The recent wave of layoffs has left many employees in India grappling with the realities of their severance packages and associated taxes. The first instinct after receiving a severance notice is often to calculate how long the financial cushion will last. However, the situation is complicated by the tax implications of these payments. Under the Income Tax Act, severance pay is classified as income and is subject to taxation, thereby reducing its value for the employee.

According to Tarundeep Sehgal, a partner at AKM Global, severance payments fall under “profits in lieu of salary” as specified in Section 17 of the Act. This means that such payments are treated in the same manner as regular salary, leading to significant upfront tax deductions that can diminish the net amount received by employees. Consequently, the financial relief that severance is intended to provide may not be fully realised by the recipient.

The Realities of Financial Cushioning

The limitations imposed by taxation can drastically affect an employee’s financial planning. For instance, an employee might anticipate receiving a severance equating to three months’ salary, only to find that a substantial portion is immediately deducted due to their tax bracket. In cases where the individual is taxed at 30 per cent, their financial buffer could effectively shrink from three months to approximately two months, creating an urgent stress to find new employment.

Employees have limited avenues for mitigating the tax impact on severance payments. Section 89 of the Income Tax Act provides some relief by allowing for the distribution of tax liabilities over previous years, yet this only offers a temporary reprieve. The fundamental issue remains that severance, typically seen as a financial cushion, is still regarded as taxable income, which generates a disconnect between the intended purpose of the payment and its actual effect.

This situation raises questions regarding the lack of structural reforms in the tax system. While there are specific provisions for voluntary retirement schemes, the majority of employees receiving severance do not benefit from these exceptions, thus experiencing the full brunt of taxation.

International Comparisons and Perspectives

India is not the only country that taxes severance pay, but it stands out for the absence of concurrent support systems common in other nations. For example, employees in the United States receive unemployment benefits alongside severance pay, providing essential financial assistance during transitions. Similarly, the United Kingdom allows for tax-free redundancy payments up to a set limit, which offers immediate relief when job loss occurs.

Countries such as Australia and Singapore also recognise the need for partial tax exemptions on redundancy payouts, indicating a growing global consensus that severance should not be treated as mere income. This contrasts sharply with the Indian perspective, where job loss is often viewed as an individual responsibility rather than a collective economic issue. The lack of a robust safety net in India exacerbates the challenges faced by workers during layoffs.

India’s workforce, particularly in sectors experiencing frequent layoffs, is becoming increasingly aware of these inadequacies. As job losses become more commonplace, the lack of universal unemployment insurance or structured income replacement highlights the growing need for reform in the policy framework governing employment and taxation.

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