TDS on VRS Compensation Under Section 10(10C): How to Claim the Rs. 5 Lakh Tax-Free Window

TL;DR

• Section 10(10C) of the Income Tax Act exempts up to Rs. 5,00,000 of voluntary retirement compensation from tax.
• The scheme must satisfy Rule 2BA conditions — including being open to all employees above 40 or with 10 years of service.
• TDS under Section 192 applies on the taxable balance after deducting the Rs. 5 lakh exemption.
• Section 89(1) relief can be claimed in addition to Section 10(10C) if the compensation is spread notionally across past years.
• The exemption is a one-time lifetime benefit, not available again from another employer in future.

What this means in plain terms

Voluntary retirement schemes have become more common in India's private and public sector as companies restructure. When you accept VRS, the lump sum hits your account in one shot, often Rs. 10 to Rs. 25 lakh depending on your tenure. Without tax planning, half of this can disappear to TDS in a single payslip month.

Section 10(10C) provides a meaningful relief. It exempts the first Rs. 5 lakh of VRS compensation outright, provided the scheme meets the qualifying conditions laid out in Rule 2BA. On top of that, Section 89(1) lets you reduce the tax impact further by treating the remaining taxable VRS as if it had been received over your past service years rather than all in the year of receipt.

What qualifies as VRS under the Act

Rule 2BA conditions

For the exemption to apply, the VRS scheme must satisfy specific conditions in Rule 2BA of the Income Tax Rules. The scheme must apply to all employees (except directors), be aimed at reducing the strength of employees, ensure the vacancy is not refilled, and the employee must have completed 10 years of service or be at least 40 years of age. Compensation cannot exceed three months' salary for each completed year of service.

Eligible employers

Section 10(10C) applies to employees of public sector companies, central or state government bodies, statutory authorities, universities, IITs, IIMs, local authorities, and notified private bodies. Most private sector VRS schemes also qualify if they meet the Rule 2BA conditions.

One-time exemption

The Rs. 5 lakh exemption is available only once in an employee's lifetime. If you availed Section 10(10C) at a previous employer, you cannot claim it again at a future VRS or separation. This is a tighter rule than the Rs. 20 lakh gratuity cap which allows aggregation up to the limit.

How TDS is computed on VRS compensation

Step-by-step computation

Your employer first applies the Section 10(10C) exemption of up to Rs. 5 lakh. The remaining VRS compensation is added to your salary income for the year. The employer then computes the average tax rate including this additional income and deducts TDS under Section 192.

Interaction with gratuity and leave encashment

A VRS package typically bundles VRS compensation, gratuity, and leave encashment. Each enjoys its own exemption — Section 10(10C) for VRS, Section 10(10) for gratuity, Section 10(10AA) for leave encashment. Make sure your employer applies all three separately while computing TDS.

Form 16 Part B reflection

The exempt Rs. 5 lakh appears as a deduction under "Section 10(10C)" in Form 16 Part B. The taxable VRS portion is part of your gross salary. TDS deducted on it is included in the overall TDS figure in Form 16 Part A.

Combining with Section 89(1)

Why this matters

The taxable portion of VRS can be very large — sometimes Rs. 15 to Rs. 20 lakh. If added in one go, it pushes you into the 30% slab and possibly into surcharge brackets. Section 89(1) allows you to redo the math as if the VRS amount had been received across your previous service years, often reducing the effective tax.

Section 10(10C) plus Section 89 explicitly allowed

Until 2009, the Income Tax Act allowed claiming either Section 10(10C) or Section 89(1), but not both, on VRS. After amendments, you can claim Section 10(10C) of up to Rs. 5 lakh first, and then apply Section 89(1) on the balance. This double benefit can save significant tax.

Form 10E filing

To claim Section 89(1) on VRS, you must file Form 10E on incometax.gov.in before submitting your ITR. The form has a specific section for compensation received on voluntary retirement. Without Form 10E, the Section 89(1) claim is disallowed.

