Not every payment from an employer is called salary. But some payments can still be taxed as salary.
That is where profit in lieu of salary becomes important. It can cover payments connected with termination, changes in employment terms, payments before joining or after leaving employment, certain fund payments and specified Keyman insurance receipts.
Profit in lieu of salary is one of the less understood components of salary income. It does not necessarily represent the regular salary credited every month. Instead, the Income-tax Act, 2025 specifically brings certain employment-related receipts within the definition of salary.
Under the new Act, Section 16 provides that salary includes profits in lieu of, or in addition to, salary or wages. The detailed definition of profits in lieu of salary is contained in Section 18.
This distinction matters because the definition is wider than termination compensation alone. Depending on the circumstances, amounts received before joining employment, after cessation of employment, from an employer or former employer, from certain funds, and specified Keyman insurance receipts can also fall within the statutory definition.
What is Profit in Lieu of Salary?
Profit in lieu of salary refers to specified amounts that are treated as salary income under the Income-tax Act, 2025, even though they may not be received as regular salary or wages.
- Compensation connected with the termination of employment or modification of the terms and conditions of employment can be covered.
- Certain amounts received before joining employment or after cessation of employment can be covered.
- Specified payments received from an employer, former employer or provident or other fund can be covered, subject to the exclusions provided by the Act.
- Specified amounts received under a Keyman insurance policy, including bonus allocated under the policy, can also be covered.
Where a receipt falls within Section 18 and is not excluded by the statutory provisions, it forms part of income chargeable under the head “Salaries”, subject to the applicable exemptions, deductions and other provisions of the Income-tax Act, 2025.
Section 16 includes profits in lieu of salary within salary, while Section 18 defines profits in lieu of salary under the Income-tax Act, 2025.
What Is Profit in Lieu of Salary?
The expression profit in lieu of salary covers specified payments that are treated as salary for income-tax purposes, even though they may not be part of an employee’s regular salary or wages.
The important point is that tax treatment depends on the nature and circumstances of the payment rather than merely the label given to it. A payment described as compensation, settlement, ex-gratia or another name may fall within Section 18 if the statutory conditions are satisfied.
Section 16 of the Income-tax Act, 2025 expressly includes profits in lieu of, or in addition to, any salary or wages within the meaning of salary.
Section 18: Profits in Lieu of Salary
Section 18 of the Income-tax Act, 2025 provides an inclusive definition of profits in lieu of salary. The provision covers several distinct categories of employment-related receipts.
Termination or Modification
Compensation due to or received from an employer or former employer in connection with termination of employment or modification of employment terms.
Before or After Employment
Certain amounts received from a person before joining employment or after cessation of employment with that person.
Employer or Fund Payments
Specified payments from an employer, former employer or provident or other fund, subject to the statutory exclusions.
Keyman Insurance
Specified sums received under a Keyman insurance policy, including the amount allocated by way of bonus on the policy.
Components of Profit in Lieu of Salary
Section 18 can be understood through the following categories. Each category has a different factual trigger, so the nature of the receipt should be established before determining its tax treatment.
1. Compensation on Termination of Employment
Section 18 includes compensation due to or received by an assessee from an employer or former employer at or in connection with the termination of employment.
This is the category most commonly associated with profit in lieu of salary. It may cover a payment made when the employment relationship comes to an end, provided the payment satisfies the statutory conditions.
Termination compensation
An employee receives ₹8 lakh from the former employer in connection with termination of employment. If the payment falls within Section 18(1)(a), it is included within the statutory definition of profit in lieu of salary.
The employee must then examine whether any deduction is available under Section 19 or another applicable provision before determining the final taxable amount.
2. Compensation for Modification of Employment Terms
Profit in lieu of salary is not restricted to termination payments. Section 18 also covers compensation connected with the modification of the terms and conditions of employment.
Therefore, employment does not necessarily have to end for a payment to fall within this category.
Compensation for changed employment terms
An employee receives ₹5 lakh from the employer in connection with a modification of the terms and conditions of employment. If the payment satisfies Section 18(1)(a), it can constitute profit in lieu of salary.
3. Payments Before Joining or After Leaving Employment
Section 18 also covers amounts due to or received, whether in lump sum or otherwise, from a person:
- before joining employment with that person; or
- after cessation of employment with that person.
This provision is significant because it demonstrates that the statutory concept is not restricted to payments received during the period of active employment.
A payment received before joining or after leaving employment does not become taxable merely because of its timing. It must satisfy the conditions of Section 18 and any other applicable provisions.
4. Payments from an Employer, Former Employer or Fund
Section 18 also covers specified payments due to or received by an assessee from an employer or former employer, or from a provident or other fund, to the extent specified in the provision.
