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Voluntary Retirement Scheme (VRS): Is it Gateway to Relaxation?

Created on 26 Dec 2022

Wraps up in 10 Min

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When I was working with UTI, I used to wait for public holidays so that I could stay at home. My father-in-law would joke, saying I should opt for VRS. I was just beginning my career and would wonder what VRS was. Soon, VRS became common in most public sector undertakings, with even my sister-in-law, who was working with Indian Oil, opting for it.

Today, most private sector organisations have also started introducing VRS. If you are still wondering what VRS' full form is, it is Voluntary Retirement Scheme. Under this, an employee can take premature retirement. However, the Voluntary Retirement Scheme comes with a whole set of conditions.

VRS Full Form?

What is VRS? Under Voluntary Retirement Scheme, employees can opt to retire prematurely from their organisation. Companies use it to reduce their staff strength and as a cost-cutting measure to improve the bottom line. The meaning of VRS could be a cost-cutting measure used extensively by both private sector and public sector organisations. The employee is given a lump sum financial compensation as a parting handshake. This is why the VRS scheme is also known as the Golden Handshake. Employees taking VRS can't join a competing firm. 

Features of a Voluntary Retirement Scheme (VRS)

Voluntary retirement might seem like a neat trick to get out of service quickly. To fully gain the benefit of VRS, however, employees should make themselves well aware of the machinations of VRS. Following are the salient features of the Voluntary Retirement Scheme:

  • Under a Voluntary Retirement Scheme, employees can opt for premature retirement.
  • A company can't force an employee to opt for VRS.
  • Voluntary retirement is offered only to those employees who have completed 10 years of service or are above 40 years of age.
  • Voluntary Retirement Schemes can be implemented in both the public sector, as well as private sector undertakings.
  • The scheme is also known as the “Golden Handshake”.
  • The main purpose behind companies offering VRS is to reduce staff strength with the ultimate objective of reducing operational costs.
  • A person taking Voluntary Retirement can't take up employment in a competing firm in the same industry.
  • In return for premature retirement, employees are offered certain benefits such as rehabilitation facilities, financial counselling, etc.
  • As monetary compensation for early retirement, employees are offered a lump sum amount which is tax-free up to ₹5 lakh.
  • Voluntary Retirement Schemes have been introduced as an optimum solution against employee retrenchment by companies.

Voluntary Retirement Scheme is normally adopted by companies in the following situations:

  • Obsolescence of product or technology
  • When there is a takeover, merger or acquisition of the company
  • Joint ventures with collaborations
  • Recession in business
  • When the company is facing intense competition

Benefits of Voluntary Retirement Scheme (VRS)

Voluntary retirement is not just a one-way process. The scheme affects and can be initiated by either the employer or the employee of an organisation. Following are the benefits for either of the parties involved in the separation:

VRS benefits for companies:

  • Today’s marketplace is dominated by intense competition. Right-sizing manpower is important from the company's point of view. Providing Voluntary Retirement Schemes to employees is a humane way of giving employees the option of premature retirement and reducing staff.
  • It reduces the overall costs to the company.  
  • As companies use this way to reduce staff, they benefit by increasing the productivity of the remaining staff.
  • The VRS process is open and transparent. This facilitates easy acceptance by employees. In such a situation, the trade unions also cannot reject the proposal. 

VRS benefits for employees: 

  • Employees get all the accrued dues and emoluments, as per company policies.
  • Employees are free to pursue their careers in another company as long as it is not in the same industry.
  • Employees can also freely invest their VRS amounts as they desire, be it to start a business or to make financial investments. 
  • Employees also get benefit packages and counselling sessions regarding future prospects, rehabilitation, etc. 

It may be noted that both employers and employees must abide by the rules of the company as far as compliance with the Industrial Disputes Act of 1947 is concerned.  

Voluntary Retirement Schemes (VRS) Eligibility Criteria

Voluntary Retirement Schemes can be offered only to long-serving employees of an organisation. Voluntary Retirement Rules include the following:

1. Belonging to the private sector: The employee must have completed 10 years of service, or the VRS retirement age should be at least 40 years of age.

The employee also can't take up employment in sister companies or groups and associate companies under the same management.

After taking VRS, the employee may not take up employment in a rival firm from the same industry.

