This is a neutral professional article. The judgment is analysed in the context of its factual background, issues framed, and conclusions reached by the Court.

2026 (6) TMI 1381 - ITAT BANGALORE

At a Glance

The tax treatment of payments made under a scheme described as voluntary retirement depends upon the statutory character of the payment, rather than its label alone. In 2026 (6) TMI 1381 - ITAT BANGALORE, the Tribunal held that compensation received under the BSNL Voluntary Retirement Scheme, 2019 was retrenchment compensation eligible for full exemption under section 10(10B) of the Income-tax Act, 1961.

The Tribunal also allowed full exemption for accumulated leave encashment under section 10(10AA) to a retiree under the same scheme. The conclusion proceeded on the view that BSNL VRS retirees were to be treated as Central Government employees for this purpose, as well as on the application of the enhanced monetary limit considered by coordinate Benches.

The ruling is important because section 10(10C) ordinarily limits exemption for voluntary-retirement payments to five lakh rupees, subject to statutory conditions and the guidelines in Rule 2BA. By contrast, section 10(10B) addresses compensation received on retrenchment and contains a distinct protective framework for a Central Government-approved scheme extending special protection to workmen. The Tribunal treated the BSNL scheme in substance as retrenchment-oriented, notwithstanding its VRS nomenclature.

• A payment called ex gratia or VRS compensation may require examination under section 10(10B) where its real character is compensation for workforce reduction or termination.
• Section 10(10C) and Rule 2BA remain relevant where the payment is genuinely voluntary-retirement compensation; they do not displace section 10(10B) merely because a scheme is termed VRS.
• For leave encashment, section 10(10AA) differentiates between Government employees and other employees. The statutory distinction and the applicable monetary limit must both be examined.
• The notification under section 10(10AA)(ii) specifies a limit of twenty-five lakh rupees for employees other than Central or State Government employees who retire on superannuation or otherwise.

Background & Context

Employees who exited BSNL under the 2019 scheme initially claimed the more familiar exemption available for voluntary retirement under section 10(10C), which is capped at five lakh rupees. The claims were reflected accordingly in the employer-issued tax documents. The subsequent controversy was whether the payment should instead be regarded as retrenchment compensation under section 10(10B), thereby attracting the treatment applicable to a Central Government-supported workforce-reduction scheme.

The Tribunal recorded that the scheme formed part of a revival and restructuring plan, was implemented through an office memorandum of the Department of Telecommunications, and was funded by the Central Government. It accepted that the separation payments represented compensation on retrenchment and directed full exemption under section 10(10B). The objection that the retirees were not workmen was also rejected by following the coordinate-Bench approach relied upon in the appeals.

A connected issue concerned accumulated leave encashment. The revenue authorities had granted only a restricted exemption. The Tribunal, however, accepted the claim for the entire disputed leave-encashment receipt. It relied on a High Court decision referred to in the proceedings which treated BSNL VRS retirees as Central Government employees for leave-encashment tax exemption, and also noted coordinate-Bench rulings that applied the enhanced limit notified under section 10(10AA)(ii) while deciding appeals for an earlier assessment year.

The case therefore brings together two legally distinct terminal receipts. Retrenchment compensation must be tested under section 10(10B), with particular attention to the nature and approval of the scheme. Leave encashment must be tested separately under section 10(10AA), which applies a different statutory structure.

Key Issues / Provisions

Section 10(10B): retrenchment compensation

Section 10(10B) excludes from total income "any compensation received by a workman" under the Industrial Disputes Act, 1947, or under other specified instruments, "at the time of his retrenchment". Its first proviso ordinarily limits the exempt amount to the lower of: the amount calculated under section 25F(b) of the Industrial Disputes Act; or the amount specified by the Central Government through notification.

The second proviso is crucial. It provides that the preceding ceiling does not apply to compensation received by a workman under a scheme approved by the Central Government, having regard to the need to extend special protection to workmen in the undertaking and other relevant circumstances. The Explanation further deems compensation on closure of an undertaking to be compensation received at the time of retrenchment. It also adopts the Industrial Disputes Act meanings of "employer" and "workman".

Section 10(10C) and Rule 2BA: voluntary retirement

Section 10(10C) applies to an amount received or receivable by an employee of specified employers, including a public sector company, on voluntary retirement, termination of service or, in the case of a public sector company, voluntary separation. The exemption is "to the extent such amount does not exceed five lakh rupees". The provision also requires the scheme to be framed in accordance with prescribed guidelines and bars a second exemption under the clause in another assessment year. Further, where relief under section 89 has been allowed in respect of such amount, exemption under section 10(10C) is not available.