In the case of payments from a provident or other fund, the provision specifically refers to the extent to which the amount does not consist of the assessee’s own contributions or interest on those contributions.
The entire amount received from a fund should not automatically be treated as profit in lieu of salary. The source and composition of the payment must be examined along with the exclusions specified under Section 18.
5. Amount Received Under a Keyman Insurance Policy
Section 18 also includes a sum received under a Keyman insurance policy, including the sum allocated by way of bonus on the policy.
The expression Keyman insurance policy is linked to the definition contained in Schedule II of the Income-tax Act, 2025.
Therefore, where a receipt is connected with a Keyman insurance policy, its classification should be examined under the specific provisions governing such policy before determining the tax treatment.
Taxability of Profit in Lieu of Salary
Profit in lieu of salary is not a separate head of income. Section 16 includes profits in lieu of salary within the definition of salary.
Included under the head “Salaries”
Where a receipt falls within Section 18 and is not excluded or otherwise dealt with by a specific provision, it forms part of salary income and is considered under the head “Salaries”.
However, it is important not to conclude that every amount falling within Section 18 is necessarily taxable in full.
The Income-tax Act, 2025 contains specific provisions dealing with deductions from salary. Therefore, the correct tax computation is based on the nature of the receipt, the statutory exclusions and the deductions available under the Act.
| Receipt / Situation | Section 18 treatment | Tax computation |
|---|---|---|
| Compensation connected with termination | May constitute profit in lieu of salary. | Check applicable deduction under Section 19 and other relevant provisions. |
| Compensation connected with modification of employment terms | Covered where the statutory conditions are satisfied. | Included in salary, subject to applicable provisions. |
| Amount received before joining employment | Covered where Section 18(1)(b) applies. | Tax treatment depends on the statutory provisions applicable to the receipt. |
| Amount received after cessation of employment | Covered where Section 18(1)(b) applies. | Consider the nature of receipt and applicable deductions/exclusions. |
| Payment from provident or other fund | Covered to the extent specified by Section 18. | Own contributions and interest thereon are treated according to the statutory wording and exclusions. |
| Keyman insurance receipt | Specified receipts are included under Section 18. | Tax treatment is subject to the applicable provisions of the Act. |
Since profit in lieu of salary forms part of income under the head “Salaries”, the timing of its taxation needs to be considered along with the salary chargeability provisions.
Under Section 15, salary is generally chargeable on a due basis or receipt basis, whichever is earlier. The provision also covers salary paid or allowed by an employer before it becomes due and qualifying salary arrears not charged to tax in an earlier Tax Year.
The date on which an employment-related amount is credited to a bank account is not necessarily the only factor that determines its taxability. The relevant due date, receipt and the specific statutory provision governing the payment should also be examined.
Exclusions, Exemptions and Deductions
One of the most important aspects of profit in lieu of salary is the distinction between being covered by Section 18 and the amount that ultimately becomes taxable.
Section 18(2) specifically provides that certain payments referred to in Section 18(1)(c) are not included within profit in lieu of salary. Therefore, the statutory exclusions must be checked before determining the tax treatment of a receipt.
The correct tax treatment requires three separate checks: first, whether the receipt falls within Section 18(1); second, whether any exclusion under Section 18(2) applies; and third, whether a specific exemption or deduction is available under another provision of the Act.
In addition, Section 19 provides deductions from income chargeable under the head “Salaries” for specified receipts, subject to the conditions, limits and calculations prescribed in that section. These include, among others:
- specified gratuity receipts;
- specified payments in commutation of pension;
- qualifying retrenchment compensation;
- qualifying voluntary retirement or termination compensation; and
- specified leave salary received on retirement.
The amount deductible depends on the relevant entry in Section 19 and the conditions and limits prescribed for that particular receipt. Therefore, not every termination-related payment is automatically exempt or deductible.
A receipt may fall within the statutory definition of profit in lieu of salary, while a specific exclusion, exemption or deduction may subsequently affect the amount chargeable to tax. The two questions should therefore be analysed separately.
Relief under Section 157
A salary receipt relating to more than one period can sometimes increase the tax burden because the income is brought to tax in a single Tax Year.
The Income-tax Act, 2025 provides specific relief under Section 157 in circumstances involving salary received in advance or arrears and specified receipts such as gratuity, retrenchment compensation and commutation of pension.
For income governed by the Income-tax Act, 2025, the Income Tax Department provides Form 39 for claiming relief under Section 157. The corresponding relief under the Income-tax Act, 1961 was claimed through Form 10E under Section 89.
