Calculating Relief Under Sections 89 & 89A: Tax Benefits Explained

The intricacies of the Indian tax system can be quite complex, especially when it comes to dealing with unique financial situations such as receiving arrears, gratuity, and foreign retirement benefits. In such cases, understanding and effectively calculating tax relief becomes paramount. This comprehensive article delves into the detailed provisions of Sections 89 and 89A of the Income Tax Act, shedding light on how individuals can navigate the tax implications of various forms of income.

Calculation of relief under Sections 89 & 89A

Relief under Section 89

• Section 89 provides relief from the increased tax burden resulting from receiving arrears of salary relating to earlier years or receiving an advance salary, which shall fall due in succeeding previous years. This relief allows the employee to be placed in the same situation as he would have been if such salary had been taxed on an accrual basis instead of being taxed on a receipt basis.
• Relief under Section 89 is allowed to an employee if he is liable to pay tax in respect of the following during the financial year:

(a) Salary received in arrears or in advance

(b) Arrears of family pension

(c) Premature withdrawal from a PF account

(d) Gratuity

(e) Commuted value of pension

(f) Compensation on termination of employment

• The employee should claim relief in the return of income for the year in which the lump sum payment is received. To do this, the employee must furnish Form No. 10E before filing his Income-tax return.

Relief in case of receipt of advance salary or arrears of salary

• An employee can claim Section 89 relief if, during the year, he is liable to pay tax in respect of the following receipts:

(a) Advance Salary

(b) Arrears of salary

(c) Family Pension

(d)Withdrawal from a PF account before completing 5 years of service

• The relief in respect of receipts enumerated above shall be calculated in the following steps.

Step 1: Calculate tax on the total income of the current year, including the above receipts Step 2: Calculate tax on the total income of the current year, excluding the above receipts

Step 3: Calculate tax on the total income of the year to which the above receipts relate after excluding these receipts

Step 4: Calculate tax on the total income of the year to which the above receipts relate after including these receipts

Step 5: Calculate the difference between (Step 1 minus Step 2) and (Step 4 minus Step 3)

If the result of the calculation in Step 5 is positive, the excess amount is allowed as a relief. If the result of Step 5 is negative, no relief shall be allowed to the employee.

Relief in case of receipt of gratuity

• Relief from gratuity is allowed only if the employee has completed 5 years of service.
• If the gratuity received by the employee is eligible for tax exemption, no relief is admissible for such an exempted portion of the gratuity. Only the taxable portion of gratuity which is included in gross salary income, is eligible for relief.
• Where the gratuity is payable in respect of past service of 15 years or more, the relief from gratuity shall be calculated in the following steps:

Step 1: Calculate the average rate of tax on the total income of the current year, including gratuity

Step 2: Calculate tax on gratuity at the average rate of tax as computed in Step 1

Step 3: Calculate the average rate of tax of the previous 3 years after adding 1/3^rd of the gratuity amount in the income of all these 3 previous years

Step 4: Calculate the average of average tax rates of the last 3 years as computed in Step 3

Step 5: Calculate tax on gratuity at the average rate of tax as computed in Step 4

Step 6: Calculate the difference between Step 2 and Step 5.

If the result of the calculation in Step 6 is positive, the excess amount is allowed as a relief. If the result of Step 6 is negative, no relief shall be allowed to the employee.

• Where the gratuity is payable in respect of past service of 5 years or more but less than 15 years, the relief shall be calculated in a similar manner as for a term of 15 years or more.
• However, instead of computing the average of average rates of the preceding 3 years, the average of average rates of the preceding 2 years is computed (Step 4) by adding one-half of the gratuity to the income of each of the preceding 2 years (Step 3).

