The Double Whammy of Leaving Early
When you resign from a job but can't serve the full notice period, your employer will usually recover "notice period pay" from your full and final (F&F) settlement.
For example, if your monthly salary is ₹1 lakh and you leave a month early, the company deducts ₹1 lakh from your final payout.
But here is the painful question: Do you still have to pay income tax on that ₹1 lakh, even though you never received it?
Unfortunately, the answer under Indian tax law is usually Yes.
Why You Are Taxed on Money You Didn't Get
The Income Tax Act taxes salary on a "due or receipt basis, whichever is earlier."
When your employer generates your payslip, the salary becomes "due" to you. The deduction for the unserved notice period is treated as an internal settlement or a breach of contract penalty, not a reduction in your gross salary.
Therefore, your Form 16 will likely show your gross salary including the notice period pay, and TDS will be deducted on that higher amount.
The Legal Gray Area
This issue has been a point of contention. Some tax tribunals (like the Ahmedabad ITAT in the case of Nandinho Rebello) have ruled in favor of employees, stating that tax shouldn't be levied on income that never actually materialized.
However, the Income Tax Department has not issued a blanket circular accepting this. Because the standard ITR forms do not have a specific column to deduct "notice period recovery," claiming this deduction manually is risky and highly likely to trigger a scrutiny notice.
Salary is taxed on a "due or receipt, whichever is earlier" basis, so the gross amount is taxed even if the notice-period recovery never reached your bank. Source: Income Tax Act Section 15; Nandinho Rebello v. DCIT, Ahmedabad ITAT.
What Happens When Your New Employer Buys It Out?
Often, the company hiring you will offer to "buy out" your notice period by reimbursing you for the amount recovered by your old employer.
This creates a double taxation scenario: 1. Old Employer: Taxes you on the gross salary (including the recovered amount). 2. New Employer: Adds the buyout reimbursement to your new salary, taxing it again as a perquisite or bonus.
How to Handle This While Filing ITR
For most salaried individuals, the safest approach to avoid tax notices is to file exactly as per the Form 16 issued by the old employer.
If the amount is very large and you wish to rely on tribunal rulings to claim a deduction, you should consult a Chartered Accountant to help you file and prepare a legal response if a notice arrives.
What you should do
- Read Part B of your old employer's Form 16 to see whether the recovery was netted off
- For a normal-sized recovery, file exactly as the Form 16 reports to stay matched with AIS
- Only attempt a deduction with a CA's help and solid documentation if the amount is large
Common mistake
Quietly reducing your salary by the recovered amount in the ITR. Your declared salary then falls below the employer's AIS figure, almost guaranteeing a mismatch query.
For standard filing, uploading your Form 16s to LastMinute ITR will ensure your taxes are calculated exactly as reported by your employers, keeping you compliant with the portal's automated checks.