such payouts before releasing them.”

In short, the severance package, no matter how large, is treated just like your regular salary. It is clubbed with other income and taxed as per your applicable slab rate.

However, not all components are taxable. "Section 10(10C) of the Income Tax Act offers employees opting for voluntary retirement a measure of relief of up to Rs 5 lakh of such payments can be exempt from tax, provided the scheme adheres to the conditions laid down in Rule 2BA of the Income Tax Rules, 1962," says Dodhi

“Some portions may be exempt if they are specifically mentioned in the termination or relieving letter,” says Bangar. For instance, retrenchment compensation is exempt up to Rs 5 lakh under the Industrial Disputes Act, VRS compensation is exempt up to Rs 5 lakh under Section 10(10C), gratuity is exempt under Section 10(10), and leave encashment is exempt under Section 10(10AA).

But these exemptions apply only if the breakup is clearly defined in official documents. “The breakup of the severance package must be clearly written in the relieving or termination letter,” warns Bangar. “Without this clarity, the tax department may question the employee later during scrutiny.”

Can one save tax on severance pay?

For employees not covered under VRS, a limited relief exists under Section 89, read with Rule 21A of the Income Tax Rules. This provision allows taxpayers to spread the tax burden of a lump-sum payment across previous years, thereby reducing the spike in taxable income for a single year.

"Employees with at least three years of continuous service and an unexpired contractual term of three years or more may claim relief by spreading the tax burden of a lump-sum payment over earlier years, thereby softening the impact of a sudden income spike," says Daodhi

But there’s a catch: “The two benefits exemption under Section 10(10C) and relief under Section 89 are mutually exclusive,” Dodhi cautions. You can claim only one, not both. It’s a subtle but crucial restriction often overlooked in the fine print.

In rare cases, when a company completely shuts down, severance payments may be treated as capital receipts, which are not taxable. However, these situations are exceptional. Most layoffs, even those due to restructuring or redundancy, do not qualify for this treatment.

Tax experts also point out that employees often wrongly assume all severance pay is tax-free. “Only the portions specifically covered by law are exempt; the rest is taxable like salary income,” says Bangar. “It’s crucial to understand what part of the package is protected by exemptions.”

The fine print matters

Since severance pay is a company decision, not one dictated by law, the documentation is critical. The relieving letter should clearly break down each component as basic pay, leave encashment, gratuity, or compensation so that exemptions can be correctly claimed. Employees should also ensure TDS certificates reflect this breakup accurately.

Financial planners advise using the interim relief period wisely. Apart from paying taxes, individuals should focus on liquidity and insurance until re-employment. “The emotional shock of losing a job often overshadows the financial planning that must follow,” says Bangar. “A severance payout gives breathing space, but the real test is how you manage it after taxes.”

The TCS layoffs have reignited conversations about job security in India’s IT sector and the taxation complexities that follow such corporate moves. While hefty severance packages may seem like a silver lining, the tax treatment can significantly erode the actual amount received. Employees must study the breakup, verify exemptions, and plan their taxes smartly. Because when it comes to severance pay, what you see in your offer letter is rarely what you get in hand.

FAQs on severance pay and taxation

1. Is severance pay fully taxable?
Not always. Severance pay is generally treated as profits in lieu of salary and taxed as part of your income. However, certain components like retrenchment compensation, gratuity, and leave encashment can be exempt under specific sections of the Income Tax Act if mentioned in the termination letter.

2. What exemption can employees claim under voluntary retirement?
Employees opting for a Voluntary Retirement Scheme (VRS) can claim tax exemption up to Rs 5 lakh under Section 10(10C), provided the scheme meets conditions specified in Rule 2BA of the Income Tax Rules.

3. Can I get any tax relief if my severance package is not under VRS?
Yes. Under Section 89, employees can seek tax relief by spreading the tax burden of a lump-sum payment over earlier years to reduce the impact of a sudden income spike. However, this relief cannot be claimed together with the Section 10(10C) exemption.

4. What should I check before accepting a severance package?
Ensure the breakup of the severance pay, such as notice pay, leave encashment, and compensatio,n is clearly stated in your termination or relieving letter. This documentation is crucial for claiming eligible tax exemptions and avoiding disputes during scrutiny.