Profits in Lieu of Salary and Accumulated Balances

Understand Profits in Lieu of Salary and Accumulated Balances

Key rules to remember

Profits in lieu of salary: test

Payment because of employment (before, during, on ending or on changing terms) − specific exemption = taxable under Salaries

Always check whether a separate exemption applies, for example gratuity, retrenchment compensation or approved voluntary retirement payment. Taxable only to the extent not exempt.

Exclusion of RPF accumulated balance (Sch. XI Pt A, para 8(1))

Excluded if: (a) continuous service ≥ 5 years; or (b) service ended by ill-health / contraction or closure of business / other cause beyond employee's control; or (c) transferred to new employer's recognised PF (to the extent transferred); or (d) entire balance moved to a notified pension scheme under section 124

Clauses (a) and (b) are alternatives. Clause (c) excludes only the amount actually transferred.

Service period when balance is transferred (para 8(2))

Continuous service = service with present employer + service with earlier employers whose balances were transferred in

Use this when the balance includes amounts transferred from previous recognised funds.

Tax when exclusion fails (para 9)

Extra tax = Σ (tax for each year as if the fund were not recognised) − Σ (tax actually paid for those years)

The extra tax is payable in the tax year in which the balance becomes payable, in addition to other tax.

TDS on such balance (para 10)

Trustees or the authorised person deduct the para 9 amount at payment; Chapter XIX-B applies as if the balance were salary

Applies only where para 9 applies.

Interest above the notified rate (para 6)

Interest credited at a rate above the Central Government notified rate = deemed received by employee and taxable in that tax year

After the 2026 amendment, para 6 deals only with excess interest. The old 12% employer-contribution test is no longer in its text.

Employee's own contribution (para 7)

Deduction as determined under section 123

Relief is for the employee's contribution in the tax year, not for the balance paid out.

How to solve Profits in Lieu of Salary and Accumulated Balances questions

1. 1Identify the receipt: is it compensation, a payment before joining or after leaving, or a fund payout? Note who pays and why.
2. 2For a non-fund payment, ask if it arises from employment or its termination or change in terms. If yes, treat it as profit in lieu of salary.
3. 3Check for a specific exemption (gratuity, retrenchment compensation, approved voluntary retirement). Tax only the non-exempt part.
4. 4For a provident fund, first confirm the fund is recognised. The para 8 rules are for recognised funds only.
5. 5Test para 8 in order: five years of continuous service (add earlier service whose balance was transferred in), then ill-health or business closure or other cause beyond control, then transfer to a new recognised fund, then transfer to a notified pension scheme.
6. 6If any test is met, state that the balance is excluded to that extent. If none is met, apply para 9 and mention TDS under para 10.
7. 7Check for excess interest under para 6 and for the employee's own contribution deduction under para 7 if the facts mention them.
8. 8Write the conclusion clearly: amount taxable, head of income and reason.

Quickest way: Four-gate check for the PF balance

Common mistakes in Profits in Lieu of Salary and Accumulated Balances

• Treating every termination payment as exempt.

  Students remember that retrenchment compensation and gratuity are exempt and extend this to all payments.

  Fix: Treat compensation as taxable profit in lieu of salary by default. Exempt only the part that a specific provision covers.

• Applying the five-year rule to an unrecognised fund.

  Students recall the rule and forget that Schedule XI Part A applies to recognised funds.

  Fix: State first whether the fund is recognised. Then apply para 8.

• Ignoring earlier service when the balance was transferred.

  Students count only service with the present employer.

  Fix: Under para 8(2), add service with previous employers whose balances were transferred into the account.

• Taxing the whole balance in the year of payment at the normal rate.

  Students overlook the method in para 9.

  Fix: Recompute tax for each earlier year as if the fund were not recognised, deduct the tax already paid, and charge the difference.

• Excluding the full balance when only part is transferred to the new employer's fund.

  Students read the transfer rule as all or nothing.

  Fix: For a transfer to a new recognised fund, only the amount actually transferred is excluded. For the pension scheme route, the entire balance must be transferred.

• Forgetting that payments before joining or after leaving can be salary-type income.

  Students link salary only to the period of service.

  Fix: Look at the reason for the payment, not the date. Payments due or received from an employer or former employer because of the employment fall in this topic.

Worked examples