This relief should not be confused with an exemption. It is intended to address the additional tax burden that may arise when eligible income relating to different periods is effectively bunched into a particular Tax Year.
Accordingly, Section 157 relief is not a general relief for every receipt that qualifies as profit in lieu of salary. The nature of the receipt and the specific conditions prescribed under Section 157 must be examined before claiming the relief.
Practical Examples
Termination compensation
An employee receives ₹8 lakh from a former employer in connection with termination of employment.
If the payment falls within Section 18(1)(a), it is included within the definition of profit in lieu of salary. The employee must then examine the relevant deduction under Section 19 and other applicable provisions to determine the taxable amount.
Payment before joining
A company pays ₹2 lakh to an individual before the individual formally joins the company.
If the payment satisfies Section 18(1)(b), the fact that the individual had not yet joined employment does not by itself prevent the amount from being treated as profit in lieu of salary.
Payment after leaving employment
An employee leaves a company in June and receives an employment- related amount from that person in December.
The fact that the employee was no longer working for the company when the payment was received does not automatically make the amount non-taxable. Section 18 specifically covers certain amounts received after cessation of employment.
Profit in Lieu of Salary vs Salary vs Perquisite
Profit in lieu of salary, regular salary and perquisites are related concepts, but they should not be treated as interchangeable.
| Particular | Regular Salary | Profit in Lieu of Salary | Perquisite |
|---|---|---|---|
| Nature | Regular employment remuneration. | Specified employment-related receipts. | Specified benefits or amenities connected with employment. |
| Typical example | Basic salary or wages. | Termination compensation. | A taxable benefit or amenity provided by the employer. |
| New Act provision | Section 16. | Section 18, read with Section 16. | Section 17, read with Section 16. |
| Tax head | Salaries. | Salaries. | Salaries. |
Employer Reporting of Profit in Lieu of Salary
Profit in lieu of salary is also relevant from an employer reporting and TDS compliance perspective. Under Section 392(5)(a) of the Income-tax Act, 2025, the person responsible for paying income chargeable under the head “Salaries” is required to furnish prescribed particulars of perquisites and profits in lieu of salary, along with their value.
Under the Income-tax Rules, 2026, Form 123 is the prescribed statement showing particulars of perquisites, other fringe benefits or amenities and profits in lieu of salary, together with their value.
Employees should reconcile employment-related receipts with the salary information, TDS certificate and other information reported by the employer before filing their income-tax return. Any difference should be reviewed against the underlying payment and the applicable tax provisions.
Key Takeaways
- Profit in lieu of salary is part of salary income and is not a separate head of income.
- Under the Income-tax Act, 2025, Section 16 includes profits in lieu of salary within salary.
- Section 18 contains the statutory definition of profits in lieu of salary.
- The definition is wider than termination compensation.
- Certain payments before joining employment or after cessation of employment can fall within Section 18.
- Specified payments from an employer, former employer or provident or other fund may also be covered.
- Specified Keyman insurance receipts are included within Section 18.
- Section 18 inclusion should not automatically be equated with final taxable income because statutory exclusions and deductions may apply.
- Section 19 provides deductions for specified salary-related receipts including certain gratuity, retrenchment compensation, VRS and leave-related payments.
- Section 157 provides relief in specified circumstances where eligible receipts create an additional tax burden because of bunching of income.
Frequently Asked Questions
Is profit in lieu of salary taxable?
Amounts that fall within the statutory definition are included within salary income, subject to applicable exclusions, deductions and other provisions of the Act.
Which section covers profit in lieu of salary under the Income-tax Act, 2025?
Section 18 defines profits in lieu of salary. Section 16 includes profits in lieu of salary within the definition of salary.
Is termination compensation profit in lieu of salary?
Compensation due to or received from an employer or former employer in connection with termination of employment can fall within Section 18(1)(a), subject to the statutory provisions and applicable deductions.
Is a payment received after leaving a job taxable?
Certain amounts received after cessation of employment are specifically covered by Section 18(1)(b). The fact that the person is no longer an employee does not by itself determine the tax treatment.
Can a payment received before joining employment be profit in lieu of salary?
Yes. Section 18(1)(b) specifically covers certain amounts due to or received from a person before joining employment with that person.
Is profit in lieu of salary different from a perquisite?
Yes. Perquisites are dealt with under Section 17, while profits in lieu of salary are dealt with under Section 18. Both form part of salary under Section 16.
Can relief be claimed when a large employment-related receipt increases tax?
Potentially. Section 157 provides relief in specified circumstances involving salary arrears or advance and certain other eligible receipts. For the new Act, Form 39 is used for claiming the prescribed relief.
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