Rule 2BA sets out the relevant guidelines. It requires, among other matters, that the scheme apply to employees who have completed ten years of service or attained forty years of age, apply to workers and executives other than directors, produce an overall reduction in employee strength, leave the resulting vacancy unfilled, and prohibit employment of the retiring employee in another concern under the same management. The compensation must not exceed three months' salary for each completed year of service or salary at retirement multiplied by the balance months of service remaining before superannuation.

Section 10(10AA): cash equivalent of earned leave

Section 10(10AA)(i) exempts "any payment" received by a Central or State Government employee as cash equivalent of leave salary in respect of earned leave standing to the employee's credit at retirement, whether on superannuation or otherwise.

For an employee other than a Central or State Government employee, section 10(10AA)(ii) is narrower. It covers the corresponding retirement payment only in respect of earned leave not exceeding ten months, calculated on the average salary during the ten months immediately preceding retirement, and subject to the notified limit. It also contains aggregation rules: payments from more than one employer in the same previous year cannot collectively exceed the specified limit, and earlier exempt payments reduce the available limit.

Notification No. 31/2023, issued under section 10(10AA)(ii), specifies twenty-five lakh rupees as the limit for employees covered by that sub-clause who retire on superannuation or otherwise. The notification states that it is deemed to have come into force from 1 April 2023 and contains an explanatory memorandum certifying that no person is adversely affected by the retrospective effect.

Detailed Analysis

Substance of the separation scheme takes precedence over nomenclature

The central feature of the ruling is the distinction between a genuinely voluntary retirement payment and a payment that is, in substance, compensation for retrenchment. The Tribunal found that the BSNL scheme was part of the approved revival and restructuring programme and held that the whole compensation received under it qualified for exemption under section 10(10B). Thus, a label such as "VRS" or "ex gratia" does not conclusively determine the relevant exemption provision.

The Tribunal's approach is consistent with 2025 (6) TMI 1622 - ITAT CHANDIGARH. That decision treated the BSNL Retirement Scheme, 2019 as a retrenchment scheme in substance, observing that the employee had no practical alternative but to accept the scheme in the prevailing circumstances. It also regarded the denial of exemption for a later instalment as untenable where a previous instalment under the same compensation package had already received the benefit.

The coordinate Bench in 2026 (3) TMI 1411 - ITAT PUNE similarly held that ex gratia received under the BSNL forced-retirement scheme was retrenchment compensation falling under section 10(10B), rather than merely a payment attracting the limited relief under section 10(10C). Significantly, that decision also addressed and rejected the objection based on whether the recipient was a workman. The Bengaluru Tribunal followed that reasoning in allowing the claims before it.

Government-backed special protection and the full-exemption result

The second proviso to section 10(10B) is designed to prevent the ordinary statutory ceiling from applying to a scheme approved by the Central Government for special protection of workmen in an undertaking. The Tribunal's grant of full exemption reflects the application of this protective framework to the BSNL scheme, having regard to its Government-supported revival and restructuring setting.

2017 (3) TMI 1270 - MADRAS HIGH COURT provides a significant statement of the substance-over-form principle in this context. It held that a severance package described as VRS could nevertheless fall within section 10(10B) where it was a specific Government-sanctioned package intended to provide special protection to employees. The Court also applied the exemption to officers covered by the Government order, notwithstanding that the Industrial Disputes Act definition of workman does not ordinarily extend to officers. The precise result rested upon the special package and its terms.

In 2023 (9) TMI 1524 - ITAT CHANDIGARH, a closure-linked VRS/VSS package was held fully exempt under section 10(10B). The decision applied the statutory Explanation deeming closure compensation to be retrenchment compensation and held that the second proviso removed the ordinary ceiling where the Central Government had approved a scheme extending special protection. It also emphasised that the nomenclature of a package is immaterial if its objective and effect are compensation in a closure or retrenchment situation.

These authorities do not mean that every payment under a voluntary-retirement scheme automatically falls under section 10(10B). The governing inquiry remains statutory and factual: the payment must be connected to retrenchment, and full exemption depends on the requirements of the special-protection proviso being met. Where those features are absent, section 10(10C), including its five-lakh ceiling and Rule 2BA conditions, remains the applicable regime.

Section 10(10C) does not absorb independent terminal benefits

The distinction between the two provisions is also supported by 2003 (2) TMI 46 - CALCUTTA HIGH COURT. That decision construed "amount received" in section 10(10C) as the compensation component payable for preponed cessation of employment. It distinguished that component from terminal benefits independently payable upon retirement or termination, including leave encashment. The ruling demonstrates why separate terminal receipts must be identified and examined under their respective statutory provisions instead of being merged into a single VRS amount.

