Income Tax on commutation of pension

By | August 5, 2018
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(Last Updated On: August 6, 2018)

 Income Tax Treatment on commutation of pension

Pension is described in section 60 of the CPC and section 11 of the Pension Act as a periodical allowance or stipend granted on account of past service, particular merits etc. Thus monthly allowance to the younger brother of a ruler was treated as a maintenance allowance and not pension (Raj Kumar Bikram Bahadur Singh Vs. CIT 75 ITR 227(MP)).

There are three important features of ‘pension’.

1.Pension is a compensation for past service.

2 It owes its origin to a past employer employee or master-servant relationship.

3 It is paid on the basis of earlier relationship of an agreement of service as opposed to an agreement for service.

This relationship terminates only on the death of the concerned employee

Pension to officials of UNO is exempt from taxation. Section 2 of the UN (Privilege & Immunities) Act, 1947 grants tax exemption to salaries/emoluments paid by U.N.

The Karnataka High Court had held that u/s 17 of the Income Tax Act, salary has been defined as including pension, therefore, if salary received from U.N. is exempt, so shall be the pension. This decision was accepted by the CBDT vide circular No. 293 dated 10.02.1981.

Pension received from a former employer is taxable as ‘Salary’. Hence, the various deductions available on salary income, including relief u/s 89(1) for the arrears of pension received would be granted to pensioners who received their pension from, a nationalised bank and in other cases their present Drawing & Disbursing Officers. Similarly, deductions from the amount of pension of standard deduction and adjustment of tax rebate u/s 88 and 88B shall be done by the concerned bank, at the time of deduction of tax at source from the pension, on furnishing of relevant details by the pensioner. Instructions in above regard were issued by R.B.I.’s Pension Circular (Central Service No. 7/C D.R./ 1992(Ref. No. DGBA:GA(NBS) No. 60/GA64-(II CVL-91-92 dated 27.4.92).

FAMILY PENSION

Pension and family pension are qualitatively different. The Pension is paid during the lifetime of the employee while the family pension is paid on his death to surviving family members.

Pension is taxed under the Head ” Salary” in Income Tax Act.

However, in case of family pension, since there is no employer-employee relationship between the payer and the payee, therefore, it is taxed as ‘Income from Other Sources’ in the hands of the nominee(s).

Family pension is defined in Section 57 of Income Tax Act as a regular monthly amount payable by the employer to a person belonging to the family of an employee in the event of death.

In respect of family pension, deduction u/s 57(iia) of Income Tax Act of

  • Rs.15,000 or
  • 1/3rd of the amount received,

whichever is less, is available.

 

Example

After the death of Mr. Raj his wife received Rs. 8,400 per month as family pension (Rs. 1,00,800 per year). What will be the amount of exemption which can be claimed by his wife from family pension?

Family pension received by the family members of the employee after the death of the employee is charged to tax in the hands of recipient under the head “Income from other sources”. In such a case, deduction of lower of 1/3rd of the amount of pension or Rs. 15,000 is available from such income.

In this case 1/3rd of Rs. 1,00,800 will come to Rs. 33,600, hence, Rs. 15,000 will be exempt from tax. and Balance Amount of Rs 100800-15000 = Rs 85800 will taxed in the hands of Wife of Mr Raj as per Income Tax Slab Rates

Income Tax Exemption to Family Pension

Incomes not included in total income.

10. In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included

(18) any income by way of—

(i)pension received by an individual who has been in the service of the Central Government or State Government and has been awarded “Param Vir Chakra” or “Maha Vir Chakra” or “Vir Chakra” or such other gallantry award as the Central Government may, by notification  in the Official Gazette, specify in this behalf;
(ii)family pension received by any member of the family of an individual referred to in sub-clause (i).

Explanation.—For the purposes of this clause, the expression “family” shall have the meaning assigned to it in the Explanation to clause (5);]

(18A4[Omitted by the Finance (No. 2) Act, 1998, w.e.f. 1-4-1999;]

[(19) family pension received by the widow or children or nominated heirs, as the case may be, of a member of the armed forces (including para-military forces) of the Union, where the death of such member has occurred in the course of operational duties, in such circumstances and subject to such conditions, as may be prescribed (See rule 2BBA of Income Tax Rules for prescribed circumstances and conditions.);]

Income Tax on Pension

Mr. Krunal retired from job after rendering service of 30 years. After his retirement he is receiving Rs. 8,400 per month as pension. Apart from Rs. 8,400 as monthly pension, he also received Rs. 5,00,000 on account of commuting of his 40% of pension.

