Income Tax on payment for notice period

Income Tax on payment for notice period: In case the employee pays for the notice period, no deduction of such amount is allowed to him/her.

Getting a job is not easy these days. Even leaving it comes with certain tax implications. While it has become common for employees to change jobs frequently, switching from one company to another doesn’t happen very quickly. Moreover, changing jobs often come with some tax complications, putting the employees at a disadvantage. Let’s understand this with an explanation of how the payment for the notice period is taxed.

Employees are required to serve a certain number of days as a notice period, which varies from organisation to organisation. For example, if the notice period is 60 days then the employee will have to serve another 60 days after putting in his papers.

Some companies allow employees to leave early if they pay for the number of days of the notice period. For example, suppose the notice period in a company is 60 days but an employee has got a better job offer that requires him to join within 30 days. In such case, the old organisation may allow him to give 30 days’ notice and pay for the short notice of the remaining 30 days.

Sometimes, the new organisation also offers to pay for the short notice period to the old organisation. It sounds smooth but gets complicated from a tax perspective because of an anomaly in tax rules, according to ICAI’s Pre-Budget Memorandum 2023.

As per ICAI’s document, if the employee leaves early, he has to pay for the short notice. Sometimes the employer also terminates the service by giving notice as per the job contract or paying for the notice period. When the employer terminates service with immediate effect, he pays for the notice period and claims deduction. But such an amount becomes taxable in the hands of the employee.

In case the employee pays for the notice period, no deduction of such amount is allowed to him/her. However, when the new organisation pays for the notice period, that amount is included in the total income of the employee and tax is deducted accordingly from the employee. This means, if the notice period is of 60 days and the new employer agrees to pay, the amount, it will be added to the employee’s total income. Thus, in effect, the employee will end up paying tax for 14 months’ salary and not just 12 months.

The ICAI has urged the Government to remove this anomaly in Budget 2023.

“It is suggested that aforesaid anomaly may be resolved and appropriate provisions be inserted so that income from notice period pay is chargeable in the hands of ex-employer and deduction of the amount of ‘notice period pay’ paid be made available to the employee as he has not effectively received that income (unless reimbursed by the new employer),” the ICAI said.

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