Section 17 of the Income Tax Act states the provisions and taxation under three categories of employee benefits provided by an employer. This section addresses taxation on salary, prerequisites and profits in lieu of a salary.
Section 17(1) addresses salary, Section 17(2) explains taxation under prerequisites and Section 17(3) of the CGST Act addresses the profits earned in addition to one’s salary. Profits in lieu also include benefits offered by employers to their employees.
Section 17(3) is a subsection under the Income Tax Act which mentions the profits one earns beyond their regular salaries which are referred to as profits in lieu of salary in income tax. To simply put the profits in lieu of salary meaning, these profits are additional benefits that one earns as a bonus or incentive which are mostly made in the form of cash. These benefits fall under the income head of salaries and are taxable by the government.
This could include keyman insurance policy, unrecognised provident funds, payments made post-termination of employment, etc.
Section 17(3) explains profits in lieu as the additional benefits one can earn above their salaries. The payments given below can be considered as part of these profits that are rightfully taxable by the government.
Any payment that you deserve or have already received from your current or former employer due to your employment termination is considered as a profit in lieu of salary. Additionally, any modifications made in terms and conditions shall also fall under this category of the Income Tax Act. As a mandatory condition, the termination of the employment must be due to resignation, retirement, premature termination, etc.
If you receive a payment from an unrecognised provident fund/an unrecognised superannuation fund wherein no contributions have been made by you or in your interest, that payment would be considered as profits in lieu of salary.
Your employer’s contribution and their subsequent interests will not be taxed during your employment. However, when it comes to your retirement or the termination of your employment, will be implied. This kind of contribution comes under income from alternate sources.
Keyman Insurance is a kind of insurance policy where the premium payer and proposer is the employer. On the other hand, the insured individual is the employee. In this case, any claims and benefits requested under this insurance will be given to the employer.
The amount given the employee in extension to that claim made under a keyman insurance will be taxed as profits in lieu of salary.
Sometimes, certain transactions are made between an employer and an employee before joining/after an individual’s employment is coming to an end (a cessation of employment). These payments are also considered as profits in lieu of salary under Section 17(3) of the Income Tax Act.
There could be various natures of payments made to an employee by an employer in addition to one’s salary. In these cases as well, any amount that crosses the threshold on an individual salary or wage will be taxed under Section 17(3).
Having understood the types of payments that are considered as profits in lieu of salary, it is now time to look at all the payment types that are not taxed. Following are the payments made by an employer to an employee which are exempt from taxes under Section 10.
A gratuity amount is paid to the employee once they retire from an institution after a given period of time. Similarly, in the event of an employee’s demise during their employment term will lead to their families earning the gratuity amount. This amount, even though it may be in addition to your usual salary, will not be taxed under Section 10(10) of the Income Tax Act.
The commuted value of your pension refers to the amount you receive in a lump sum after your employment has been terminated due to retirement. This lump sum amount is not taxable according to Section 10(10A) of the Income Tax Act. However, uncommuted pensions are taxable once the pension amount crosses ₹15,000.
Retrenchment of an employee refers to an employer terminating your employment for reasons other than termination established as a disciplinary action. Hence, if your employment is about to end, not because of bad behaviour, inefficiency, etc. but due to other reasons, your employer will give you a compensation amount. This retrenchment compensation will not be taxed.
Statutory Provident Fund, also known as General Provident Fund (GPF), was introduced in the Provident Funds Act of 1925. It is meant to provide people employed by accredited education institutions, railways, government organisations, and other entities specified under the act.
As per Section 10(11), Statutory Provident Fund, or SPF, is another such incentive or addition to one’s regular income that is not taxed under Section 17(3) of the Income Tax Act.
Recognised Provident Fund is elaborated upon in the Provident Fund Act of 1952. An RPF functions with regards to employees of a private organisation or business which has more than 20 employees to consider as a workforce. Here, the companies have two options: they can set up their own RPF trust or they could join a pre-existing government-approved PF scheme.
Recognised Provident Funds are not taxable under Section 10(12) of the Income Tax Act.
Superannuation funds are also known as company pension programs. It is established by an organisation for the betterment of their employees wherein funds are pooled in a superannuation account until it has grown until retirement or withdrawal.
Such withdrawals, under Section 10(13), are tax exempt.
Rent Allowance, also known as HRA on your salary slips, is an allowance given to employees by their employers in addition to their salaries on a monthly basis. This is to help employees meet basic accommodation needs.
This allowance, according to Section 10(13A), is not taxable.
Let’s evaluate two hypothetical scenarios to understand what profits in lieu of salary under Section 17(3) would mean.
Person A has retired after working with Company XYZ for 20 years and is to receive returns from an unrecognised provident fund.
Person B is provided with house rent in addition to their monthly salary.
Payments received from UPF
House Rent Allowance
In both scenarios, Person A and Person B have received an amount that is an addition to their regular salaries. However, under their respective sections of the Income Tax Act, Section 17(3) and Section 10(13A), the payments received from an unrecognised provident fund will be taxed while house rent allowance will not.
Here’s a light download of all the subsections of Section 17.
This section defines the term salary as per the Income Tax Act and the incomes given below are considered under this subsection.
Section 17(2) includes the benefits provided to an employee in kind, called prerequisites. A list of those are as follows.
Value of concessional rent
Value of a benefit or amenity provided for free to the employee
Value of other fringe benefits or amenities, etc.
Section 17(3) of the Income Tax Act considers all profits in lieu of salary and a list of those are given below.
Payment from an Unrecognised Provident Fund/an Unrecognised Superannuation Fund
Payment Under Keyman Insurance Policy
Amount Received Before Joining/After Cessation of Employment, etc.
A recognised provident fund is a government-approved PF scheme set up independently by a private business for its employees. Unrecognised provident funds, on the other hand, are PF schemes that have been similarly set up for employees, however, without the approval of an income tax authority.
If the amount you receive from a Provident Fund investment, under the Provident Funds Act of 1925, that amount will not be taxed. This is one of the perks of income tax on retirement benefits in India.
A terminal compensation is given to an employee during premature termination, resignation, retirement, etc. This compensation is taxed under Section 17(3) of the Income Tax Act.
Both sections do speak about benefits and profits earned in addition to regular salaries. However, Section 17(2) talks about benefits received in kind while Section 17(3) states that taxes are applicable to monetary profits earned above one’s salary.
No, pension is not taxed according to Section 10(10A) of the Income Tax Act.