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VRS compensation and retrenchment compensation are not interchangeable for Indian income-tax purposes. For a payment governed by the Income-tax Act, 1961, retrenchment exemption under section 10(10B) is generally limited to qualifying compensation paid to a statutory “workman.” VRS exemption under section 10(10C) is a separate, scheme-based relief for specified employees and has its own eligibility test and calculation.
The first question is the tax year. The Income-tax Act, 2025 commenced on 1 April 2026. Tax years beginning before that date continue under the 1961 Act; tax years beginning on or after it are governed by the 2025 Act. The older section numbers therefore cannot be carried into a post-1 April 2026 calculation without checking the new Act and the Income-tax Rules, 2026.
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Quick comparison
| Issue | Retrenchment compensation under the 1961 Act | VRS or voluntary-separation compensation under the 1961 Act |
|---|---|---|
| Provision | Section 10(10B) | Section 10(10C) |
| Who may qualify | A qualifying “workman” retrenched under the statutory conditions | Employees of specified classes of employer leaving under a qualifying voluntary-retirement or voluntary-separation scheme |
| Core event | Retrenchment, not merely any termination or severance arrangement | Voluntary retirement, qualifying termination, or, for a public-sector company, voluntary separation under the prescribed scheme |
| Statutory computation | Least of actual compensation, the section 25F(b) calculation, and ₹5,00,000 | Lower of the prescribed salary-and-service formula and ₹5,00,000 |
| Formula described by the Income Tax Department | 15 days’ average pay for each completed year of continuous service, or part of a year exceeding six months | Three months’ salary for each completed year of service, or salary at retirement multiplied by the number of months left to retirement, subject to the ceiling |
| Section 89 interaction | The department identifies section 89 relief as available for retrenchment compensation; calculate it separately | If section 89 relief has been allowed for the relevant VRS, termination, or separation amount, section 10(10C) exemption is not allowed for that amount |
| Post-1 April 2026 payments | Check the corresponding provision in the Income-tax Act, 2025 and the 2026 Rules | Check the corresponding provision in the Income-tax Act, 2025 and the 2026 Rules; the detailed new-law scheme criteria must be verified from the complete texts |
The figures in this table are statutory limits or formulas, not average payouts or tax-saving guarantees. The Income Tax Department summaries cited here were current in 2026.
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Do not begin with the employer’s letterhead or the word used in the settlement. Begin with the period to which the payment relates. The Income-tax Act, 2025 came into force on 1 April 2026, and official transition guidance says the 1961 Act continues for tax years that began before that date.
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| Payment-related period | Starting point for analysis | Practical implication |
|---|---|---|
| A tax year beginning before 1 April 2026 | Income-tax Act, 1961 | Use the section 10(10B) or 10(10C) tests described below, if the facts qualify |
| A tax year beginning on or after 1 April 2026 | Income-tax Act, 2025 | Do not assume the old section numbers, wording, or limits continue; read the new Act and Rules for the relevant year |
For example, a payment connected with a tax year that started before 1 April 2026 is analyzed under the 1961 Act even if payroll paperwork is completed later. Conversely, a payment relating to a tax year beginning on or after 1 April 2026 requires the new-law provisions. Confirm the exact tax year with payroll or a tax professional when the exit date, payment date, and accounting year do not line up.
Retrenchment compensation: section 10(10B) under the 1961 Act
Who the exemption is designed for
Section 10(10B) applies to qualifying compensation received by a “workman” at the time of retrenchment. The word is a statutory status, not a casual description of every employee who loses a job. A managerial employee, an office employee, or a person whose contract labels a payment “retrenchment” does not automatically satisfy the test.
The underlying event must also be retrenchment in the statutory sense. A negotiated severance package, dismissal for misconduct, resignation, ordinary redundancy payment, or payment in lieu of notice may have different legal character. Review the termination notice, the employer’s scheme, the employee’s duties, and the reason for the separation together.
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For the ordinary section 10(10B) relief, the exempt amount is the least of three figures:
- The compensation actually received.
- The amount calculated under section 25F(b) of the Industrial Disputes Act, 1947.
- ₹5,00,000.
The section 25F(b) measure uses 15 days’ average pay for each completed year of continuous service, or for a part of a year exceeding six months. That service calculation is a statutory formula, not a general rule that all severance is worth 15 days’ pay per year.
Illustrative calculation
Assume a qualifying workman receives ₹7,20,000 on retrenchment. Suppose the section 25F(b) calculation produces ₹4,40,000. The three comparison figures are ₹7,20,000, ₹4,40,000, and ₹5,00,000. The ordinary exemption is therefore ₹4,40,000, because it is the lowest figure. The calculation does not make the entire ₹7,20,000 exempt merely because the payment is described as retrenchment compensation.
