• Feb
  • 16
  • 2011

How to Calculate Gratuity and its Tax Treatment after recent amendments

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How to Calculate Gratuity

a)     In respect of Employees covered Under the Payment of Gratuity Act, 1972:

As per the Act, the gratuity amount is 15 days’ wage multiplied by the number of years put in by you. Here wage refers to basic salary plus dearness allowance. Take the monthly salary drawn by you last (basic + dearness allowance) at the time of resignation or retirement. Divide this by 26. This gives you your daily salary. Multiply this amount by 15 days, and further by the number of years of service you have put in.

If you have put in 10 years and seven months in an organisation, your service period will be taken to be 11 years. But if your service tenure is 10 years and five months, then for the purpose of this calculation your tenure will be taken to be 10 years only.

Take an example. Suppose that your average monthly salary is Rs 26,000. Your daily salary will be Rs 1,000. Multiply this by 15 and then by 10. The gratuity you are entitled to after 10 years of service will be Rs 1.5 lakh.

Formula :- Gratuity shall be calculated as per the below formula:

Gratuity = Last drawn salary x 15/26 x No. of years of service

Your last drawn salary will comprise your basic + DA. For computation of gratuity, your service period will be rounded off to the nearest full year.

b)     In respect of Employees not covered Under the Payment of Gratuity Act, 1972:

For non-government employees, who are not covered under this Act, the manner of calculating gratuity is different. First, the average salary is calculated: for this the average of last ten months’ salary is taken (this will include the basic plus dearness allowance plus commission as a percentage of turnover achieved by the employee). Divide this average salary by 30 (ignore fractions). Now, multiply this amount by 15 and further with the number of years of service put in. Dividing the daily salary by 30 instead of 26 does put those not covered by the Gratuity Act at a disadvantage.

Formula :- Gratuity shall be calculated as per the below formula

Gratuity = Last drawn salary x ½ x No. of years of service

Your last drawn salary will comprise your basic + DA+ commission on sales on turnover basis. For computation of gratuity, your service period will not be rounded off to the nearest full year. While calculating completed years, any fraction of the year will be ignored. For instance, if the employee has a total service of 20 years, 10 months and 25 days, only 20 years will be factored into the calculation.

What is the Tax treatment of Gratuity?

For the purpose of exemption of gratuity under sec.10 (10) the employees are divided under three categories:

A) In Respect of Government Employees

Any death cum retirement gratuity received by Central and State Govt. employees, Defense employees and employees in Local authority shall be exempt.

B) In Respect of Non Government Employees covered by Payment of Gratuity Act

Gratuity amount received by non government employees covered by the Payment of Gratuity Act is tax free up to the least amount of the following:

  • Amount of gratuity paid, or
  • 15 days salary for every completed year of employment (salary is the amount of last salary drawn)
  • Rs 10 lakh (Increased from Earlier limit of Rs. 3.50 Lakh  w.e.f. 24.05.2010)

C) In Respect of Voluntary Payment of Gratuity to Employees not covered by Payment of Gratuity Act

Where companies pay gratuity voluntarily to employees who are not eligible to receive gratuity under the Act, such amount is tax free up to the least amount of the following:

  • Amount of gratuity paid, or
  • Half month’s salary for every completed year of employment (salary is average salary received in the last 10 months of service.)
  • Rs 10 lakh (Increased from Earlier limit of Rs. 3.50 Lakh  w.e.f. 24.05.2010)

Ø      The exemption in respect of gratuity is permissible even in cases of termination of employment due to resignation. The taxable portion of gratuity will qualify for relief u/s 89(1). Gratuity payment to a widow or other legal heirs of any employee who dies in active service shall be exempt from income tax subject to provisions mentioned above.

Ø      The ceiling of Rs.10 lakh applies to the aggregate of gratuity received from one or more employers in the same or different years.

Under What head it is Taxable?

Gratuity received by an employee on his retirement is taxable under the head “Salary” and gratuity received by the legal heir is taxable under the head” Income from Other Sources”.

Frequently Asked Question:-

QUESTION:

I am a pensioner from Maharashtra State Government. I retired in 2009 receiving an amount of Rs. 300,000 as gratuity. But I received a further amount of Rs. 6.50 lakhs in December 2010 consequent on revision of pay. At the time of my retirement the exemption limit was Rs. 3.50 lakh. Am I eligible for the higher exemption limit under Sec. 10(10) available at the time of receipt? The higher limit of Rs. 10 lakhs is raised from 24th May 2010.

ANSWER:

Every time the limit has been raised, such limit has only referred to the retirement on or after the date on which it was raised. Hence the limit on the date of retirement time would alone have to be considered. The present limit is Rs. 10 lakhs for exemption under Sec. 10(10)(iii) vide Notification No. 43/2010 [F.No.200/33/2009-ITA.I], dated 11-6-2010 for retirees after May 23, 2010, so that the exemption with reference to the enhanced limit will not apply to the reader’s case. It is stated that the reader is a government pensioner. There is no ceiling for Central or State pensioners. If the reader is a retiree from the civil service of a State or held a civil post under a State or had even been an employee of a local authority, the gratuity amount, that is received, is totally exempt vide Sec. 10(10)(i) of the Income-tax Act irrespective of the date of retirement or the notification.


5 Responses to “How to Calculate Gratuity and its Tax Treatment after recent amendments”

  1. pavan agrawal says:

    Hello

    If i complete 4 year 7 months in a company and than resign , will i be eligible for gratuity , i mean to say that rounded off rule is applicale to gratuity eligiblity or not.

  2. Manish says:

    In gratuity formula (Basic + da) x 15 x no of years of service / 26

    what stands for 26 taken for dividation.

  3. Bhartesh says:

    Can you please elaborate the difference between

    In Respect of Non Government Employees covered by Payment of Gratuity Act

    and

    In Respect of Voluntary Payment of Gratuity to Employees not covered by Payment of Gratuity Act

    Thx

  4. srikanth says:

    sir am ksrtc employee of karnataka state i got retire on 30-09-2012 and received gratuity of rs 1200000 whether it is taxable r not

  5. raj malhotra says:

    sir i have few queries for you. please provide a solution.
    sir,

    i was a public sector bank employee. i retired in year 2006. i received gratuity payment in 2007. again gratuity as arrears is received by me in december 2010. i would like to ask you Whether the concept of pension (defined or otherwise) makes any distinction between the pension benefit available to Central Government employees and Public Sector Banks or Public Sector Undertakings?
    whether public sector bank employee are central or state employees for purpose of graduity treatment?

    2. Is it a fact that the ceiling of gratuity payable to Central Government Employees has been enhanced from Rs. 3.5 lac to Rs. 10 lac with effect from 01/01/2006?

    3. Is it also a fact that gratuity payable to employees of Public Sector Banks, Public Sector undertakings and other organizations has been enhanced from Rs.3.5 lac to Rs.10 lac w.e.f 24/05/2010?

    sir i would like to know whether public sector bank employee can claim an exemption of 10 lakhs where he has retired in year dec 2006 as this celing has been enhanced with retrospective effect from 1.1.2006.

    whether i can claim back any amount of tax paid previously on gratuity as ceiling has been enhanced retrospectively?

    please reply early ..
    thank you

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