Indian Gratuity Laws and Tax Exemption Policies

main-moderator Jun 7, 2021 | 163 Views
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Gratuity is a benefit given by the employer to employees. A recently approved amendment by the Centre has increased the maximum limit of gratuity. Now it is tax exempt up to Rs 20 lakh from the previous ceiling of Rs 10 lakh, which comes Section 10(10) of the Income Tax Act. The CBDT Notification no. S.O. 1213(E), dated 8 March 2019, clarified that the exemption limit of Rs 20 lakh would be applicable to employees in the event of retirement or death or resignation or disablement on or after 29 March 2018.

Let us understand the impact of this amendment in comparison with the previous provisions.

Understanding the Basics of Gratuity

Gratuity is a monetary benefit given by the employer, but not paid as part of the regular monthly salary. The provisions of gratuity are governed by the Payment of Gratuity Act, 1972, and it is given on the occurrence of any of the following events.

  • On superannuation (means an employee who attains the age of retirement is said to be in superannuation)
  • On retirement or resignation
  • On death or disablement due to accident or disease (the time limit of 5 years shall not apply in the case of death or disablement of the employee) It is mandatory for the employee to have completed a minimum of five years in service to be able to receive gratuity. It is not available for interns or temporary employees.

Employees Covered Under the Payment of Gratuity Act

Every individual – 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.

Once the Act becomes applicable to an employer, even if the number of employees goes below 10, gratuity is still applicable.

Calculation of the amount of gratuity exempted from tax

The least of the following is exempt from tax:

  • Last salary (basic + DA)* number of years of employment* 15/26;
  • Rs. 20 lakhs (which has been hiked from Rs. 10 Lakh as per the amendment);
  • Gratuity Actually received

Let us understand this through an illustration: The last salary drawn by an employee is Rs.1 Lakh per month (basic + DA). He / She is entitled to receive a gratuity of Rs. 11 Lakhs.

Sr. No. Particulars Previously As Amended
1 Last drawn salary (Basic + DA) 1 lakh 1 lakh
Number of years of employment 20 (will be rounded off) 20 (will be rounded off)
Gratuity 1,00,000*20*15/26 = 11,53,846 1,00,000*20*15/26 = 11,53,846
2 Maximum exemption allowed 10 lakhs 20 lakhs (as amended)
3 Gratuity actually received 11 lakh 11 lakh
Amount of exemption (least of the above) 10 lakh 11 lakh
Taxable gratuity 1 lakh

Points to note:

  • 15 days salary based on the salary last drawn for every completed year of service or part thereof i.e. 15/26.
  • Number of years in service is rounded off to the nearest full year.

Employees Not Covered Under the Payment of Gratuity Act

There is no law that restricts an employer from paying gratuity to his employees, even if the organization is not covered under the Payment of Gratuity Act. The amount of gratuity payable to the employee can be calculated based on half month’s salary for each completed year.

Calculation of amount of gratuity exempted from tax

The least of the following are exempt from tax:

  • Last 10 month’s average salary (basic + DA)* number of years of employment* 1/2;
  • Rs. 10 lakhs (the hike to Rs 20 lakhs is not applicable for employees not covered under the Payment of Gratuity Act)
  • Gratuity actually received

Gratuity exemption for such employees would be computed as follows:

Raghav has been in employment for 25 years and 2 months. The average salary for the last 10 months is Rs. 90,000. The actual gratuity received by him is Rs. 11 Lakhs.

Sr. No. Particulars Amount (Rs.)
1 Average of last 10 month’s salary 90,000
Number of years of employment 25 (will be rounded off)
Gratuity 90,000*25*1/2 = 11,25,000
2 Maximum exemption allowed 10 lakhs
3 Gratuity actually received 11 Lakhs
Amount of exemption (least of the three) 10 Lakhs
Taxable Gratuity 1 Lakh

Points to note:

  • An average salary of previous 10 months is considered
  • Number of years in service is rounded off to the nearest full year

Government Employees – Gratuity paid by the government to government employees is fully exempt from tax.

Impact of the Amendment – The impact of the amendment is evident from the example. A hike in the ceiling limit of maximum exemption helps reduce the taxable gratuity amount. This amendment is going to benefit those earning higher salaries in the short run. However, if you have a long time left before your retirement, this amendment will benefit most employees.

Frequently Asked Questions on Gratuity

1. If I resign from a company after 4.5 years of service, am I eligible for gratuity?

Answer: No, you have to serve at least 5 years in a company to get gratuity payment. A Madras High Court ruling held that you can avail gratuity if you have completed 240 days of service in the fifth year. It is best to check with the HR of your company about this. However, if someone dies while in service, the gratuity amount will be paid to their legal heir even if they have not completed 5 years of service. In addition, the amount received by a nominee/heir will not be taxed.

2. I am a contract employee in a company. Will I get gratuity if I resign or retire after 5 years?

Answer: If you are on the company rolls and are considered an employee of the company, then you will receive gratuity. However, if you are under a contractor that is separate from the company then the gratuity should come from the contractor and not the company.

3. What kind of employees does the Gratuity Act, 1972 cover?

Answer: Payment of Gratuity Act, 1972, applies to employees of factories, mines, oilfields, plantations, ports, railway companies, shops or other establishments related to them. All kinds of government jobs have also been included under the purview of this act. It is applicable in all states of India except Jammu and Kashmir.

4. Is there any difference in calculation of gratuity for employees who are not covered under the Gratuity Act?

Answer: Even if you are not covered by the Gratuity Act, your employer may pay you gratuity. The calculation for this is: Gratuity = Average salary (basic + DA) * ½ * Number of service years. In this case, the service years are not rounded off to the next number. So if you have a service of 12 years and 10 months, you get gratuity for 12 years and not 13 years.

5. Is there a cap to the amount I can receive as gratuity?

Answer: Yes. A company cannot pay you more than Rs.10 lakh as gratuity, irrespective of the number of years you have completed. This limit is also applicable to gratuity you can receive from different employers during your lifetime. If your company wishes to pay you more money, they can title it under ex-gratia or bonus.

6. How do I nominate someone to receive my gratuity in case of my death?

Answer: To nominate one or more heirs for your gratuity amount, you need to fill in Form F when joining a company.

7. How many days will it take for the employer to remit the gratuity amount?

Answer: Usually, gratuity is released along with or just before/after your full and final settlement is done. The government mandates employers to pay the amount within 30 days. If there is any delay in payment, the employer has to pay a simple interest on the amount from the due date until the date when payment is made.

Additional Information:

Government of India - Chief Labour Commissioner Website: 
https://clc.gov.in/clc/acts-rules/payment-gratuity- https://clc.gov.in/clc/acts-rules/payment-gratuity-act
 

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