Taking a lump sum by commuting your Indian pension

Commutation means giving up part of your future monthly pension in return for a lump sum now, and the tax on that lump sum is set by Section 10(10A). For a government employee, the commuted pension is fully exempt, there is no tax on the lump sum at all.

For a non-government employee it is a proportion. The exemption is one-third of the full commuted value of the pension if you also receive gratuity, and one-half if you do not. Full commuted value means the total lump sum you would get if you commuted the whole pension, so the exemption is calculated on that notional figure, then set against what you actually took. The practical upshot is that a large slice of the lump sum, a third or a half, comes tax-free, and only the balance is taxable. So whether you are receiving gratuity as well genuinely changes the exempt amount, which is worth knowing before you decide how much to commute.

The part of the pension you do not commute, the monthly pension you continue to draw, is treated differently. It is fully taxable as salary in your hands, at your normal rates, though because it is taxed as salary you do get the salary standard deduction against it, which softens the charge a little.

For an NRI there is a further layer worth checking. A pension for your past Indian employment is Indian-source income, so India can tax it, and an Indian payer may deduct tax at source. But many of India's tax treaties assign a private pension to the country where you now live, giving that country the sole right to tax it, so India should not. Where that applies, you claim the treaty with a tax residency certificate and Form 10F to stop or reclaim the Indian tax, though a government-service pension is often the exception and stays taxable in India. A practising CA maximises the commutation exemption, taxes the monthly pension correctly, and applies your treaty position so the pension is not taxed twice.