What is Gratuity?
Gratuity is a lump sum that a company pays when an employee leaves an organization and is one of the many retirement benefits offered by a company to an employee. In India, gratuity rules and requirements are set out under the Payment of Gratuity Act, 1972. An employer may also choose to pay gratuity outside of that which is required by this Act.
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Gratuity may be one of the components of your CTC. It is taxed under the head Income from Salaries. Some portion of gratuity received is exempt from tax as per Section 10(10) of the Income Tax Act and we will see how exemption is calculated.
Rules relating to Gratuity which are applicable to an Employer are set out in Payment of Gratuity Act 1972.
Gratuity is payable to an employee when an employee leaves employment after completing at least five years in service with an employer – so this is payable –
Gratuity is not paid as part of your regular monthly salary; it is only payable on the occurrence of any of the above events.
Every person working in a factory, mine, oil field, port, railways, plantation, Shops & Establishments, or educational institution having 10 or more employees on any day in the preceding 12 months is entitled to Gratuity. It is applicable for only permanent employees and not for trainees/interns.
Once the Act becomes applicable to an employer – even if the number of employees goes below 10, gratuity is still applicable.
In the case of Gratuity received by a Government Employee
Any gratuity received by an employee of the Central Government, State Government or local authority, on death or retirement is fully exempt from tax.
In case of Gratuity received by an employee where the Employer is covered by the Payment of Gratuity Act.
The least of the following is exempt from Tax
Last drawn salary is Basic salary and DA. The number of years in service is rounded off to the nearest full year. For example – if you have worked in an organization for 12 years and 2 months, the number of years in employment shall be considered to be 12 years. And in case you have worked for 12 years and 7 months, the number of years in employment shall be considered to be 13 years.
Let’s understand this by way of an example – Rahul worked for a company for 18 years and 7 months. His company is covered by the Payment of Gratuity Act. At the time of his retirement, his salary was Rs 20,000. He received Rs 8,00,000 as Gratuity from his employer.
Calculation of amount which is exempt from Rs 8,00,000 – lower of the following 3
The amount that is exempt from Gratuity payment for Rahul is Rs 2,19,230 and remaining amount of Rs 8,00,000 – Rs 2,19,230 = 5,80,769 is taxable for Rahul.
In case of Gratuity received by an employee where Employer is not covered by the Payment of Gratuity Act
The least of the following is exempt from Tax
For example – Sunil who works for XYZ Ltd. Retires after 30 years and 9 months of service. He receives Rs 8,00,000 as a gratuity. His average monthly salary of 10 months immediately preceding month of retirement is Rs 50,000.
For Sunil the minimum of these amounts shall be exempt from Tax
Therefore for Sunil Rs 7,50,000 shall be exempt from Tax and he will pay tax on Rs 8,00,000 – 7,50,000 = Rs 50,000. Rs 50,000 shall be taxed and included under the head ‘Income from Salaries’.
Few Notable Points:
The employer can pay a Gratuity of more than Rs 10,00,000, the exemption shall be calculated in the same manner as listed above.
If the employee’s services have been terminated due to any misconduct, the employer has the right to reject payment of Gratuity to the employee.
In case of death of the employee, the Gratuity can be paid to the nominee or the legal heir of the employee. In this case, the exemption is calculated in the same manner as above and is taxed for the receiver under the head ‘Income from other sources’.
now the exemption limit has been increased to Rs 20lakhs