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If the actual payment is ₹3,60,000 and the statutory calculation is ₹4,40,000, the exemption is limited to the ₹3,60,000 actually received. Any balance not covered by the exemption must be dealt with under the applicable salary-tax rules rather than assumed to be tax-free.
Approved special-protection schemes
The ordinary ₹5,00,000 ceiling has a statutory exception for a special-protection scheme approved by the Central Government. Approval is a substantive condition: an employer cannot create the exception simply by calling an internal package a “special scheme.” Preserve the approval and the scheme documents if this route is being considered.
VRS compensation: section 10(10C) under the 1961 Act
Who can claim it
Section 10(10C) covers amounts received or receivable by employees of specified classes of employer who retire voluntarily or are terminated under a qualifying voluntary-retirement scheme. For a public-sector company, the provision also addresses voluntary separation. The employee category and the employer category must both fit the statutory framework.
This is why a private employer’s “early exit,” “mutual separation,” or “redundancy” letter does not by itself establish VRS eligibility. The scheme must follow the prescribed guidelines, and the employee must leave through that scheme rather than through an unrelated individual bargain.
The scheme-based formula and ceiling
The Income Tax Department summarizes the relevant amount as the lower of:
- Three months’ salary for each completed year of service; or
- Salary at retirement multiplied by the number of months of service left before the normal retirement date.
That result is subject to the overall ₹5,00,000 exemption ceiling. The formula is applied to the salary figure and service information required by the law and scheme, not automatically to every component of a final settlement.
Illustrative calculation
Suppose the first formula produces ₹6,30,000 and the second produces ₹4,80,000. The lower formula amount is ₹4,80,000, which is below the ₹5,00,000 ceiling. If both formulas produce more than ₹5,00,000, the ordinary exemption cannot exceed ₹5,00,000. If the qualifying amount itself is only ₹3,20,000, the exemption cannot exceed the amount received or receivable.
These examples show the order of the calculation; they do not establish that a particular employer’s scheme qualifies. Scheme approval, employee category, service record, and the wording of the retirement offer still have to be checked.
Why “VRS,” “severance,” and “retrenchment” labels are unreliable
Tax treatment follows the statutory character of the event, not the label printed on a payslip. A package called “VRS” may fail section 10(10C) if it is not a qualifying scheme. A package called “retrenchment” may fail section 10(10B) if the recipient is not a workman or the termination was not statutory retrenchment.
Use these questions to classify the payment:
- What was the employee’s actual role and statutory status?
- Did the employer terminate employment, or did the employee elect to leave?
- Was there a formally issued scheme with prescribed conditions?
- Does the scheme identify a voluntary-retirement, voluntary-separation, or retrenchment event?
- How does the settlement break the payment into compensation, notice pay, leave-related amounts, gratuity, bonus, and other components?
- Which tax year began during the period to which the payment relates?
A single settlement can contain several components with different tax rules. Do not apply one exemption to the gross amount without examining the payroll schedule and the governing documents.
Section 89 relief: where it fits and where it does not
Retrenchment compensation
The Income Tax Department’s section 10(10B) summary specifically identifies section 89 relief as available for retrenchment compensation. That relief is a separate calculation intended to address the effect of receiving certain employment income in one year rather than over the years to which it relates. The amount eligible for section 10(10B) exemption and any amount considered for section 89 relief should therefore be identified separately; do not treat the entire settlement as automatically qualifying for both.
VRS and qualifying termination amounts
Section 10(10C) contains an explicit restriction: when section 89 relief has been allowed for the relevant VRS, termination, or separation amount, exemption under section 10(10C) is not allowed for that amount in the same or another assessment year. In practical terms, a taxpayer cannot claim section 89 relief and then claim the section 10(10C) exemption as a second benefit for the same payment.
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Before filing, reconcile the employer’s tax certificate, the exemption claimed, and any section 89 computation. If payroll has already allowed one treatment, obtain a written explanation before selecting a different one.
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The 2025 Act applies to tax years beginning on or after 1 April 2026. The department’s current section 19 search summary places retrenchment compensation in salary deductions at serial 10, a separate approved-scheme entry at serial 11, and VRS or termination-scheme amounts at serial 12. Those serial references are a navigation aid, not a substitute for reading the operative provision and rules.
The available official material does not establish every detailed VRS eligibility condition under the complete Income-tax Rules, 2026. Consequently, a post-1 April 2026 claim should not be approved solely by mapping an old section 10(10C) checklist onto the new Act. Verify the complete current Act, the applicable Rules, and any notified forms or employer-scheme requirements for the relevant tax year.
