Chapter IV - Computation of Total Income
Section 18
Section 18: profits in lieu of salary
Section 18 defines "profits in lieu of salary" - amounts an employee (or ex-employee, or future employee) receives that are connected to employment but aren't ordinary salary as such, most commonly compensation on termination or payments made before joining or after leaving a job.
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This article is for general information. Refer to the Income-tax Act, 2025 as amended by the Finance Act, 2026 and the Taxation and Other Laws (Amendment) Act, 2026 for the official provisions. If you need professional advice for your situation, contact Bizeneed.
Statutory text
Bare law
(1) For the purposes of this Part, “profits in lieu of salary” includes,— (a) the amount of any compensation due to, or received by, an assessee from his employer or former employer at or in connection with the— (i) termination of his employment; or (ii) modification of the terms and conditions relating thereto; (b) any amount due to, or received, whether in lump sum or otherwise, by any assessee from any person— (i) before his joining any employment with that person; or (ii) after cessation of his employment with that person; (c) any payment due to or received by an assessee— (i) from an employer or a former employer; or (ii) from a provident or other fund, to the extent to which it does not consist of contributions by the assessee or interest on such contributions; or (iii) any sum received under a Keyman insurance policy as defined in Schedule II (Note 1), including the sum allocated by way of bonus on such policy.
(2) The payment referred in sub-section (1)(c) shall not include any payment referred to in–– (a) Schedule II (Table: Sl. No. 3); (b) Schedule II (Table: Sl. No. 4); (c) Schedule II (Table: Sl. No. 8); and (d) Schedule III (Table: Sl. No. 11).
Introduction
Employment can produce payments outside regular wages, including compensation connected with a changed or ended employment relationship. Section 18 determines which of those payments count as profits in lieu of salary.
Key takeaways
Employment-linked compensation
Profits in lieu of salary include specified amounts received from an employer or former employer on termination or changes to employment terms.
Before or after employment
Specified payments connected to a person before joining or after leaving employment may also fall within this definition.
Statutory exclusions
The section excludes particular payments listed in Schedules II and III; the precise exception should be checked before classifying a receipt.
What is included
Section 18(1) treats the following as "profits in lieu of salary":
- Compensation due to or received by an assessee from an employer or former employer, in connection with the termination of employment or a modification of its terms and conditions
- Any amount due to or received (lump sum or otherwise) by an assessee from any person, before joining employment with that person, or after ceasing employment with that person
- Any payment due to or received by an assessee from an employer/former employer, or from a provident or other fund, to the extent it does not consist of the employee's own contributions or interest on those contributions
- Any sum received under a Keyman insurance policy (as defined in Schedule II, Note 1), including bonus allocated on such a policy
What is excluded
Section 18(2) excludes certain payments referred to in Schedule II (Table entries at serial numbers 3, 4 and 8) and Schedule III (Table entry at serial number 11) from being treated as "profits in lieu of salary" under section 18(1)(c).
Trace why the payment arose
Review the employment agreement, settlement and payment record to identify whether an amount replaces salary or compensates for termination or changed terms.
Apply the section's exclusions and related provisions separately; a payment's label alone does not decide its tax head.
Step-by-step flow for applying Section 18
- 1
Who paid the amount and why?
Section 18 looks at receipts from an employer, former employer, prospective employer, a provident or other fund, or under a Keyman insurance policy.
- 2
Is it compensation on termination or on modification of employment terms?
- Yes: Profits in lieu of salary under Section 18(1)(a).
- No: Go to the next step.
- 3
Was it received from a person before joining employment with that person, or after cessation of employment with that person?
- Yes: Profits in lieu of salary under Section 18(1)(b).
- No: Go to the next step.
- 4
Is it any other payment from an employer, a fund (beyond the employee's own contributions and interest on them) or a Keyman insurance policy (including bonus)?
- No: Not covered by Section 18; examine other provisions.
- Yes: Go to the next step.
- 5
Is the Section 18(1)(c) payment one referred to in Schedule II (Sl. Nos. 3, 4 or 8) or Schedule III (Sl. No. 11)?
- Yes: Excluded from profits in lieu of salary by Section 18(2).
- No: Profits in lieu of salary under Section 18(1)(c).
Practical checklist
Do
- Keep termination, modification and settlement documents with the payment computation.
- Identify the precise statutory limb before reporting a one-time employment payment.
Avoid
- Do not automatically classify all compensation as capital or exempt.
Illustrative example
Worked example: a joining amount and a compensation for changed terms
Hypothetical facts (illustration only, not a real taxpayer): Mr. Das receives ₹5,00,000 from his former employer as compensation for a change in his employment terms before he resigned. He also receives ₹3,00,000 from his new employer a month before he joins.
Compensation from former employer
Compensation from an employer or former employer in connection with modification of the terms and conditions of employment falls in Section 18(1)(a)(ii).
Amount from new employer before joining
An amount received from a person before joining employment with that person falls in Section 18(1)(b)(i), whether lump sum or otherwise.
Schedule exclusions
The Section 18(2) exclusions apply only to payments under clause (c). Neither receipt here is a clause (c) payment.
Total
₹5,00,000 + ₹3,00,000 = ₹8,00,000 treated as profits in lieu of salary.
Outcome
- ₹8,00,000 is profits in lieu of salary for the tax year.
- Keep the settlement letter and offer letter, since the reason for each payment decides the clause.
Glossary
- Profits in lieu of salary
- Specified payments connected to employment that Section 18 treats as part of the salary head instead of ordinary wages.
Frequently asked questions
Is a termination or severance payment taxable?
Compensation received from an employer/former employer in connection with termination of employment (or a change in its terms) is included as "profits in lieu of salary" under Section 18(1)(a), and is therefore chargeable to tax as salary income, subject to any applicable Schedule II/III exclusions.
Is a joining bonus paid before I start work taxable as salary?
Yes - Section 18(1)(b) includes amounts due to or received by an assessee from a person before joining employment with that person.
Need help applying this provision to your situation?
Talk to our tax team about this sectionLast updated 10 October 2026