The deduction follows eligibility, not the package label
For tax year 2026–27, section 19(1), Table item 12, permits a deduction equal to the lower of qualifying voluntary-retirement compensation and ₹5,00,000. Read it with section 19(2)(e) and (h) and the applicable scheme requirements. A contractual severance payment or resignation settlement is not automatically an eligible VRS receipt. These are salary-computation rules; the deduction is not a ₹5 lakh reduction in tax payable.
This article addresses the statutory VRS deduction for eligible schemes, using the Income-tax Act, 2025, as amended by Finance Act, 2026 and Income-tax Rules, 2026, Rule 20. They apply from 1 April 2026. References in older working papers to section 10(10C) and Rule 2BA belong to the earlier framework; do not paste those references into a current-year calculation without checking the applicable period.
Build an eligibility file before the computation
Section 19(2)(h) identifies employer classes, including companies, specified statutory authorities, local authorities, co-operative societies, qualifying universities and institutions, IITs, Government and notified institutions. Rule 20 sets conditions for the employer classes it lists. The examples below concern company employees, for whom the rule can be applied directly; they do not infer that every employer or government exit scheme has identical conditions.
For an ordinary company scheme under Rule 20, the employee must have completed ten years of service or attained forty years of age. The tests are alternatives. The scheme must cover the specified employee population, excluding company directors, reduce overall employee strength, leave the resulting vacancy unfilled and prevent the retiring company employee from taking employment in another concern under the same management. For a public sector company’s voluntary-separation scheme, Rule 20(3) removes the age/service requirement in sub-rule (2)(i); the remaining conditions still matter.
Separate the scheme-payment formula from the deduction ceiling
Rule 20(2)(vi) expresses the scheme amount condition by reference to A = 3 × completed years of service × retirement salary, or B = balance months to normal superannuation × retirement salary. Record the actual scheme basis and both figures in the file. These figures test the scheme payment; they do not raise the independent ₹5 lakh deduction ceiling. The examples deliberately use payments below both figures, so no choice between alternative formula bases affects their conclusions.
Rule 20 salary includes dearness allowance where the employment terms so provide and excludes other allowances and perquisites. Use completed service years, not a rounded-up service period. Do not substitute gross monthly cost to company for this salary. Retain the service record, superannuation date and salary-component reconciliation.
One claim year and no overlapping salary relief
Section 19(2)(e)(ii) prevents another deduction under the item in a different tax year once it has been allowed. A shortfall below ₹5 lakh does not create an annually reusable allowance. Section 19(2)(e)(iii) and section 157(2) prevent the specified overlap with salary-arrears/advance relief. Review compensation received or receivable, the claim history and the relief position before filing; instalments do not by themselves create fresh caps.
Section 202(2) does not list Table item 12 among the salary deductions it removes for the new regime. Accordingly, eligible VRS relief is not lost merely because the employee uses that regime. The taxable package balance must still enter the complete salary computation, with other receipts, permitted deductions and final tax calculated separately. Gratuity, leave encashment, notice pay and pension require their own characterisation; the examples below show the VRS component only.
What commonly goes wrong
An employer’s package summary rarely proves every scheme condition. Obtain the signed scheme, acceptance and relieving documentation, confirmation of non-refilling and employment restrictions, and an itemised settlement. Do not infer a universal tax-free character from a fact-specific severance dispute or assume that a payment above a guideline can simply be treated as a qualifying scheme with only the excess taxed. Scheme validity comes first.
Worked illustrations
These illustrations use fictional facts and expressly stated assumptions. Amounts are Indian rupees unless a different currency or unit is specified. They are independent examples, not findings about any actual client.
Illustrative example 1: Service test succeeds before age forty
A private-company employee is 38, has completed 12 years and has 180 months until superannuation. Rule 20 salary is ₹30,000 a month. A = 3 × 12 × ₹30,000 = ₹10,80,000; B = 180 × ₹30,000 = ₹54,00,000. The otherwise compliant scheme pays ₹4,20,000, below both figures. The ten-year condition is met despite age below forty. Deduction = min(₹4,20,000, ₹5,00,000) = ₹4,20,000; taxable VRS balance = nil.
Illustrative example 2: Age test succeeds with eight completed years
An employee aged 43 has eight completed years and 204 months to superannuation. Salary is ₹50,000; A = ₹12,00,000 and B = ₹1,02,00,000. An otherwise qualifying ₹6,20,000 payment satisfies both monetary comparisons. Age forty is sufficient even though service is below ten years. Deduction is ₹5,00,000 and taxable VRS compensation is ₹1,20,000.
Illustrative example 3: Ordinary company employee fails both entry tests
An employee aged 36 has eight completed years, 288 months remaining and salary of ₹40,000. A = ₹9,60,000 and B = ₹1,15,20,000. Payment is ₹4,00,000. Although the amount is below both monetary figures and below ₹5 lakh, neither age nor service test is met. Assuming this is an ordinary company VRS and no different relief applies, the item-12 deduction is nil; ₹4,00,000 remains in the salary computation.
