Taxation on Gratuity

Taxation & Provisions of Gratuity

Taxation on Gratuity under the head “Salaries” in the hands of the employee. However, there is an exemption limit of Rs. 20,00,000 (limit applicable for FY 2020-2021) which means that gratuity received up to this limit is tax-free. Any amount received above this limit is taxable.

TAXATION AND LEGAL PROVISIONS ON GRATUITY

What is Gratuity?

Gratuity’ is a retirement benefit. Gratuity Act, 1972 act provides retirement benefit to the workman who have rendered long service to the employer.

Gratuity is a reward for long and meritorious service. Earlier, it was not compulsory for an employer to reward his employee at the time of his retirement or resignation. But in 1972 the government passed the Payment of Gratuity Act that made it mandatory for all employers with more than 10 employees to pay gratuity.

How is Gratuity Applicable as per Act,1972?

According to the act, it provides  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.

What is the eligibility criteria for Gratuity?

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

Establishment covered under Gratuity Act:

  • Every factory, mine, oil field, plantation
  • Port, railways, shop & Establishments
  • Educational institution

EXEMPTION FROM TAX:

Employees who get exemption under section 10(10) against Gratuity are:

  • Government Employee
  • Employees of Local Authorities
  • Employee covered under the Payment of Gratuity Act,1972.
  • Other employees not covered under the Payment of Gratuity Act,1972.

How is Gratuity Exempted from Tax?

Amount should be Minimum of the Following:

i) Actual gratuity received

ii) 15 days Basic and DA for each completed year of service or part thereof in excess of six months

iii) Rs 20 Lakhs

Calculation of Gratuity:

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.

An example to understand how Gratuity is calculated

Mr. P receives following amount in previous year: Gratuity receive 3,00,000 Year of service 30 years 7 months( excess of 6 month should be taken as full year) Average salary 20000

Calculation:

3,00,000 (31 * 20,000 * 15/26) = 357692.31 20,00,000 Therefore 3,00,000 shall be exempted

Tax treatment of gratuity

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

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

2. Any gratuity received by persons covered under the Payment of Gratuity Act, 1972 shall be exempt subject to following limits:-

  • For every completed year of service or part thereof, gratuity shall be paid at the rate of fifteen days wages based on the rate of wages last drawn by the concerned employee.
  • The amount of gratuity as calculated above shall not exceed Rs. 20,00,000/- (Limit increased to Rs. 20 Lakh with effect from 29.03.2018, earlier limit was Rs. 10 Lakh.)

3. In case of any other employee, gratuity received shall be exempt, subject to the following exemptions

  • Exemption shall be limited to half month salary (based on last 10 months average) for each completed year of service or Rs. 10 Lakhs whichever is less.
  • Where the gratuity was received in any one or more earlier previous years also and any exemption was allowed for the same, then the exemption to be allowed during the year gets reduced to the extent of exemption already allowed, the overall limit being Rs. 10 Lakhs.

 

 

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