  • Rs 8400 monthly pension is Called uncommuted Pension . It is taxable as salary under section 15 in the hands of a government as well as a non government employee.
  • Rs 5,00,000 is called Commuted Pension .Taxability of the commuted pension is dependent upon:-
    • the status (Govt/ Non Govt/ Defense services ) of the employee and
    • whether or not such employee has received gratuity.

Un-commuted pension

Illustration (Un-commuted pension in case of Government employee) Mr. Sunil retired from Government service after rendering service for 30 years. After his retirement he is receiving Rs. 8,400 per month as pension. What will be tax treatment of monthly pension received by Mr. Sunil?

As per section 10(10A)(i), any commuted pension, i.e., accumulated pension in lieu of monthly pension is exempt in the hands of a Government employee. There is no exemption in respect of un-commuted pension. Thus, un-commuted pension of Rs. 8,400 per month will be fully taxed in the hands of Mr. Sunil.

Illustration (Un- commuted pension in case of non-Government employee) Mr. Suraj retired from his job (non-Government) after rendering service for 20 years. After his retirement he is receiving Rs. 18,400 per month as pension. What will be tax treatment of monthly pension received by Mr. Suraj?
**
Un-commuted pension is fully charged to tax in the hands of Government as well as nonGovernment
employee. Thus, un-commuted pension of Rs. 18,400 per month will be fully taxed in the hands of Mr. Suraj.

Computed Pension

Commuted pension is a lump sum payment in lieu of periodical payment. For instance after his retirement, X gets 25 percent of his pension commuted for Rs. 60,000/- (after commutation he will get the remaining 75% i.e. Rs. 1,500/- by way of monthly pension).

In this case, Rs. 60,000/- is commuted pension which X has received in lieu of 25% of his monthly pension.

The taxability of the commuted pension is dependent upon the status of the employee and whether or not such employee has received gratuity.

Commuted pension is received by a government employee

If such commuted pension is received by a government employee (i.e. employee of the Central Government, State Government, Local Authority , Defence Services, and Statutory Corporation established under Central or State Acts, ) who may or may not have received gratuity, then such commuted pension would be completely exempt from tax.

Illustration (Commuted and Un-commuted pension in case of Government employee) Mr. Krunal retired from Government job after rendering service of 30 years. After his retirement he is receiving Rs. 8,400 per month as pension. Apart from Rs. 8,400 as monthly pension, he also received Rs. 5,00,000 on account of commuting of his 40% of pension. What will be tax treatment of pension received by Mr. Krunal?

As per section 10(10A)(i), any commuted pension, i.e., accumulated pension in lieu of monthly pension is fully exempt in the hands of a Government employee.

There is no exemption in respect of un-commuted pension.Thus, un-commuted pension of Rs. 8,400 per month will be fully taxed in the hand of Mr. Krunal.

However, commuted pension will be fully exempt in the hands of Government employee, hence, Rs. 5,00,000 will be fully exempt from tax

Commuted pension is received by a non-government employee

Non-government employee Received Gratuity

If such commuted pension is received by a non-government employee who has received gratuity, then only one-third of the pension which he is normally entitled to receive, would be exempt from tax.

Non-government employee does not Receive Gratuity

If the same commuted pension is received by a non-government employee who has not received gratuity, then only one-half of the pension which he is normally entitled to receive is exempt from tax.

Judges of S.C. & H.C. shall be entitled to exemption of commuted value upto ½ of the pension (Circular No. 623 dated 6.1.1992).

If the payment in commutation of pension received by an employee exceeds the aforesaid limits, such excess pension received is liable to tax in the assessment year relevant to the previous year in which it is due or paid.

The assessee can however, claim relief under section 89.

