As discussed in our previous blog, Gratuity is one of the incomes which are partially tax-free. In general terms, gratuity is a sum of money paid by an employer to its employee at the end of the period of his/her employment as a tip for contributing to the company and is one of the many retirement benefits offered by an employer to an employee upon leaving a job. While the whole amount of gratuity is not exempted for all employees, a part of the income is exempted u/s 10(10) for every employee. We will discuss the provisions of gratuity in detail here as per the Payment of Gratuity Act, 1972 as well as the Income Tax Act, 1961:
Who is entitled to Gratuity?
If you are an employee (except apprentice) working in a factory, mine, oilfield, port, railways, plantation, shops, establishments or educational institution which has 10 or more employees on any day in the preceding 12 months, then you are entitled to gratuity. However, gratuity is entitled to even if the number of employees goes below 10 after the Act becomes applicable to your employer once.
How does Gratuity Payment Work?
An employer may at his own discretion offer a gratuity amount to its employees out of his own funds or may approach a life insurer in order to purchase a group gratuity plan. In such a case, he has to pay annual contributions as decided by the insurer. Generally, the gratuity amount is totally paid by the employer; however, in case the employee wishes to make contributions to his gratuity fund, he is free to do so. The gratuity will be then paid by the insurer based upon the terms and conditions of the group gratuity scheme.
When is Gratuity payable?
After completing five years of continuous service with the same company, you will be eligible to receive the gratuity benefit. It is payable:
- On Superannuation (or) Retirement.
- On your Resignation (or) Termination (the gratuity can be rejected in case the termination is on account of misconduct of employee)
- On death or Disablement due to accident or disease. (the sum of gratuity will be paid to the nominee or legal heir, in this case, continuous service of five years is not applicable in this case)
Tax and Gratuity
How is the amount of exemption on Gratuity Calculated?
There are three categories of employees for the calculation of exemption of Gratuity:
- Any gratuity received by an employee of the Central Government, State Government or local authority
Gratuity is wholly exempt from tax.
- Any gratuity received by a non-Government employee covered by the Payment of Gratuity Act, 1972 is exempt to the extent of lower of the following:
- 15/26 x last salary drawn x number of years in employment (i.e. 15 days’ salary x years of service).
- Maximum amount specified, i.e., Rs. 20,00,000/- [earlier it was Rs. 10 lakh]
- Gratuity actually received.
For the purpose of last drawn salary, only the basic salary and dearness allowance is taken into consideration. And for the calculation of years of service, the number of years is rounded off to the nearest full year i.e., 6 months rounding off. For instance, if you have worked for 11 years and 7 months in an organisation, your service period will be taken to be 12 years. But if your service tenure is 11 years and 5 months, then for the purpose of this calculation your tenure will be taken as 11 years only. Further, in the case of seasonal employment, gratuity shall be calculated by replacing 15 days in (a) above by 7 days.
Suppose, Mr Baid worked for a company covered under Gratuity Act for a period of 14 years and 11 months. He received an income of Rs. 5,000 per month initially and reached to Rs. 20,000 per month by retirement. Further, he received an amount of Rs. 5,00,000/- as gratuity from his employer. The amount of exemption available to him shall be lower of the following:
- 15/26 x last salary drawn x number of years in employment = 15/26 x 20000 x 15 i.e Rs. 1,73,077/-
- 20,00,000 (maximum amount specified)
- Actual gratuity received i.e. Rs. 5,00,000/-
Thus, Mr Baid is entitled to an exemption of Rs. 1,73,077/- as gratuity under income tax and the balance shall be taxable.
- Any gratuity received by a non-Government employee not covered by the Payment of Gratuity Act, 1972 is exempt to the extent of lower of the following:
- Half month’s average salary for each completed year of service, i.e., [Average monthly salary × ½] × Completed years of service.
- Gratuity actually received.
For the purpose of calculation of average salary, the basic salary, dearness allowance and commission is taken into consideration for the last 10 months preceding the month of retirement. Further, unlike above, your service period will not be rounded off to the nearest full year in this case but instead will be rounded off to completed years only. For instance, if you have a total service period of 21 years and 11 months, only 21 years will be considered for the calculation of completed years of service.
Let’s say, Mr Baid’s employer is not covered under the Gratuity Act, and his average monthly salary of 10 months immediately preceding month of retirement is Rs 30,000. In this case, the amount of exemption available to him shall be lower of the following:
- Average monthly salary × ½ × Completed years of service = 30000 x ½ x 14 i.e. Rs. 2,10,000/-
- Gratuity actually received i.e. Rs. 5,00,000/-
Thus, Mr Baid is entitled to an exemption of Rs. 2,10,000/- as gratuity under income tax and the balance shall be taxable.
Note: If gratuity is received from more than one employer either in the same year or in different years, the limit of Rs. 10,00,000/- cannot be exceeded for the total amount received from both employers.
Gratuity received: Taxable under which ‘head’ of income?
Gratuity received by you on your retirement (or) during your service period is taxable under the head “Income from Salary. If the gratuity amount becomes due and paid to the legal heir/nominee before the death of the employee, then it is taxable under the head ‘Income from Other Sources’.
We hope you can now calculate the amount of Gratuity exemption on your own. Go look at your gratuity calculation right now! Come back here and tell us about the before-and-after. We bet you’ll have something to say! And stay tuned, because we shall bring you the in and out of Provident Fund in our next blog! In any case, you still have doubt(s), drop a comment below or just contact us at [email protected] or +91-9660996655!