VRS Tax-Free? Here’s How You Can Save Up to ₹16 Lakh Under New Draft Income Tax Rules 2026

Synopsis: This article discusses what the new draft rules are, how they are changing the taxation of VRS, the eligibility to claim tax exemption on VRS income, how VRS is calculated, and other important conditions to know related to VRS.

Voluntary Retirement Schemes (VRS) have been a primary way for employees to exit the workforce early. When employees opt to leave, employers usually offer VRS in a lump sum to support the employee. Data shows that the corporate VRS expenses exceeded ₹1,000 cr over 12 months ending in December 2025, indicating the rise in voluntary retirement even during the economic slowdown.

What is New in the 2026 Draft Rule?

The Draft Income Tax Rules, 2026, were issued to support the implementation of the New Income Tax Act, 2025, which will take effect on April 1, 2026. While under the old rule, VRS income up to ₹5 lakh was exempt from taxation, under the new Draft Tax Rules, an employee can claim a complete deduction on either the 3 months’ salary for every year completed or the salary payable for the remaining months of service until retirement, whichever is lower.

Eligibility Criteria to be met for Tax Exemption

1. Eligible Employers: VRS from the following authorised employers are eligible for tax exemption
   • Companies
   • Local Authorities
   • Co-operative societies
   • Universities
   • Other institutions recognised under the Income Tax Framework.
2. Minimum service and age: At the time of applying for the VRS, the employee should have completed at least 10 years of continuous service or be at least 40 years of age to claim the deduction.
3. Workforce reduction: When an employee chooses VRS, the vacancy created should not be filled to frame the retirement as a move to reduce the workforce. This is to ensure that the benefit of the exemption is not misused.
4. Re-employment: The retired employee should not be re-employed by the same employer or any other entity working for the same employer. 

Note: Failing to meet these requirements will result in disqualification for the VRS tax exemption.

Also read: 7 Flexi Cap Mutual Funds That Delivered Over 20% CAGR in the Last 5 Years to Keep an Eye On

How is the VRS Amount Calculated under the New Draft Rules, 2026?

The amount eligible for tax deduction can be calculated in two alternative ways, and whichever is lower is exempted. Let’s consider that A and B are the two amounts, and the lower value is tax-exempt.

• A = 3 × N × S
• B = M × S

Here, N= number of years of continuous service completed, M =number of months until the employee’s retirement, and S = salary the employee received at the time of retirement. 

Here’s How You Can Save More Than ₹16 Lakh on VRS under the proposed New Draft Rules 2026.

Let’s consider an individual with a monthly salary (S) of ₹2 lakh, who has completed 15 years of service (N) and has left 30 months before normal retirement (M).  Here,

• A = 3 × N × S = 3 × 20 × ₹2,00,000 = ₹90,00,000
• B = M × S = 36 × ₹1,00,000 = ₹60,00,000

The value of B is lower than that of A. Therefore, according to the new draft rules, the employee can claim a tax deduction of ₹60 lakh. The remaining amount is taxable, subject to the new tax rules, which are yet to be officially notified. 

If the employee were to follow the old rules, VRS up to ₹5 lakh is exempt. The remaining ₹55 lakhs will be taxed at income tax slab rates of 30%. which is ₹55,00,000 × 30% =  ₹16,50,000. Hence, the employee saved around ₹16.5 lakh of VRS income from tax.

Other Important Conditions to Know

• Dearness Allowance can be included in the calculation of VRS if, according to the terms of employment, it is considered as a component of the retirement benefits.
• Other allowances and benefits, such as HRA, bonuses, commissions, leave encashment, etc., are not included in the calculation of the VRS amount exempt.
• The VRS should be officially sanctioned by the employer. Informal or negotiated exit arrangements won’t be qualified for tax exemption.

Conclusion

On comparing the old rules and the draft rules 2026, it’s evident that the tax benefits remain the same, but they can be claimed only if the conditions are met. Earlier, the VRS income was treated as an exemption; under the draft rules 2026, it is considered as deductions which can be claimed upon fulfilling the requirements.

Written by Nila Maria Jacob