Mukesh Patel.in
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TAX LIABILITY OF LEGAL HEIRS

Can PF, superannuation, leave salary, gratuity & pay arrears of a deceased employee be taxed?

Benjamin Franklin said that, “Only two things are certain in life, death and taxes.” In several countries including the US and UK, taxes are not only a concern for an individual during his lifetime, but also a nightmare that continue to haunt the family of the deceased. Fortunately post 1985, legal heirs in India have no taxes to pay by way of any death duties in respect of the estate received from the deceased.

However, the taxability of various payments, in the nature of gratuity, leave encashment, superannuation, arrears of salary and the like, received by the widow or legal heir of a salaried employee, who passes away while in active service, is quite an enigma, since it stands on a different footing than in the case of an employee, who receives such amounts on retirement during his own lifetime.

EXEMPTION FOR PF & SUPERANNUATION

Sections 10(11) and 10(12) of the Income-tax Act grant total tax exemption, without any monetary ceiling, in respect of all payments representing the credit balance of an employee’s account with any statutory or recognised provident fund (PF). This exemption, which is applicable in case of retirement of an employee, would squarely apply also where PF due to an employee is paid on his death to his legal heirs.

Under Section 10(13), any payment out of an approved superannuation fund is treated as exempt, if paid either at the time of death of the employee or upon his retirement after reaching a specified age or on the employee becoming incapacitated prior to such retirement. Accordingly, superannuation payments paid to legal heirs upon death of the employee are also fully exempt.

LEAVE SALARY & GRATUITY – CBDT VIEW

Nearly 50 years ago, the Central Board of Direct Taxes (CBDT) vide its Letter No. 35/1/65-IT(B), dated 5-11-1965, took the view that, “the leave salary paid to the legal heirs of the deceased employee in respect of privilege leave standing to the credit of such employee at the time of his/her death is not taxable as salary.” A similar opinion was rendered by the CBDT under its subsequent Circular No. 309, dated 3-7-1981, wherein it was stated in regard to the taxability of cash equivalent of leave salary paid on the death of an employee that, “the Board have been advised that this receipt in the hands of the family is not in the nature of one from an employer to an employee. This payment is only by way of financial benefit to the family of the deceased. In view thereof the amount will not be liable to income-tax.”

Interestingly, the Board’s above viewpoint was rendered prior to the introduction of the statutory provisions of Section 10(10AA), which prescribe a monetary ceiling of Rs.3,00,000, where the amount is received by an employee on retirement. However, the same continues to hold good even on date, as the same has been officially cited in the I.T. Department’s own publication ‘TDS on Salaries,’ 2012 edition. Accordingly, full exemption can be claimed by the legal heirs and the employer would be duly justified in making the payment without any TDS deduction from the same.   

As regards exemption in regard to gratuity received by an employee from his employer, Section 10(10) prescribes a monetary ceiling of Rs.10,00,000, subject to an amount calculated at the rate of one half month’s salary for each completed year of service in the case of the employee.

However, in the above referred departmental publication, ‘TDS on Salaries (2012),’ relying on the CBDT Circular No. 573 dated 21-08-90, it has been noted that, “Gratuity payment to a widow or other legal heirs of any employee who dies in active service shall be exempt from income tax.” This means that the gratuity exemption in such a case can be fully availed of, irrespective of any monetary ceiling and further, no tax is required to be deducted at source by the employer making such payment.

The aforesaid 1990 Circular states that, “Clarifications have been sought from the Central Board of Direct Taxes whether 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 taxable as income under the Income-tax Act, 1961. The issue has been examined by the Board and it is clarified that any such lump sum payment will not be taxable as income under the aforesaid Act.”

The logical reasoning, for supporting the view that gratuity received by a widow or a legal heir of the deceased employee should not attract any tax, has been lucidly explained by the ITAT Madras Bench in its decision in the case of ‘Smt. L. K. Thangammal vs. ITO.’ Dealing with this situation, the Tribunal held that, “Gratuity will be includible in the assessment of the legal representative, only if it had accrued to the deceased before death. The right to receive gratuity arose on account of death and became payable thereafter and hence it was not includible in the widow’s hands as the legal representative of the deceased.”

Similarly, if after the death of an employee, arrears come to be sanctioned upon pay revision that is undertaken by the employer after the employee’s life time and the widow receives such pay arrears, its character can be treated as a capital receipt not liable to tax. In this case, the accrual of income being after death, it cannot be treated as arising out of employment, because there is no employer-employee relationship between the employer and the deceased or as between the employer and the widow on the date of accrual.

 

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