2. Belonging to the public sector: The employee must have completed 20 years of service.

They should give written notice of at least 3 months.

The request for VRS can't be denied.

It must be noted that companies can't recruit employees to fill the vacant positions created by employees who have taken VRS. 

How is VRS compensation calculated? 

Voluntary Retirement Scheme compensation is calculated by the following methods:

3 months’ salary for every year of completed service.

OR

The last drawn salary of the employee, multiplied by the remaining months of service left up to the actual date of retirement.

The actual VRS amount paid will be the lower of the above two calculations.

I give below an example of the calculation of the financial compensation under the Voluntary Retirement Scheme:  

Let Mr Satish be an employee in a private organisation. He has completed 10 years of service in the organisation. His company offers him voluntary retirement as a cost-cutting measure. His actual retirement date is 25 years later. His last drawn salary is Rs 50,000 per month. The calculation of the Voluntary Retirement salary is as follows: 

Calculation under method I:

3 * 50,000 * 10 years of completed salary = ₹15,00,000 

Calculation under method II:

50,000 * 25 years remaining for retirement = ₹12,50,000 

The financial compensation payable is the lower of the two. In this case, the financial compensation payable is ₹12,50,000. 

Voluntary Retirement Scheme salaries are taxed in the hands of the employee under the head 'income from salary' under Section 17(3) of the Indian Income Tax Act. Exemptions are available under Section 10(10C) with relief under Section 89.

The employee also receives provident fund and gratuity dues accrued until that date. Only basic salary and HRA are considered while calculating the gratuity payment.

The financial compensation received by the employee is tax-free up to ₹5 lakh under Section 10(10C) of the Indian Income Tax Act 1961. But to receive this benefit, the employee must file their assessment in the same year that they receive the financial compensation.

The person can be an employee of the following type of organisations: 

  • A public sector company
  • Any other company
  • A company established under the Central or State government or Provincial Act
  • A local authority 
  • A co-operative society 
  • A university incorporated under the State government or Provincial Act 
  • An Indian Institute of Technology
  • A State or Central government employee
  • Any other important institute in India
  • Any management institute incorporated by the Central Government by notification in the Official Gazette.

The exemption amount allowed under the Indian Income Tax Act is the lowest of the following three amounts: 

  • Rs 5 lakh
  • 3 months' salary for every year of completed service
  • Last drawn salary multiplied by the balance period of months to the end of service and the actual date of retirement.

This exemption under Section 10(10C) can be availed only once by the employee in their lifetime. They may take VRS multiple times in their lifetime but avail of the exemption benefit under the Indian Income Tax Act only once. 

Relief under Section 89

This section provides relief to the employee when he receives a huge payout in the form of VRS compensation. Under Section 21A, the tax payable is calculated as the average tax payable.

This is the case when the amount of such compensation is bifurcated over three previous financial years immediately preceding the year in which such VRS compensation is received.

This principle is used to determine whether the tax payable should be paid in one go or should be taxed in parts over the three previous years.  

The tax liability is computed as follows: 

  1. Compute the tax payable in the previous year in which the amount is payable and the tax on the total amount, including the compensation
  2. Calculate the tax by adding one-third of the total VRS amount to the immediate three preceding financial years to the year when the compensation is received. 
  3. Calculate the rate of tax on each of the preceding three years separately. 
  4. Calculate the average of the three rates for tax for the three preceding years
  5. Relief is calculated as a tax on the total amount computed in step 1 – the average of the tax calculated for the three preceding years in step 4 multiplied by the compensation amount. 

Recipients can either claim an exemption on the tax payable under Section 10(10C) or relief under Section 89. Both sections are mutually exclusive. Employees receiving VRS compensation can't claim both benefits under the Indian Income Tax Act. 

Voluntary Retirement rules for State government and Central government employees

The voluntary retirement rules for state government employees and the VRS schemes for central government employees are summarised below.

Central government employees can apply for voluntary retirement after completing 30 years of service. Central government employees are eligible for full pension benefits under the Fundamental Rules and CCS(Pension) Rules of 1972 before the age of superannuation.

