ITAT Hyderabad Rules Severance Pay is Taxable: How Employees Can Avoid Costly Tax Mistakes
Tribunal says severance packages count as ‘profits in lieu of salary’ unless exempt under Section 10
Simple steps employees can follow to stay compliant and protect themselves from big financial losses
By Our Legal Correspondent
New Delhi: December 13, 2025:
A recent ruling by the Income Tax Appellate Tribunal (ITAT) Hyderabad has sent shockwaves among salaried employees across India. The Tribunal held that severance pay received by a terminated employee is taxable as “profits in lieu of salary” under the Income Tax Act. The case involved an employee who received ₹26 lakh as severance pay but did not declare it in his income tax return. As a result, he lost his tax battle and faced a heavy financial setback.
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This ruling highlights the importance of understanding tax obligations on severance packages and taking proactive steps to avoid similar losses.
What Happened in the Hyderabad Case
- The employee was terminated and received ₹26 lakh as severance pay.
- He assumed the amount was exempt and did not disclose it in his income tax return.
- The Income Tax Department issued a notice, treating the severance pay as taxable income.
- The employee challenged the demand, but ITAT Hyderabad ruled against him.
- The Tribunal clarified that severance pay is taxable unless a specific exemption under Section 10 applies.
Why Severance Pay is Taxable
Under the Income Tax Act, severance packages fall under the category of “profits in lieu of salary.” This means:
- Any compensation received due to termination of employment is treated as income.
- Unless exempted under Section 10 (such as retrenchment compensation under the Industrial Disputes Act), severance pay is taxable.
- Employees must declare such payments in their income tax returns.
The ITAT ruling makes it clear that employees cannot assume severance pay is tax-free. Only specific exemptions apply, and they must be carefully checked.
Lessons for Employees
The Hyderabad case offers important lessons:
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- Always declare severance pay in your income tax return.
- Check exemptions under Section 10 – only certain types of compensation are exempt.
- Consult a tax expert before filing returns if you receive a large severance package.
- Keep documentation such as termination letters and payment details to support your case.
- Don’t rely on assumptions – tax laws are complex and require professional guidance.
How to Avoid Big Losses
Employees can protect themselves by following these simple steps:
- Understand your severance package: Ask your employer for a clear breakup of the payment.
- Check if exemptions apply: For example, retrenchment compensation under the Industrial Disputes Act may be exempt up to certain limits.
- File accurate returns: Declare severance pay as income and pay applicable taxes.
- Plan: If you expect a large severance, consult a tax advisor to plan investments and deductions.
- Avoid litigation: Non-disclosure can lead to notices, penalties, and court battles.
Expert Opinions
Tax professionals have welcomed the ITAT ruling as a step toward clarity. They advise employees to:
- Treat severance pay like salary income unless proven otherwise.
- Use exemptions wisely but avoid misinterpretation.
- Stay updated on tax laws to prevent costly mistakes.
Broader Implications
The ruling has wider implications for India’s workforce:
- Employees: Must be more vigilant about tax compliance.
- Employers: Should clearly communicate tax treatment of severance packages.
- Government: May need to issue guidelines to reduce confusion.
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This case also highlights the importance of financial literacy among employees. Understanding tax obligations is as important as negotiating severance benefits.
Conclusion
The ITAT Hyderabad ruling is a wake-up call for employees across India. Severance pay is taxable unless specifically exempted. Ignoring this fact can lead to heavy losses, as seen in the ₹26 lakh case.
Employees should declare severance pay, consult experts, and plan taxes carefully. By doing so, they can avoid penalties, protect their finances, and ensure peace of mind.
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