Illustration (Commuted and Un-commuted pension in case of non-Government employee)

Mr. Krunal retired from his job (non-Government) after rendering service for 20 years. After his retirement he is receiving Rs. 2,520 per month as pension. Apart from Rs. 2,520 as monthly pension, he also received Rs. 1,00,000 on account of commuting of his 40% of pension. He has received gratuity of Rs. 1,00,000, however, entire amount of gratuity is charged to tax. What will be tax treatment of pension received by Mr. Krunal?

Un-commuted pension is fully charged to tax in the hands of Government as well as nonGovernment
employee. Thus, un-commuted pension of Rs. 2,520 per month will be fully taxed in the hand of Mr. Krunal.

In this case gratuity is received, hence, one third of full value of commuted pension will be exempt from tax. Rs. 1,00,000 is commuted value of 40% of pension, hence, commuted value of 100% pension will come to Rs. 2,50,000 (100000/25%) . Exemption will be one third of Rs. 2,50,000 which will come to Rs. 83,333.

Thus Taxable Computed pension will be Rs (100000 Less 83,333) = Rs 16667

Illustration (Commuted and Un-commuted pension in case of non-Government employee)

Mr. Krunal retired from his job (non-Government) after rendering service for 20 years. After his retirement he is receiving Rs. 2,520 per month as pension. Apart from Rs. 2,520 as monthly pension, he also received Rs. 1,00,000 on account of commuting of his 40% of pension. He has not received any gratuity. What will be tax treatment of pension received by Mr. Krunal?

Un-commuted pension is fully charged to tax in the hands of Government as well as nonGovernment
employee. Thus, un-commuted pension of Rs. 2,520 per month will be fully taxed in the hand of Mr. Krunal.

In this case no gratuity is received, hence, one half of full value of commuted pension
will be exempt from tax. Rs. 1,00,000 is commuted value of 40% of pension, hence, commuted value of 100% pension will come to Rs. 2,50,000( i.e 100000/25%) . Exemption will be one half of Rs. 2,50,000 which will come to Rs. 1,25,000. In this case actual amount of commuted pension is Rs. 1,00,000 which is less than Rs. 1,25,000, hence, entire amount of commuted pension will be exempt from tax.

Commuted pension Received from Insurance Fund

Any payment in commutation of pension received from a fund set up by Life Insurance Corporation of India on or after the 1st day of August, 1996 or any other insurer under a pension scheme approved by IRDAI is also exempt from Income tax

 

Relevant Section 10(10A) of Income Tax Act

Incomes not included in total income.

10. In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included—

…..

(10A) (i) any payment in commutation of pension received under the Civil Pensions (Commutation) Rules of the Central Government or under any similar scheme applicable to the members of the civil services of the Union or holders of posts connected with defence or of civil posts under the Union (such members or holders being persons not governed by the said Rules) or to the members of the all-India services or to the members of the defence services or to the members of the civil services of a State or holders of civil posts under a State or to the employees of a local authority or a corporation established by a Central, State or Provincial Act ;

(ii) any payment in commutation of pension received under any scheme of any other employer, to the extent it does not exceed—

(a)in a case where the employee receives any gratuity, the commuted value of one-third of the pension which he is normally entitled to receive, and
(b)in any other case, the commuted value of one-half of such pension,

such commuted value being determined having regard to the age of the recipient, the state of his health, the rate of interest and officially recognised tables of mortality ;

(iii) any payment in commutation of pension received from a fund under clause (23AAB) ;]

Relevant Section 10(23AAB) of Income Tax Act

Incomes not included in total income.

10. In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included—

…..

[(23AAB) any income of a fund, by whatever name called, set up by the Life Insurance Corporation of India on or after the 1st day of August, 1996 or any other insurer under a pension scheme,—

(i)to which contribution is made by any person for the purpose of receiving pension from such fund;
(ii)which is approved by the Controller of Insurance or the Insurance Regulatory and Development Authority established under sub-section (1) of section 3 of the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999), as the case may be].

Explanation.—For the purposes of this clause, the expression “Controller of Insurance” shall have the meaning assigned to it in clause (5B) of section 2 of the Insurance Act, 1938 (4 of 1938) ;]

 

 

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