Layoffs: What to expect and Tax Implications

At the moment, employees of multinational corporations (MNCs) are being laid off in large numbers all over the world. The economy will suffer from these layoffs, and more people will lose their jobs all over the world. Find out what severance pay is and how it affects your taxes.

This document covers

1. Types of Employment
2. Types of Layoffs
   1. In Organized employment
   2. In Semi-organized employment
   3. In Unorganized employment
3. Types of Layoff Compensation in India and Taxability
4. Tax Filing after Layoff

1. Types of Employment

Depending on the type of work, most jobs can be put into three groups: organised, semi-organised, and unorganised.

1. Organized Employment:

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   • Organized Employment is when a person works for an organisation, whether it's private or run by the government, and there is an employer-employee relationship. Generally, organised employment has more job security, stability, rules, and regulations. Organized employments play the most important role in the economy. Labor laws cover people who work for a company.
2. Semi-Organized Employment:

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   • This type of work is in between organised and unorganised work. People have an employer-employee relationship in semi-organized work, but they might not get benefits from the law, and they don't have a job guarantee. When you choose semi-organized work, you give up stability for growth. Example: Startups
3. Unorganized Employment:

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   • Unorganized Employment is when people work outside of the boundaries of an employer-employee relationship. Self-employment, informal work, gig work, and casual labour are all examples of unorganised work. Labor laws don't cover people who work in unorganised jobs.
      NOTE

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   Recently with the introduction of Code on Social Security 2020, Gig & platform workers are formally recognized under labour law

2a. Different types of Layoffs in Organized employment

There are many reasons why people lose their jobs in organised work. Layoffs will be used to cut costs, make the company run better, or change the size of its operations.

1. Voluntary Retirement Scheme (VRS): Under VRS, employees can leave their jobs on their own and get a one-time payment based on the number of years they worked there. This lets companies cut the number of workers and future costs without having to lay people off.
2. Involuntary layoff: is a term for when a company fires an employee for no reason of their own. Layoffs can also happen when automation makes an employee's skills useless to the company. The company will lay off these people to save money.
3. Firing of Employees: Employees can be fired for many different reasons, such as poor performance, bad behaviour, breaking company rules, etc.
4. Termination under contract: When an employee is let go because of a contract, this will happen according to the terms that were set up when the employee was first offered a contract. This kind of layoff is a mutual breakup.

2b. Different types of Layoffs in Semi-organized employment

1. Reduction in Pay: Aka Pay Cut, An employer could cut a worker's pay if the market conditions change.
2. Closure of Business : Workers risk losing their jobs if the company they work for goes out of business because of financial difficulties, such as a lack of sales or an inability to break even.
3. Termination without notice: Employees can be terminated without notice for a variety of reasons by their employers, and the employers may not provide any benefits or notice to the employees at the time of termination.

2c. Different types of Layoffs in Unorganized employment

1. Unexpected Termination: Employees in Unorganized employment may be terminated suddenly and without notice. This may arise for several causes, including economic situations, market fluctuations, etc.
2. Reduction in Pay: Workers may earn lower wages compared to their previous pay. This is typical in industries where wages are relatively low.
3. Reduction in Work hours: Due to a lack of work, unorganised employment will experience a reduction in work hours. This will convert full-time job to part-time employment, resulting in a reduction in income.
4. Non renewal of contracts: contracts are not renewed for unorganised work. If the contract expires, the employees must hunt for new employment.

3. Types of compensation at the time of layoffs and Taxability

In India, compensation for layoffs is determined by the Industrial disputes act of 1947 or any other applicable statute.

1. Retrenchment Compensation:
   
   
   1. It is a payment made to an employee upon termination of employment or alteration of work conditions.
   2. Termination money is sometimes referred to as Severance pay.
   3. Received severance pay is taxable as profit in place of salary under the heading salaries.
   4. Retrenchment compensation is exempt under section 19 of IT Act 2025 (section 10 (10B) of IT Act 1961) subject to the lower of the following limits:
      1. 15 days average pay* completed years of service and part thereof in excess of 6 months
      2. Rs 5,00,000
2. Notice Pay:
   
   
   • Depending on the terms of employment, employers are required to offer workers with a specified amount of notice.
   • If the employer fails to provide proper notice, they must pay the notice pay for the comparable number of months.
   • It is taxable under the head "Salary".
3. Gratuity:
   
   
   • Gratuity is a lump sum payment made to employees with five or more years of service if the employer has more than 10 employees during the past 12 months.
   • Gratuity has now become a standard payment applied to all employees upon resignation or retirement.
   • For government employees’ gratuity is tax-free.
   • For other than Government employees - exempt upto Rs 20,00,000 subject to other conditions
4. Provident Fund:
   
   
   • It is a plan designed to provide large benefits to employees upon retirement or termination.
   • Employees are permitted to withdraw their contributions to the EPF along with interest. Withdrawals from provident funds are exempt from tax under Schedule II(Table: S. No. 3) of IT Act 2025 (section 10 (11) of IT Act 1961), subject to specific conditions. Yet, the accruing interest is taxable.

For Understanding, refer at @ Employee Provident Fund

5. Voluntary Retirement Receipts:
   
   
   • This is a lump sum payout the employee receives upon retiring voluntarily. It is taxable under the head "Salary"
   • Section 10(10C) provides an exemption upto Rs 5,00,000 and this deduction can be taken only once.
6. Ex-Gratia:
   
   
   • Ex-gratia is a voluntary payment made by an employer to an employee as a goodwill gesture at the time of resignation, layoff, retirement, or termination.
   • It is not statutory payment and is usually paid at the employer’s discretion or as part of a settlement agreement.
   • Ex-Gratia is taxable under the head "salary"

Refer Tax on Retirement Benefits for taxation perspective

4. Tax Filing after Layoff

Losing a job can be financially stressful, but many employees overlook an important question - Is filing Income Tax Return (ITR) mandatory after a layoff?

• The answer to above question is a big YES.
• Filing income Tax Return is mandatory if your income exceeds Basic exemption limit.
• Layoff compensation often includes multiple components such as notice pay, retrenchment compensation, leave encashment, and provident fund withdrawals. Some of these components may be partially or fully tax-exempt, which can reduce your overall tax liability
• Even if your income is below the taxable limit, filing ITR is recommended because it helps maintain financial records and supports loan, credit card, or visa applications
• Employees should collect all relevant documents such as Form 16, full and final settlement statements, and provident fund withdrawal details before filing returns. It is important to review the breakup of settlement amounts because certain components like gratuity, retrenchment compensation, and leave encashment may be eligible for tax exemption