People employed in organised sector and with governments  receive gratuity at the time of their retirement/death. Gratuity also becomes payable on termination of services. The gratuity becomes payable only if one has service for continuous five years with the same employer. Though many of your might have received gratuity but most of you are not aware as to how the gratuity is calculated. This article deals with how the gratuity is calculated as well as its taxation part.

Who is entitled to receive gratuity

Any person who is working in an establishment where more than ten persons were employed during any day in a year is entitled to get gratuity provided he has rendered continuous services for minimum five years as on the date of his retirement/death or termination of his employment with the same employer. The requirement of five years of continuous service does not apply in case of death and disablement of the employee for being entitled to receive the gratuity.

Computation of Gratuity

For employees of the Central Government, gratuity  is calculated with reference to the Pension rules as applicable for them. Likewise calculation of pension for members of civil services, defence personnel, all India services, state administrative services and state employees are calculated as per the pension rules made and applicable for such services.

Those for whom separate pension rules are not prescribed, the pension is calculated as per the provisions of Payment of Gratuity Act, 1972.  The gratuity is be computed at the rate of 15 days salary for each completed year of service. For the purpose of computing a year for calculation of gratuity, a period of more than six month has to be treated as full year and therefore the period of service of less than six months is ignored. While computing salary for the 15 days period,  salary drawn by him at the time of retirement is be divided by twenty six and multiplied by fifteen. This is the minimum gratuity an employee is entitled so employer if so wishes can pay higher sum as gratuity.

Taxation of gratuity

The gratuity received by all the government employees, employees of municipalities and defence forces is fully exempt. For other employee the gratuity paid to an employee as calculated under the payment of gratuity Act, 1972 is  fully exempt. While calculating the amount of exempt gratuity if the gratuity paid exceeds 15 days of salary for each completed year of service, the excess shall become taxable in your hands. For the purpose of computing the salary for 15 days, the salary drawn by you during the ten months just before the date when the gratuity becomes due shall only be considered.

Salary for the purpose of computing gratuity exemption shall include dearness allowance only if the terms of employment provide so. However no other allowances including House Rent Allowance, Leave Travel Allowance shall be taken into account though these in broader parlance are treated as salary. So even if your employer computes the amount of gratuity payable on the basis of  salary which includes the other allowances, for exemption purposes under the income tax laws only the basic salary and the dearness allowance will only be considered.

In absolute terms as per the recent amendment of   Payment of Gratuity Act, 1972, gratuity upto 20 lakhs is exempt. Any gratuity received beyond this limits is taxable. It is not that the basic amount of exemption is twenty lakhs rupees for each incidence of gratuity but the limit of twenty lakhs is t be applied for all the gratuities received by an employee during his lifetime. So in case you had received any gratuity in the past and claimed exempt, the amount of such gratuity shall be reduced from the amount of gratuity eligible for exemption. Since the amount of gratuity exempt in absolute terms has been increased very recently, employees who had paid tax on gratuity due to it being in excess of ten lakhs rupees earlier will be able to claim the exemption for the enhanced balance of ten lakhs now whenever they receive further gratuity. So in case of multiple gratuities even if the amount of gratuity received presently does not exceed 15 days of salary for each completed year of service, if will become taxable if it exceeds the amount of twenty lakh rupees including the amount claimed exempt in the past.

Writer is a tax and investment expert.

Balwant Jain is a tax and investment expert and can be reached on jainbalwant@gmail.com, @jainbalwant on twitter.

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6 responses to “Taxation of Gratuity”

  1. parashinduja says:

    Sir,
    My Freind Working as a Teacher in a Private School getting Salaries in the Pay Scales as applicable to the Government servant as 30 days per month basis including PL/ CL & other benefits etc. (& not 26 days wages as per minimum wages act ) & gratuity being paid as payable to the government servants 15 days for each completed year of service without dividing the pay by 26 days formulae as mentioned in the Gratuity Act 1972. He is asking whether he is entitled to the division of salaries by 26 formulae.

  2. Summaiya Rayees says:

    My husband is working in a private sector company.there is no of cut from his salary.will he get gratuity.he has completed 13 yrs.there are around 50 employes

  3. A. Narayana says:

    For Example ABC Ltd., has paid gratuity of Rs.12 lakhs to Mr. A, the whole time director, who worked 20 years, whether the gratuity received by Mr. A is exempt or not, If Gratuity Act, 1972 is not applicable to ABC Ltd., as it employs only 6 people.

  4. A. Narayana says:

    If the Whole time Director receives Gratuity of Rs.12 lakhs from ABC Ltd., wherein less than 10 people are employed and Gratuity Act, 1972 is not applicable, in that scenario whether the Gratuity of Rs.12 Lakhs received by the Whole Time Director is exempt or not?

  5. A. Narayana says:

    How about an employee, a whole time director, who has worked in a Public Limited company where less than 10 people are employed and Gratuity Act, 1972 is not applicable, but Payment of Gratuity has been approved by the Share holders of a public limited company to the Whole time director, and if the whole time director receives Gratuity for his service of about 20 years, which is less than Rs.20 lakhs, and is calculated as per the Payment of Gratuity Act, 1972, then that Gratuity is Taxable in the hands of the Whole Time Director or not? Further except the whole time director no other employee is eligible for Gratuity and the company is not paying the gratuity as Gratuity Act, 1972 is not applicable to the said public limited company.
    If Gratuity is paid to the whole time director then is the said Public Limited company is required to make TDS or not?

  6. Kingshuk Das says:

    Sir,pls explain with example.

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