ASSOCHAM urges Finance Ministry for gratuity/leave encashment of deceased employee not taxable in India

The Associated Chamber of Commerce and Industry of India (ASSOCHAM) has suggested the Central Board of Direct Taxes (CBDT) to issue instructions that 'leave encashment', 'gratuity' or other termination benefits received by the legal heir of deceased employee will not be taxable.

In a note to the CBDT Chairman, the chamber has stated that death of an employee creates a lot of financial hardship to the legal heirs and it will be difficult for the legal heirs to calculate and pay taxes on the termination benefits received.

The chamber says there is a CBDT circular No. 573 dated 21.08.90 which states that a lump-sum payment made gratuitously or by way of compensation or otherwise to the widow or other legal heirs of an employee, who dies while still in active service, is not taxable as income under the Income-tax Act, 1961. Infact this circular will cover all other lump sum termination benefits being paid to the legal heir of a deceased employee, who dies while still in active service.

Though there is already a judgement which clearly established the law that gratuity received by the legal heir of a deceased employee is not taxable, even after taking into account the provisions of section 10(10) (iii) of the Act.

However, Section 56(1) and section 2(24) has been amended w.e.f AY 2005-06 to include gratuitous payments received by an Individual / HUF (any sum of money received not exceeding the prescribed amount without any consideration) with a view to widen the scope of Income. There is certain specific exclusion to such gratuitous receipts but such exclusions do not cover the leave encashment, gratuity or other termination benefits received by the legal heir of any deceased employee in connection with the services rendered by him.

Hence, due to the introduction of Section 56(1)(v)/(vi)/(vii) the leave encashment, gratuity and other termination benefits received by the legal heir is now getting taxable though there were CBDT circular issued [before the introduction of Section 56(1)(v)/(vi)/(vii) of the Act] which had exempted such payments. As the earlier CBDT circulars have not been withdrawn there is confusion as to whether these payments to legal heir are taxable income in their hands or not.

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