Accordingly, a taxpayer asserting section 10(10B) relief should distinctly identify the retrenchment compensation. Leave encashment should be independently claimed and assessed under section 10(10AA). This segmentation is especially important where employer records, Form 16, settlement statements, and tax withholding details describe the payments differently.

Leave encashment: employee status and the enhanced limit

The leave-encashment issue has two dimensions. The first is whether the retiree is covered by section 10(10AA)(i) as a Central or State Government employee, or by section 10(10AA)(ii) as another employee. The second is the monetary limit, together with the ten-month and average-salary restrictions, if sub-clause (ii) applies.

2019 (11) TMI 1143 - DELHI HIGH COURT held, as a general proposition, that employees of public sector undertakings and nationalised banks do not become Central or State Government employees merely because their employer may be treated as State for other constitutional purposes. The statutory classification between Government employees and other employees under section 10(10AA) was held valid. That general principle underscores why the employment status inquiry cannot be resolved solely by reference to Government ownership or control.

In the BSNL VRS context, however, the Tribunal accepted the specific conclusion urged from the High Court decision placed before it: retirees under the scheme were to be treated as Central Government employees for leave-encashment exemption. That finding formed part of the Tribunal's basis for allowing the full disputed receipt. The general classification principle does not displace the fact-specific conclusion reached in relation to the BSNL scheme.

The Tribunal also relied on the line of decisions applying the increased notification limit. In 2025 (7) TMI 1812 - ITAT AHMEDABAD, the Tribunal held that the enhanced twenty-five-lakh limit could be applied to allow leave-encashment exemption for a non-Government employee in an earlier assessment year. It relied upon the beneficial character of the notification and its explanatory memorandum.

2025 (8) TMI 1778 - ITAT JAIPUR adopted the same approach, directing exemption in accordance with Notification No. 31/2023 where the retirement payment was within the revised ceiling. The Bengaluru Tribunal followed coordinate-Bench reasoning that treated the enhanced limit as available at the appellate stage, including for the assessment year involved in the BSNL appeals. The notification's text nevertheless specifies its effective date; the application of the enhanced limit to earlier periods therefore rests on the judicial approach reflected in these decisions and must be pleaded with the relevant facts and authorities.

Practical Implications

For retirement schemes implemented as part of restructuring, revival, closure, or manpower rationalisation, the primary compliance question is not the scheme's title. The material to be assembled should establish its legal and commercial substance. Relevant records include the scheme document, Government approval or supporting directions, employer communications, settlement computation, and evidence showing the link between the payment and cessation of employment.

• Segregate the final settlement into retrenchment compensation, leave encashment, gratuity, provident-fund amounts, pension-related amounts, and any other terminal component.
• For section 10(10B), document why the payment is retrenchment-linked and, where full exemption is claimed, why the Central Government special-protection proviso is attracted.
• For section 10(10C), verify Rule 2BA conditions instead of assuming that every VRS payment automatically receives the five-lakh exemption.
• For section 10(10AA), verify employee status, earned-leave credit, average salary for the preceding ten months, prior leave-encashment exemptions, and payments from other employers in the same previous year.
• Where section 10(10AA)(ii) is invoked, expressly claim the benefit of Notification No. 31/2023 and address its stated effective date together with the appellate rulings that have applied it beneficially.
• Reconcile the claim with Form 16, tax deducted at source, return disclosures, and the computation of income. An employer's treatment is relevant evidentiary material but does not conclusively settle the statutory character of the receipt.

The Tribunal also entertained claims that were not fully reflected in the original return position. The related decisions support the settled proposition that an appellate authority may examine a fresh legal claim necessary for determining the correct tax liability. The claim must, however, be supported by the foundational scheme documents and a clear computation of the consequential exemption and refund, if any.

Key Takeaways

• The Bengaluru Tribunal held that compensation under the BSNL Voluntary Retirement Scheme, 2019 was in substance retrenchment compensation and directed full exemption under section 10(10B).
• The VRS label is not determinative. The statutory enquiry focuses on the substance, objective, Government approval, and termination consequences of the scheme.
• Section 10(10B) and section 10(10C) address different kinds of separation payments. The latter's five-lakh limit cannot be mechanically applied where the payment properly falls within the retrenchment-compensation framework.
• Accumulated leave encashment remains a separate receipt governed by section 10(10AA), with distinct rules for Government employees and other employees.
• The Tribunal allowed full leave-encashment exemption to the BSNL VRS retiree, relying on the scheme-specific Government-employee treatment and the judicial application of the enhanced twenty-five-lakh notification limit.
• Careful classification and documentary substantiation of every settlement component are essential to avoid an incorrect restriction of exemption at the return-processing or assessment stage.

Full Text:

2026 (6) TMI 1381 - ITAT BANGALORE