Entry in Service

Age of Voluntary Retirement

Group A and B officers who entered service before attaining the age of 35 years

After reaching the age of 50 years

All other Group A and B officers and all Group C officers

After reaching the age of 55 years

1) Scientists and technical experts who are on assignment from the ITEC program of the Ministry of External Affairs

2) Employees posted abroad in a foreign-based office of a ministry or a department

3) Employees on a specific assignment to a foreign government

After transfer to India, they should have served for a minimum period of one year, fulfilling other conditions.

All employees

After completing 30 years of service

All government employees have the right to retire voluntarily after completing 20 years of service by giving 3 months’ notice in writing to the appointing authority. This must be done voluntarily by the employee themself without interference from the government authority. They can avail of the benefit of the retiring pension. The 20-year service period is mandatory to avail of the pension payments.

In certain deserving cases, the appointing authority, in agreement with the Ministry of Finance, may decide to accept a notice period of fewer than three months.

If such a retirement application is given by the employee while they are on leave, the date of the VRS is also deemed to commence from the date of starting the leave. 

The government employee should also not be subject to disciplinary action or pending dismissal for the approval of his VRS application.

While granting a proportionate pension to a government employee under this scheme, weightage of up to five years would be given for adding five years of qualifying service rendered by the employee. After adding such excess weightage, the total qualifying service of the employee can't exceed 30 years. 

Examples: 

1. If a 47 years old government employee has rendered 22 years of service under Fundamental Rules 560(1) or seeking voluntary retirement under Fundamental Rules 56(K), the weightage to pension would be only three years.  

2. If the government employee aged 51 years has retired after 24 years of service, the weightage to pension would be four years.

This weightage will only add to the qualifying service period and does not entitle the employee to additional pay. Government employees will also be eligible for terminal leave salaries in such cases. 

There will also be no discrimination in payments of VRS or in the promotion policy in case of government employees who are disabled while on the job. 

In the case of state public sector undertakings, the compensation payable is limited to 45 days of basic salary. Plus, DA will be payable for every year of completed service.

Voluntary Retirement Compensation for government employees

Voluntary retirement compensation for State and Central government employees is as follows:

  • All government employees who comply with the government conditions for seeking voluntary retirement are entitled to a periodical pension. 
  • A government employee who takes VRS after completing 10 years of service is eligible for the grant of pension calculated at 50% of the emoluments or average emoluments, whichever is more beneficial to them. This is subject to a minimum of ₹9,000 or a maximum of ₹1,25,000 per month.  
  • After 10 years of service, such government employees also become eligible for a compulsory retirement pension or a superannuation pension. After completing 80 years of age, such government employees are eligible for additional pension or additional compassionate allowance on a graduated scale from 20% to 100% as the age progresses from 80 years to 100 years. 
  • The government employee is also eligible for a superannuation service gratuity. 

Government employees can commutate their pensions as well. The formula for arriving at the commutated value of the pension is as follows:  

40% * Commutation factor * 12

The commutation factor will be regarding the age next birthday on the date when the commutation becomes absolute as per the new table annexed to the CCS or Commutation of Pension Rules, 1981.  

The formula for the retirement gratuity is 1/4th month basic pay plus dearness allowance drawn on the date of the retirement for each completed six monthly periods of qualifying service. This is subject to a maximum of Rs 20 lakh.

Some employees may opt for the payment of a commuted pension payment in the form of a lump sum payment. They also receive gratuity, leave encashment, and payments from their statutory Provident Fund. Payments from the government-approved superannuation fund are also included.

Most of the above payments are exempt from tax. Pension payments are exempt from tax under section 10(10A). Gratuity payments are exempt from tax under Section 10(10). Leave encashment is exempt from tax Section 10(10 AA). Voluntary Retirement Compensation is exempt from tax under Section 10(10C) up to an amount of ₹5,00,000. Payments from the Statutory Provident Fund are exempt under Section 10(11) and Section 10(12). All payments from an approved Superannuation Fund will be tax-exempt if such payments are made in case of death, incapacitation, and retirement under Section 10(13) of the Income Tax Act of 1961.  

The Bottom Line

With layoffs becoming commonplace in the current job market, VRS might not be the most affordable option from a company's point of view. However, for employees being let go due to internal changes in an organisation, VRS is a more humane approach to the whole process of letting employees go.

VRS can be also an employee-initiated process in case they want to live that "early retirement" life.

Either way, the proper protocol needs to be followed to make sure that the employer-employee separation does not end on a rocky, or worse, bitter note.

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