A real example

Divya, 51, Rs. 22L CTC, Pune, accepts a VRS scheme from her PSU employer in January 2026 after 24 years of service. Her package includes Rs. 18,00,000 VRS compensation, Rs. 14,00,000 gratuity, and Rs. 8,00,000 leave encashment. Her FY 2025-26 salary up to the date of VRS is Rs. 16,00,000.

Here is the tax planning:

1. Section 10(10) exempts the entire Rs. 14,00,000 gratuity since it is below Rs. 20 lakh and within the formula.
2. Section 10(10AA) exempts the leave encashment using the formula; assume Rs. 7 lakh is exempt and Rs. 1 lakh is taxable.
3. Section 10(10C) exempts Rs. 5,00,000 of the VRS compensation. The remaining Rs. 13,00,000 is taxable as salary.
4. Her total taxable income for FY 2025-26 becomes Rs. 16,00,000 plus Rs. 13,00,000 plus Rs. 1,00,000, that is Rs. 30,00,000.
5. Without Section 89(1), her tax under old regime is approximately Rs. 7,00,000 plus cess.
6. She files Form 10E spreading the Rs. 13,00,000 VRS across her past service years. The Section 89(1) relief works out to Rs. 1,50,000.
7. Net tax after relief is around Rs. 5,50,000.

If Divya had not claimed Section 89(1), she would have paid Rs. 1.5 lakh more.

What to do this week

1. Read your VRS offer letter carefully and confirm the scheme satisfies Rule 2BA conditions.
2. Ask your employer for a breakdown of the VRS amount, gratuity, and leave encashment in writing.
3. Verify whether you have claimed Section 10(10C) at any earlier employer — this exemption is once in a lifetime.
4. Prepare Form 10E for Section 89(1) relief before filing your ITR, with year-by-year computation.
5. Run the 6-step assessment at https://myfinancial.in to see your old-vs-new regime delta, unused deductions, and insurance gap in under 10 minutes.

FAQ

Can I claim Section 10(10C) under the new tax regime?

Yes. The Rs. 5 lakh VRS exemption under Section 10(10C) applies under both old and new tax regimes for AY 2026-27. The new regime restricts many other exemptions but preserves this one.

What if my VRS scheme does not meet Rule 2BA conditions?

If the scheme fails any Rule 2BA condition — for example, the position is refilled within 30 days — the Section 10(10C) exemption is not available. The entire VRS compensation becomes taxable as salary, although Section 89(1) relief may still apply.

Is the Rs. 5 lakh limit per employer or lifetime?

Lifetime. You can claim Section 10(10C) only once in your career. Even if you avail VRS from multiple employers, the cumulative exemption cannot exceed Rs. 5 lakh.

Does Section 10(10C) apply to early retirement or mutual separation?

Only if the scheme is structured to meet Rule 2BA. A simple early retirement or mutual separation agreement without these conditions does not qualify. The label on the document matters less than the substance.

Can I get the entire VRS amount tax-free by combining schemes?

In limited cases, yes. If your gratuity, leave encashment, Section 10(10C), and Section 89(1) relief together cover your entire compensation, the after-tax amount can be very close to the gross. Plan with a CFP before signing.

What happens if my employer does not apply Section 10(10C) at TDS?

You can still claim the exemption in your ITR. Reflect the gross VRS as salary and claim Section 10(10C) up to Rs. 5 lakh. The excess TDS deducted will be refunded.

Does the exemption apply to deferred VRS payments?

If the VRS amount is paid in instalments over multiple years, the Rs. 5 lakh exemption is applied in the first year only. Subsequent instalments are fully taxable, though Section 89(1) relief is still available if applicable.

Sources

• Income Tax Department, Section 10(10C) and Rule 2BA: https://incometax.gov.in/
• TRACES, TDS information: https://www.tdscpc.gov.in/
• CBDT circulars on VRS: https://incometax.gov.in/iec/foportal/
• Finance Ministry tax announcements: https://finmin.nic.in/

This is general information, not personalised advice. For your situation, consult a Certified Financial Planner.