Relief in case of receipt of compensation on termination of employment

• If an employee receives compensation due to termination of his employment after continuous service of 3 years or more and where the unexpired portion of his term of employment is also not less than 3 years, the relief is calculated in the same manner as if the gratuity was paid to the employee in respect of service rendered for 15 years or more.
• If an employee claims relief Section 89 in respect of voluntary retirement compensation, no other exemption shall be allowed to him. An employee can claim either an exemption up to Rs. 5,00,000 in respect of voluntary retirement compensation or relief under Section 89, but not both.

Relief in case of receipt of pension

• Relief in respect of commutation of pension is computed in the same manner as if the gratuity was paid to the employee in respect of service rendered for a period of 15 years or more.

Calculation of relief under Section 89A

• Section 89A of the Income Tax Act provides an option to a resident individual to defer the payment of tax on the income earned from foreign retirement benefits accounts from the year of accrual to the year of withdrawal.
• An individual can claim relief under Section 89A if they meet the following conditions:

(a) He is a resident of India in the year in which relief is claimed;

(b) He has opened a specified retirement benefits account in a notified country (see the Notifications Tab for the notified countries);

(c) He was a non-resident in India and a resident in that country while opening such an account; and

(d) The income from such retirement benefits account is not taxable on an accrual basis but is taxed by such country at the time of withdrawal or redemption.

• The income from the specified retirement benefits account shall be taxed in the manner and year prescribed in Rule 21AAA. The rule provides an option to the resident individual to include income from the specified retirement benefits account in his total income in the assessment year in which such income is taxed at the time of withdrawal (or redemption) in the notified country.
• It should be noted that the individual can pay tax on such income in the year of accrual or defer it to the year in which it is taxed in the respective country on withdrawal. Further, such an option can be exercised only for the income accrued on or after 01-04-2021 in the specified account.
• The specified person can exercise the option by filing Form No. 10EE electronically on or before the due date for furnishing of return of income. Once this option is exercised, it will apply to all subsequent previous years and cannot be withdrawn.
• If the specified person exercises the option, his total income for the previous year in which the specified income is taxable shall not include the following income:

(a) Income which has already been included in the total income of any earlier previous year during which such income accrued and tax thereon has been paid; or

(b) Income which was not taxable in India in the previous year during which such income accrued due to the residential status of such person, being a non-resident or resident but not ordinarily resident, or the applicability of DTAA, if any.

• Where an income is not included in the total income of the specified person, the tax paid on such income outside India, if any, shall be ignored from the computation of foreign tax credit.
• If the specified person becomes a non-resident after exercising the option, then it shall be deemed that he has never exercised it. In that case, the income accrued in the specified account between the following period shall be taxable in his hand:

(a) Starting from the previous year in which such an option was exercised

(b) Ending in the previous year immediately preceding the previous year, during which the specified person becomes non-resident.

• Further, the tax shall be paid on such income on or before the due date for furnishing the return of income for the year in which the specified person has become a non-resident.

Calculation of relief under Sections 89 & 89A – Important Points

1. Relief under Section 89 is allowed to an employee if he is liable to pay tax in respect of Salary received in arrears or in advance, Arrears of family pension, Premature withdrawal from a PF account, Gratuity, Commuted value of pension, and Compensation on termination of employment during the financial year.

2.  The employee should claim relief in the return of income for the year in which the lump sum payment is received. To do this, the employee must furnish Form No. 10E before filing his Income-tax return.

3. Relief from gratuity is allowed only if the employee has completed 5 years of service.

4. Section 89A of the Income Tax Act provides an option to a resident individual to defer the payment of tax on the income earned from foreign retirement benefits accounts from the year of accrual to the year of withdrawal.

5. The specified person can claim relief under section 89A by filing Form No. 10EE electronically on or before the due date for furnishing of return of income.

Conclusion: Understanding tax relief under Sections 89 and 89A is crucial for individuals with various sources of income. Whether it’s arrears, gratuity, or foreign retirement benefits, these provisions offer a way to manage tax liabilities effectively. By following the prescribed steps and meeting the eligibility criteria, individuals can make informed decisions about when and how to claim these valuable tax benefits.