The transition does not erase the 1961 Act for earlier tax years. A return involving an earlier period must still be tested under the 1961 Act, even if the taxpayer is filing after the 2025 Act has commenced.
A step-by-step method for classifying a payment
- Identify the tax year. Record the beginning date of the tax year to which the payment relates and decide whether the 1961 Act or 2025 Act governs.
- Collect the source documents. Obtain the appointment record, role description, termination or retirement letter, scheme booklet, board or government approval where relevant, service calculation, payslip, and tax certificate.
- Separate the payment components. List compensation for retrenchment or VRS separately from notice pay, leave encashment, gratuity, bonus, unpaid salary, and reimbursements.
- Test the event. Determine whether the employee was retrenched as a qualifying workman or elected to leave under a qualifying VRS or voluntary-separation scheme.
- Apply the correct formula. For a 1961 Act retrenchment claim, compare actual compensation, the section 25F(b) amount, and ₹5,00,000. For a 1961 Act VRS claim, calculate both prescribed salary-and-service limits and then apply the ₹5,00,000 ceiling.
- Check section 89. Determine whether relief has been claimed or allowed and whether the chosen exemption is legally compatible with that relief.
- Check the new-law position when applicable. For a tax year beginning on or after 1 April 2026, confirm the current Act and Rules instead of importing an old section number.
- Keep an audit trail. Save the calculation, assumptions, scheme version, service dates, salary definition, and correspondence with payroll or an adviser.
Documents and questions to ask payroll
- Which statute and tax year did payroll use?
- Does the employer classify the payment as retrenchment compensation, VRS compensation, voluntary separation, or another component?
- If retrenchment is claimed, how was “workman” status determined?
- What exact service period and average-pay figures were used for the section 25F(b) calculation?
- If VRS is claimed, where are the prescribed scheme conditions and employer-category basis documented?
- Was the scheme approved by the Central Government where an approved special-protection exception is being used?
- Has section 89 relief been allowed, requested, or reflected in payroll calculations?
- Does the tax certificate show the exempt amount separately from other salary components?
Written answers matter because a settlement agreement may use commercial language that does not match the statutory test. Ask for the calculation, not just a statement that the payment is “tax-free.”
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Applying the ₹5 lakh figure to every exit package
The ₹5,00,000 amount is a ceiling within particular statutory routes. It does not create a general exemption for every severance payment, resignation settlement, or redundancy package.
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Assuming every employee is a workman
Section 10(10B) is tied to the statutory workman concept. Correct the analysis by examining duties, status, and the legal nature of the retrenchment.
Treating a voluntary settlement as VRS
Section 10(10C) requires a qualifying scheme and specified employer and employee categories. Correct the analysis by obtaining the scheme and testing its conditions before using the exemption.
Using the wrong salary or service measure
Retrenchment uses the section 25F(b) average-pay measure, while VRS uses its separate three-months-per-year or months-left comparison. Correct the error by rebuilding the calculation from service dates and the salary definition required for the applicable provision.
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Claiming section 89 relief and section 10(10C) exemption for the same VRS amount
The 1961 Act expressly prevents that combination for the relevant amount. Reconcile the payroll treatment before filing a return.
Carrying 1961 Act section numbers into a 2025 Act year
The 2025 Act commenced on 1 April 2026. Correct the error by identifying the tax year first and consulting the current Act and Rules for later periods.
When professional review is sensible
Obtain a chartered accountant or other qualified tax adviser’s review when the employee’s status is disputed, the settlement combines several payments, the employer’s scheme spans the 1 April 2026 transition, a Central Government approval is being relied on, or section 89 relief has already been processed. Those facts can change the legal route even when the settlement amount is modest.
For a straightforward pre-1 April 2026 case, the calculation can be organized from the documents above, but the taxpayer should retain the employer’s scheme terms and the statutory computation. For a post-1 April 2026 case, insist on confirmation under the complete Income-tax Act, 2025 and Income-tax Rules, 2026 rather than relying on an old VRS checklist.
Practical conclusion
Under the 1961 Act, qualifying retrenchment compensation and qualifying VRS compensation are two different exemptions. Retrenchment relief turns on workman status, statutory retrenchment, the section 25F(b) calculation, and the least-of-three limit. VRS relief turns on specified employer and employee categories, a prescribed voluntary-retirement or separation scheme, its salary-and-service formula, and the ₹5,00,000 ceiling. Section 89 relief must be checked separately, and it cannot be stacked with section 10(10C) exemption for the same VRS or termination amount.
For any tax year beginning on or after 1 April 2026, verify the corresponding provisions in the Income-tax Act, 2025 and the 2026 Rules before making a claim. The payment’s label is only a starting clue; the tax result follows the statute, the scheme, the employee’s status, and the tax year.
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