Income Tax Exemption on Gratuity
Gratuity, a benefit provided by employers to employees, has recently undergone a significant amendment. The maximum tax exemption limit for gratuity has been increased from Rs. 10 lakh to Rs. 20 lakh, as per Section 10(10) of the Income Tax Act. The CBDT Notification No. S.O. 1213(E), dated 8 March 2019, has clarified that this enhanced exemption limit applies to employees in case of retirement, death, resignation, or disablement on or after 29 March 2018.
Basics of Gratuity
Gratuity, governed by the Payment of Gratuity Act, 1972, is a monetary benefit provided by employers. It is not part of the regular monthly salary and is granted on occurrences such as superannuation, retirement, resignation, or death or disablement due to accident or disease. However, the employee must have completed a minimum of five years of continuous service to be eligible for gratuity.
Eligibility Criteria
To be eligible for gratuity, an employee must fulfill the following conditions:
- Draw wages as a full-time employee of the organization.
- Be in continuous service for a minimum of five years.
- Gratuity can be received upon resignation, superannuation, disablement due to accident or disease, or death.
Employees Covered Under the Payment of Gratuity Act
Every individual working in specified sectors with 10 or more employees is entitled to gratuity. Even if the employee count falls below 10, gratuity remains applicable once the Act applies to an employer.
Tax Exemption Calculation:
The tax-exempt gratuity is determined as follows:
- Last salary (basic + DA) × number of years of employment × 15/26.
- Rs. 20 lakhs (as amended).
- Gratuity actually received.
Government Employees
Gratuity paid to government employees is fully exempt from tax.
Impact of the Amendment
The increase in the maximum exemption limit benefits employees, particularly those with higher salaries, reducing the taxable gratuity amount and providing them with enhanced financial security in the long run.
Exemptions on Gratuity
- Government Sector Employees: Fully exempted from paying tax.
- Private Sector Employees: Tax exemption depends on coverage under the Payment of Gratuity Act.
- For covered employees: Least of gratuity amount of Rs. 20 lakhs, last 15 days salary × number of years of employment, or actual gratuity received.
- For non-covered employees: Least of actual gratuity received, Rs. 20 lakhs, or last 10 months average salary × number of years of employment × 1/2.
These provisions ensure equitable tax treatment for gratuity across sectors, providing employees with financial stability upon retirement or resignation.
Payment of Gratuity in Case of Death:
- Minimum Service Requirement: If the employee completed at least one year of continuous service, gratuity becomes payable.
- Nominee or Legal Heir: Paid to the nominee or legal heirs of the deceased employee.
- Gratuity Calculation: Based on completed years of service up to the date of death.
- Formula: (Last drawn salary × 15 days × completed years of service) / 26.
- Tax Implications: Exempt from income tax up to a specified limit.
Here's a better presentation using tables and a different example:
Example:
Mr. B retired on 15.12.2023 after completing 30 years of service and received a gratuity of INR 18,00,000. During retirement, his salary was:
- Basic Salary: INR 50,000 p.m.
- Dearness Allowance: INR 20,000 p.m. (of which 50% is for retirement benefits)
- Commission: 2% of turnover (in the last 12 months, turnover was INR 1,50,00,000)
- Bonus: INR 40,000 p.a.
Computation of Taxable Gratuity:
(a) Private Sector Employee Covered by the Payment of Gratuity Act 1972:
Particulars | Amount (in INR) |
Gratuity received at the time of retirement | 18,00,000 |
Less: Exemption under section 10(10)(ii) | |
Least of the following: | |
i) Statutory limit = INR 20,00,000 | |
ii) Gratuity received = INR 18,00,000 | |
iii) As per formula: | |
(salary last drawn x number of years of employment x 15/26) | 7,50,000 |
Taxable Gratuity | 10,50,000 |
(b) Private Sector Employee Not Covered by the Payment of Gratuity Act 1972:
Particulars | Amount (in INR) |
Gratuity received at the time of retirement | 18,00,000 |
Less: Exemption under section 10(10)(iii) | |
Least of the following: | |
i) Statutory limit = INR 10,00,000 | |
ii) Gratuity received = INR 18,00,000 | |
iii) As per formula: | |
1/2 x (last 10 months salary) / 10 x years of employment | 7,00,000 |
Taxable Gratuity | 11,00,000 |
(c) Government Employee:
Particulars | Amount (in INR) |
Gratuity received at the time of retirement | 18,00,000 |
Less: Exemption under section 10(10)(i) | 18,00,000 |
Taxable Gratuity | Nil |
This method provides a clear breakdown of the calculation for each scenario, making it easier to understand the taxability of gratuity.
