Gratuity: Entitlement, Computation, Taxation, Exemption

The income tax laws exempt gratuity: for some it is fully tax-free whereas for some it is tax-free to certain extent. Likewise, there is confusion about manner of calculating the eligibility as well as the computation of quantum of gratuity. This article deals with how the gratuity is calculated as well as its taxation part.

Who is entitled to receive gratuity?

Any person working in a factory, Port, plantation etc. and a person working in any other establishment, where ten or more persons were employed on any day during the preceding twelve months, are entitled for if they have rendered continuous services for minimum of five years with the same employer. The gratuity is payable at the time of his retirement/death or termination of his employment. In case of death or disablement of the employee the requirement of five years of continuous service is not applicable.

While ascertaining the period of five years, a period of more than 240 days of continuous services shall be taken as a full year. So in case you leave your organisation before completion of full five years but have rendered services for four years and two hundred and forty days, you are eligible to get gratuity. However, in case of persons working with establishments which works for less than six days a week continuous service of more than four years and one hundred and ninety days is considered as a continuous service of five years for determining whether one is eligible to get gratuity or not.

Computation of Gratuity

In case of Central Government employees, members of civil services, defence personnel, all India services, state administrative services, employees of local authorities and state employees the calculation of gratuity is done according to the pension code and rules for applicable for such services.

In case separate pension rules are not prescribed, the pension is calculated as per the provisions of Payment of Gratuity Act, 1972.  The amount of gratuity payable is worked out at the rate of 15 days’ salary for each completed year of service.  For the purpose of computing a year for calculation of gratuity, a period of more than six month has to be treated as full year and therefore the period of service of less than six months is to be ignored. The salary for 15 days is arrived at by dividing the monthly basic salary by 26 and multiplying it by 15. This is the minimum gratuity an employee is entitled. An employer if so wishes can pay gratuity higher than the one minimum prescribed under payment of gratuity Act, 1972.

Taxation of gratuity

The gratuity received by all the government employees, employees of municipalities and defence forces is fully exempt without any upper monetary limit.

For other employees the gratuity to the extent of minimum payable under the Payment of Gratuity Act, 1972 is tax-free. So in case the gratuity is paid for more than 15 days of each completed year of service the excess gratuity shall become taxable in your hands irrespective of the overall amount of gratuity. For the purpose of computing the salary for 15 days, the salary drawn by you during the ten months just before the date when the gratuity becomes due has to be considered.

Salary for the purpose of computing gratuity exemption is basic salary and dearness allowance payable if the same is to be treated for terms of employment so provide whereas the other payments like House Rent Allowance, Leave Travel Allowance are not taken into account though in broader sense these payments are also treated as salary. So even if your employer computes the amount of gratuity payable on the basis of salary which includes the other allowances, for exemption purposes under the income tax laws, the basic salary and the dearness allowance will only be considered.

In absolute terms gratuity received in aggregate upto 20 lakhs is exempt during your lifetime and gratuity received beyond this limits becomes taxable for other category of employee. The exemption limit of twenty lakhs is to be applied cumulatively to the gratuities received by you from all the employers taken together. So in case of all gratuities received and claimed exempt in the past have to be reduced from exempt amount of twenty lakhs for determining the gratuity eligible for exemption from your last employer. Since the amount of gratuity exempt in absolute terms has been increased very recently, employees who had paid tax on gratuity due to it being in excess of ten lakhs rupees earlier will be able to claim the exemption for the enhanced balance of ten lakhs now whenever they receive further gratuity. So in case of multiple gratuities even if the amount of gratuity presently received does not exceed 15 days of salary for each completed year of service, if will become taxable if it exceeds the amount of twenty lakh rupees including the amount claimed exempt in the past.

Balwant Jain is a tax and investment expert and can be reached on [email protected] and @jainbalwant on twitter