Meaning of Gratuity :-Gratuity refers to the emoluments received by an employee from his employer in gratitude for the services rendered. Such sum can be paid on retirement, resignation, superannuation, death or disablement. Under the Gratuity Act, the sum can be paid only after an employee has rendered continuous service of not less than five years. Exceptions being termination of employment on account of death/disablement.

There are two conditions that must be satisfied in order to be eligible to get the gratuity benefit

  • Your organisation has a minimum of 10 people on payroll, i.e., at least 10 employees receiving salaries from the organization. Note that people on contract are not considered.
  • You have completed at least 5 years with the organization. If an employee dies during the tenure of his employment, the 5 year rule is relaxed. So, even if such employee’s period of service is as little as 1 year, he / she is eligible to receive gratuity if the first condition is met.

Applicability of the Act: The act provides for the payment of gratuity to workers employed in every factory, mine, oil field, plantation, port, railways, shop & Establishments or educational institution employing 10 or more persons on any day of the proceeding 12 months.

A shop or establishment to which the Act has become applicable shall continue to be governed by the Act even if the numbers of persons employed falls below 10 at any subsequent stage.

Here employees are defined as those hired on the company’s payroll. Trainees and interns are not eligible for this compensation.

Eligibility criteria

Gratuity shall be payable to an “employee” on the termination of his employment after he has rendered continuous service for not less than five years.

  • On his superannuation.
  • On his retirement or resignation.
  • On his death or disablement due to accident or disease.

Note: However, the condition of five years of continuous service is not necessary if service is terminated due to death or disablement.

To whom is Gratuity Payable?

Gratuity is normally payable to the employee himself, however in the case of death of the employee it shall be paid to his nominee & nomination has been made to his heirs. Incase the nominee is a minor; share of the minor shall be deposited with the controlling authority who shall invest the same for benefit of the minor, until he/she attains majority.

Nomination facility: – Yes, by filling Form “F” at the time of new joinee formality, each employee is required to nominate one or more member of his family, as defined in the Act, who will receive the gratuity in the event of the death of the employee.

Forfeiture of Gratuity:- The gratuity of an employee whose service have been terminated for any Act of willful omission or negligence causing any damage or loss to or destruction of property belonging to the employer, gratuity shall be forfeited to the extent of the damage or loss caused. The right of forfeiture is limited to the extent of damage.

The gratuity payable to an employee shall be wholly forfeited:

  1. If the services of such employee have been terminated for his riotous or disorderly conduct or any other act of violence on his part, or
  2. If the service of such employee have been terminated for any act which constitutes an offense involving moral turpitude, provided that such offense is committed by him in the course of his employment.

Applicability to contract Employee:- Yes, the only criterion is to serve at least 5 years of service at a stretch.

Calculating 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.

Tax treatment for gratuity

In Respect of Government Employees:-

The amount of gratuity received by a person is taxed as salary income under the head ‘Income from salaries’ on the income tax return. If you are a government employee, then according to the provisions of Section 10 (10) of the Income Tax Act, the gratuity amount paid is completely tax free.

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

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

Note that this limit is a maximum exemption for all your years of service. It applies to all the amounts of gratuity you will receive in your entire career from all your employers.

Taxable under what head:- 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”.

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0 responses to “Post Amendment all you want to know about taxability of gratuity payment”

  1. Rahul says:

    Dear Tax Guru,

    I have served a Representative office of a European bank in India for more than 6 years, Bank has more than 10000 employees in Europe but have 4 in India. Can I claim for Gratuity as in my contract it says that it is goverened by the indian law.

  2. BARATHIDASON says:

    What is the effective date for the increased limit of Rs.10 lakhs under the I.T. Act

  3. Nand says:

    The IT Act Section 10(10) speaks of Gratuity. It says, the Income tax exemption is available upto the amount of Gratuity calculated as per provisions of Gratuity act. Therefore, there is no need for specific amendment to Income Tax act. The ceiling raised as per Gratuity act would automatically flow in terms of Income tax act

  4. Gc Swain says:

    Sir,
    Will you please confirm whether payment of gratuity of Rs.10 lakhs under Gratuity Act-1972 has been recognised by IT Act for exemption purpose or the limit of Rs.3.50 lakhs is still continuing under IT Act. If amended in IT Act, then please let me know the Notification No and date. Thanks. CA.GC Swain, Nagpur

  5. jose says:

    Dear Tax Guru,
    Is it correct to say that gratuity is calculated on the basis of salary “drawn”, since it is laid down in Sec.(8) 5 that “Wages” is defined as emoluments which are EARNED by an employee.
    The Govt has declared periodical DA installments,but the employer has not actually paid it.Does it mean that the employee had not “earned” it ?. I think the employee had earned it. “Earning” and “payment” are not the same thing,is it?What do you say Guruji?

  6. srinivasan says:

    A govt servant after retirement now works for an advocate. if he gets gratity of 10 lakhs ( subject to the i/2 month’s salary will Rs10 lakhs be exempt , as the gratuity recd from govt is exempt unseer section 10 (10) ?

  7. Chandrahash Chaudhary says:

    I retired from India Trade Promotion Organisation, Pragati Maidan, New Delhi on 31.12.2008.

    At that time , I was paid a gratuity of Rs. 3.50 lacs but no income tax was deducted as the amount of gratuity payable under The Payment of Gratuity Act 1972 was income tax free upto Rs.3.50 lacs.
    Subsequently, the amount payable as gratuity to employees of ITPO was raised to Rs 10.00 lakhs.

    Accordingly,I was also sanctioned Rs 5,59606/-as arrears of gratuity vide office order of ITPO dated5.10.2009. However, a net amount of Rs4,76,119 was paid to me by the ITPO vide cheque dated 26.03.2010 after
    deducting income tax for Rs.83487/-.

    Please advise whether I can claim refund of Rs.83487
    from Income Tax Authorities while filing my Income Tax return in July’2010.

    Chandrahash Chaudhary

  8. jha says:

    in which category do employees of a stste govt, transmission company regd under companies act fall?
    are they eligible for geatuity exemption uoto 10 lacs as per recent notification.

  9. m jagadish says:

    kindly indicate the date from which the tax exemption limit is applicable

    SAIL is paying gratuity of 10 L from 1.1.2007 whereas recent amendment is from 24.5.2010 for 10 L of gratuity

  10. D.CHINNA RAO says:

    This article is very comprehensive and informative.

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