The government's decision, in agreement with the All India Trade Union Congress (AITUC), to raise the tax-free gratuity limit to Rs 20 lakh for non-government employees may lead to big tax savings. The decision is yet to be approved.
Gratuity, a retirement benefit, is simply the employer's way of saying 'thank you' to the employee for rendering his continuous service to the organisation.
As per current laws under the Payment of Gratuity Act 1972, the gratuity received by government employees is tax exempted, i.e., one is not required to pay any tax on the gratuity amount.
On the other hand, for a non-government employee, the gratuity received in his entire working life is tax-free up to a maximum limit of Rs 10 lakh.
Applicability
The Act is applicable to those establishments where 10 or more employees work on any single day in the preceding 12 months of the year.
The Act also states that once an establishment is covered under its ambit then it will always be covered, even if the number of employees falls below 10. If the organisation is not covered under the Act then it can make an ex gratia payment to its employees.
Eligibility
As per the Act, an employee is eligible to receive gratuity only if he has completed at least five years of continuous service with an organisation, without any interruption.
However, the interruption may be allowed if it is on account of sickness, accident, layoff, strike or lockout, which is not the employee's fault.
Payment of gratuity
As said earlier, gratuity is generally paid to the employee on his retirement. However, there are other instances, other than retirement, when it has been paid to the employee, such as:
a) On his superannuation.
b) If he has tendered his resignation after serving the organisation for more than five years.
c) On his death, even if the employee has not covered the mandatory five-year working period.
d) If he becomes disabled due to accident or disease even when the working period of five year is not completed.
Two categories of non-government employees
To calculate the tax exempted amount for non-government employees, they are divided into two categories:
a) Those covered under the Payment of Gratuity Act, 1972
b) Those not covered under the Payment of Gratuity Act, 1972
Calculation of tax exempted gratuity
1. For the employees covered under the Act, the least of the following is exempted from tax:
a) Rs 10 lakh.
b) Actual gratuity received.
c) 15 days salary* based on the last drawn salary for each completed year of service or part thereof in excess of six months.
*Salary includes basic salary received by the employee and the dearness allowance and commission received if any.
It is calculated as follows:
(Last drawn Salary x 15 days x Tenure of working) divided by 26
2. For the employees not covered the Act, the least of the following is exempted from tax:
a) Rs 10 lakh
b) Actual gratuity received.
c) Half month's average salary* for each completed year of service.
*Salary includes basic salary received by the employee and the dearness allowance and commission received if any.
The average salary is taken as the average of the salary of last 10 months immediately preceding the last working month.
It is calculated as follows:
(Last drawn Salary x 15 days x Tenure of working) divided by 30
Calculation of service tenure
The tenure for which the employee has rendered his services is based on whether the organisation is covered under the Act or not.
If the organisation is covered under the Act, the employee's service tenure will be considered for a full year, provided he has worked for more than six months, but less than a year.
If the organisation is not covered under the Act then the tenure of the employee whose services exceeds six months, but is less than a year will not be considered as a full year.
Illustration
Mr ABC is working with an organisation covered under the Act. He will be retiring the organisation after rendering his services for 20 years, six months and one day.
In this case, the tenure of his services will be seen as 21 years because his organisation is covered under the Act and he has worked for the organisation for more than six months in a year.
On the other hand, if the organisation was not covered under the Act, Mr ABC's tenure will be taken as 20 years.
Tax benefit impact
For employees covered under the Act
Scenario 1: Mr ABC has worked with an organisation XYZ Ltd., covered under the Act, for 20 years and four months. He has received Rs 12 lakh as a gratuity from the organisation. His last drawn basic salary was Rs 1 lakh. How much of this gratuity would be tax exempted?
As per the Act, it is the least of the following:
a) Rs 10 lakh.
b) Actual gratuity received: Rs 12 lakh.
c) 15 days salary based on the last drawn salary for each completed year of service, or part thereof in excess of six months.
15 days salary will be calculated for 20 years as:
(15 x 20 x 1 lakh) divided by 26 = Rs 11,53,846
Therefore, the tax exempted gratuity will be actual minus the least of the above, i.e., Rs 10 lakh. On the remaining Rs 2 lakh, Mr ABC will pay tax as per his tax slab.
Alternate scenario: As proposed, if the limit for the tax exempt gratuity is increased to Rs 20 lakh then the formula-driven calculated gratuity will become the least amount and Mr ABC will be required to pay tax on the balance of Rs 46,000 only (approx).
| HEAD | Tax-free limit: Rs 10 lakh | Tax-free limit: Rs 20 lakh |
| Maximum exemption | Rs 10 lakh | Rs 20 lakh |
| Actual received | Rs 12 lakh | Rs 12 lakh |
| As per 15 days salary | Rs 11,53,846 | Rs 11,53,846 |
| Tax exempted amount | Rs 10 lakh | Rs 11,53,846 |
| Taxable amount | Rs 2 lakh | Rs 46,000 |
For employees not covered under the Act
Scenario 2: Mr ABC has worked with an organisation XYZ Ltd, which is not covered under the Act, for 20 years and four months. He has received Rs 12 lakh as a gratuity from the organisation. His last drawn basic salary was Rs 1.1 lakh. How much of this gratuity would be tax exempted?
As per the Act, it is the least of the following:
a) Rs 10 lakh.
b) Actual gratuity received - Rs 12 lakh.
c) Half month's average salary for each completed year of service.
Here, half a month's average salary will be calculated for 20 years as:
(15 x 20 x Average*) divided by 30 = Rs 11 lakh
*Average salary: Rs 11 lakh divided by 10 = Rs 1.1 lakh
Therefore, the tax exempted gratuity will be the actual minus the least of the above, i.e., Rs 10 lakh. On the remaining Rs 2 lakh, Mr ABC will pay tax as per his tax slab.
Alternate scenario: As proposed, if the limit for the tax exempt gratuity is increased to Rs 20 lakh then, in that case, the formula-driven calculated gratuity will become the least amount and Mr ABC will be required to pay tax on the balance of Rs 1 lakh only.
| HEAD | Tax-free Limit: Rs 10 lakh | Tax-free Limit: Rs 20 lakh |
| Maximum exemption | Rs 10 lakh | Rs 20 lakh |
| Actual received | Rs 12 lakh | Rs 12 lakh |
| Half salary basis | Rs 11 lakh | Rs 11 lakh |
| Tax exempted amount | Rs 10 lakh | Rs 11 lakh |
| Taxable amount | Rs 2 lakh | Rs 1 lakh |
Points to remember
1. Gratuity received during the period of service is fully taxable.
2. When gratuity is received from two or more employers in the same year, the exemption limit for tax will remain the same.
3. When gratuity is received from a former employer and another employer thereafter, the limit for exemption will be reduced by the exemption limit taken earlier.
