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 extremely difficult these days. Even quitting 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.
Depending on the organisation, employees are expected to serve a specific number of days as a notice period. The employee will have to spend an additional 60 days after submitting his papers, for instance, if the notice period is 60 days.
Some employers permit early departure if the employee pays for the amount of notice days. For instance, let’s say an employee receives a better job offer that demands him to start within 30 days but the company’s 60-day notice period. In this situation, the previous employer might permit him to provide 30 days’ notice and pay for the extra 30 days’ worth of notice.
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.
According to 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.
Employees who pay for the notice period are not permitted to deduct that amount from their compensation. However, when the new employer pays for the notice period, that sum is counted toward the employee’s overall income, and the appropriate amount of tax is withheld from the employee. This means that if the new employer agrees to pay the sum due during the 60-day notice period, it will be added to the employee’s overall income. As a result, the employee will actually end up paying tax for 14 months’ worth of wages rather than just 12.
The Government has been encouraged by the ICAI to correct this loophole in the 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.