Tax on Gratuity

Gratuity is a lump sum amount that an employee receives from a company when he leaves after serving continuously for five years. This is also one of the many retirement benefits. Furthermore, tax can be applicable on gratuity only where its amount exceeds the Exemption Amount as calculated under Section 10(10) of the Income-tax Act.

It is calculated based on two factors: the number of years an employee completes with an organization and the last drawn salary at the organization. It is provided by the employer to the employee on completion of 5 years of service.

Eligibility Criteria to Receive Gratuity

The employer shall pay this amount only after an individual satisfies a few basic criteria. Following are the criteria’s:

  • Employee – An individual should be an employee drawing wage from an organization. An apprentice is not eligible to receive this benefit.
  • Term – The employee should have put in continuous service for a minimum of 5 years.
  • Resignation/superannuation – It is payable only on the resignation, superannuation, or death of an employee, after completion of the requisite term.

Moreover, any organization which has 10 or more employees at a given point of time shall extend this benefit to eligible candidates.

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Gratuity Exemption

Exemption u/s 10(10) is available for this benefit received at the time of retirement/separation and for that employees has been classified into 2 categories:

  1. Govt Employees
  2. Non- Govt Employees (including PSU employees)

The whole amount received by Govt employees is fully exempt u/s 10(10)(i). This extends to employees of both State and Central Government employees, employees from the defense sector, and those working in any local authority. For Non-Govt employees / other employees, the exemption amount depends on whether the employee is covered under the Payment of Gratuity Act 1972 or not.

Tax on Gratuity

To calculate the tax-exempt gratuity amount, the law divides non-government employees into two categories. Differential tax treatment is provided based on these criteria. In case this amount is received by a nominee/heir on the demise of an employee, the amount received is liable to be taxed, falling under the “Income from other sources” head.

Employees Covered Under the Payment of Gratuity Act

This benefit received by an individual will be viewed as a part of his/her salary component, making it a taxable entity as per existing laws. If the employee is covered by Payment of Gratuity Act 1972- Exemption is available u/s 10(10)(ii). The least of the following is exempt from tax:

  1. Amount of Gratuity received
  2. INR 20 Lacs
  3. Last salary (basic + DA)* number of years of employment* 15/26

For Example:

  • Mr. A receives the following amount in the previous year:
  • Gratuity received INR 7,00,000
  • Year of service 25 years 7 months( excess of 6 months should be taken as a full year)
  • Last salary INR 40000
Sr. No. Particulars Amount (INR)
1 Last drawn salary (Basic + DA) 40,000
  Number of years of employment 26 (rounded off)
  Gratuity 40,000*26*15/26 = 600000
2 Maximum exemption allowed 20 lakhs
3 Gratuity actually received 7 Lakhs
  Amount of exemption (least of the three) 6 Lakhs
  Taxable Gratuity 1 Lakh

Note:

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

Employees Not Covered Under the Payment of the Act

If the employee is not covered by Payment of Gratuity Act 1972- Exemption is available u/s 10(10)(iii) being least of the following:

  1. Amount of Gratuity received
  2. INR 20 Lacs
  3. Last 10 month’s average salary (basic + DA)* number of years of employment* 1/2

For Example:

  • Mr. B receives the following amount in the previous year:
  • Gratuity received INR 9,00,000
  • Year of service 19 years 7 months( excess of 6 months should be taken as a full year)
  • Average of last 10 month’s salary INR 70000

 

Sr. No. Particulars Amount (INR)
1 Average of last 10 month’s salary 70,000
  Number of years of employment 20 (rounded off)
  Gratuity 70,000*20*1/2 = 7,00,000
2 Maximum exemption allowed 20 lakhs
3 Gratuity actually received 9 Lakhs
  Amount of exemption (least of the three) 7 Lakhs
  Taxable Gratuity 2 Lakh

FAQ

Whether TDS is to be deducted by the employer on payment of Gratuity to Employees?

The employer shall deduct TDS only when this amount exceeds exemption amount under section 10(10) of Income-tax Act, otherwise, employer shall not deduct any TDS.

When is Gratuity Amount paid?

It is payable on:
– Superannuation (or) Retirement.
– Your Resignation (or) Termination.
– Death or Disablement due to accident or disease.
– Retrenchment (or) Layoff.
– VRS (Voluntary Retirement Scheme).

Will I get an interest in gratuity?

Yes, if the employer makes a delay in the payment of gratuity, you are entitled to get a simple interest for the same from the due date of the payment made.

How do I show my gratuity exemption in income tax?

The exemption varies and depends on whether you are covered under the Payment of Gratuity Act or not. The maximum limit is INR 20 lakhs. In the ITR form, firstly enter the amount as income after deducting the exempted amount under the head Income from Salaries. Secondly, the same exempted amount to be entered in the ‘Exempt Income’ section for verification.

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