Illustrative example 4: Public sector voluntary-separation exception
Use the same age 36, eight completed years, 288 remaining months, ₹40,000 salary and ₹4,00,000 payment, but under an otherwise compliant public sector company voluntary-separation scheme. Rule 20(3) disapplies the age/service condition. A remains ₹9,60,000 and B ₹1,15,20,000. Deduction is ₹4,00,000 and the VRS balance is nil; the exception does not waive the other scheme requirements.
Illustrative example 5: Exclude other allowances from retirement salary
An eligible employee has ten completed years and 120 months remaining. Monthly basic pay is ₹35,000, qualifying DA ₹5,000 and other allowances ₹10,000. Rule 20 salary = ₹40,000, not ₹50,000. A = ₹12,00,000; B = ₹48,00,000. For an otherwise compliant payment of ₹5,80,000, deduction is ₹5,00,000 and the taxable VRS balance ₹80,000. The salary correction matters to scheme testing even though the deduction cap determines this result.
Illustrative example 6: Two instalments within the same tax year
An eligible company employee has 15 completed years, 120 months remaining and ₹40,000 monthly salary. A = ₹18,00,000; B = ₹48,00,000. The qualifying compensation of ₹7,00,000 is received as ₹4,00,000 and ₹3,00,000 in the same tax year, with no additional accrual or other VRS amount. Aggregate compensation is ₹7,00,000, the single deduction is ₹5,00,000 and the taxable balance ₹2,00,000. Applying a separate ₹5 lakh cap to each instalment would overstate the deduction by ₹2,00,000.
Ten-step verification table
| Step | Verification | Evidence to retain |
|---|---|---|
| 1 | Identify the tax year and governing Act. | Receipt/accrual schedule and current law copy. |
| 2 | Classify each settlement component separately. | Itemised employer settlement. |
| 3 | Confirm the employer is within section 19(2)(h). | Employer constitution and applicable notification, if needed. |
| 4 | Obtain and assess the actual scheme. | Scheme, acceptance and relieving letter. |
| 5 | Test age or completed service and any PSU exception. | Birth date, joining date and scheme classification. |
| 6 | Check staff reduction, vacancy and same-management conditions. | Employer confirmations and employment restrictions. |
| 7 | Reconcile retirement salary and both Rule 20 formula figures. | Basic/DA breakdown and superannuation record. |
| 8 | Aggregate qualifying compensation received or receivable. | Settlement ledger and instalment reconciliation. |
| 9 | Check previous deduction and section 157 relief. | Earlier computations and current relief decision. |
| 10 | Apply the cap once and reconcile taxable salary. | Final salary working and payroll/return reconciliation. |
Sixteen practitioner FAQs
1. Does every early-exit payment qualify?
No. The actual payment and scheme must satisfy the relevant employer and statutory conditions; a payroll description is insufficient.
2. Is ₹5 lakh a tax rebate?
No. It is the maximum qualifying compensation deduction in computing salary, not a direct reduction of tax.
3. Must both ten years and age forty be satisfied?
For Rule 20(2)(i), either condition suffices. Document which alternative the employee meets.
4. Does voluntary separation by a PSU remove every restriction?
No. Rule 20(3) relaxes the age/service requirement, not the remaining scheme conditions.
5. Can a company director use the ordinary employee scheme test?
Rule 20(2)(ii) excludes directors of a company from the scheme population specified there; do not treat a director as an eligible executive automatically.
6. Should salary include every allowance?
No. Rule 20 includes qualifying DA but excludes other allowances and perquisites. Keep a component-by-component working.
7. Are incomplete service years rounded upward?
The formula uses completed years. An additional part-year is not automatically another completed year.
8. Can the scheme formula increase the deduction beyond ₹5 lakh?
No. Scheme amount conditions and the statutory deduction ceiling serve different purposes.
9. What if the employer intends to refill the position?
The non-refilling condition needs examination. A small payout alone does not cure a scheme-condition failure.
10. Can the employee join a sister concern immediately?
For a retiring company employee, the same-management employment restriction in Rule 20 must be satisfied; review the proposed employer before claiming.
11. Is the deduction available under the new tax regime?
Item 12 is not excluded by section 202(2). Eligibility and the other section 19 conditions still apply.
12. Does each instalment carry its own ceiling?
No. Reconcile the compensation and the single claim; payment splitting is not a multiplication of the cap.
13. Can unused headroom be carried into another claim year?
Do not treat it as a carry-forward allowance. Section 19(2)(e)(ii) bars the deduction in another tax year after it has been allowed.
14. Can section 157 relief also be claimed on the same VRS income?
The Act restricts this overlap through section 19(2)(e)(iii) and section 157(2). Reconcile the claims before choosing the computation.
15. Are gratuity and leave encashment covered by this ₹5 lakh cap?
They have separate provisions and conditions. Keep them outside the VRS working rather than combining every retirement receipt.
16. Does the taxable balance equal the final tax bill?
No. Include it in the full annual computation; other income, deductions, rates, rebate, surcharge and cess require separate calculation.
Working-paper organisation
Keep the source documents, calculation and final conclusion together for the same entity and period. If using assureTax or other assureOffice tools, use only confirmed available functions and retain this evidence with the output.
Conclusion
Sign off eligibility and the scheme-payment condition before applying the lower-of-compensation-and-₹5-lakh deduction. A separate history check prevents instalments, another exit or an overlapping relief claim from producing a second benefit.