Gratuity Act And Its Impact

By BankBazaar | July 25, 2017

 

Gratuity Act And Its Impact

Waking up every morning to go to work may seem like a daily struggle for most of us. The rush, the traffic and sometimes a “difficult” boss to deal with is no joke. More often than not, you may feel like you’re stuck in a very thankless world, with no appreciation whatsoever, no rewards or no recognition of any kind, let alone a decent hike! But the bright side of this is that if you somehow manage to survive through all the tough times in your organisation for more than five years, you will be eligible for a sweet something – gratuity!

Additional Reading: When Will You Get Gratuity Payment?

Oh, yeah! Consider gratuity to be a way that your organisation thanks you for rendering your services to them over the five years or more that you gave it your all.  And here’s some good news regarding gratuity that you should be aware of.

Earlier this week, the Monsoon Session of Parliament aimed at doubling the ceiling for tax-exempt gratuities from the current Rs. 10 lakh to Rs. 20 lakh. This decision will be an amendment to The Payment of Gratuity Act, 1972. This decision was cleared by the cabinet, earlier this year on March 15th.

As per the current law under the Payment of Gratuity Act, 1972, the gratuity received by government employees is tax exempted, which means you don’t have to pay tax on the amount you will receive. However, this only applies to government employees. On the other hand, if you’re a non-government employee, then the gratuity you earn for the entire tenure of your employment with a company is tax-free up to a maximum limit of Rs. 10 lakh.

Additional Reading: Tips To Make Your Salary Extremely Tax-Efficient

The Applicability Of The Act

This Act is applicable to only those organisations wherein 10 or more employees work on any single day in the preceding 12 months of the year. However, the Act also states that once an establishment is covered under its ambit then it will always be covered even if there is a drop in the number of employees. And for organisations that aren’t covered under this Act, they can make an ex gratia payment to its employees.

The Eligibility Of The Act

The Act states that an employee is eligible for gratuity, only if he/she has completed at least five years of continuous service with an organisation, sans any interruption or break. But, the interruption may be allowed if it is on account of sickness, accident, layoff, strike or lockout, which is not an employee’s fault.

Additional Reading: How To Survive A Layoff

Payment Of Gratuity

Gratuity is paid to an employee on his/her retirement. But there may be instances where the gratuity can be paid to the employee other than retirement. Some of the cases include:

  • On superannuation
  • If the employee has tendered his/her resignation after serving the organisation for more than five years
  • Upon death, even if the employee has not covered the mandatory five-year working period.
  • If he/she becomes disabled due to an accident or disease even when the working period of five years is not completed.

Categories Of Non-Government Employees

To calculate the tax exempted amount for non-government employees, they are divided into two categories.

  • Those covered under the Payment of Gratuity Act, 1972
  • Those not covered under the Payment of Gratuity Act, 1972

Calculation of Tax Exempted Gratuity

For employees covered under the Act, the least of the following is exempted from tax:

  • 10 lakh
  • Actual gratuity received
  • 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 employees 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

For the employees not covered under the Act, the least of the following is exempted from tax:

  • 10 lakh
  • Actual gratuity received
  • Half month’s average salary for each completed year of service.

Salary includes basic salary received by the employees 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

Additional Reading: You Need Not Pay Tax On Certain Incomes

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 service exceeds six months, but is less than a year will not be considered as a full year.

Let’s give you an example to help you understand this better

Vishnu works for an organisation and his organisation is covered under the Act. He will be retiring from the organisation after rendering his services for 20 years, six months and one day.

In Vishnu’s 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.

However, had Vishnu’s organisation not been covered by the Act, his tenure would have been calculated as 20 years.

Additional Reading: How To Maximise Your Take Home Pay

Here are some more examples based on:

Employees Covered Under the Act

Scenario 1: Madhav has worked for 20 years and four months with his organisation called ‘Global Tour’ which is covered under the Act. He has received Rs. 12 lakh as gratuity from the organisation. His last drawn basic salary was Rs. 1 lakh. So how much of this gratuity would be exempted from tax?

As per the Act, it is the least of the following:

  • 10 lakh
  • Actual gratuity received: Rs 12 lakh
  • 15 days salary based on the last drawn salary for each completed year of service, or part thereof in excess of six months.

It will be calculated as follows

(15 x 20 x 1 lakh)/ 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, Madhav will have to pay tax as per his tax slab.

Scenario 2: 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 Madhav will be required to pay tax on the balance of Rs 46,000 only (approx).

Scenario 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

Employees Not Covered Under The Act

Scenario 1: Rakesh worked for ‘Global Foundation’ for 20 years and four months. However, his company is not covered under the Act. He has received Rs. 12 lakh as gratuity from the organisation upon retirement. His last drawn basic salary was Rs. 1.1 lakh. So, how much of this gratuity would be tax exempted?

As per the Act, it is the least of the following:

  • 10 lakh
  • Actual gratuity received – Rs. 12 lakh
  • Half month’s average salary for each completed year of service.

In this scenario, half a month’s average salary will be calculated for 20 years as:

(15 x 20 x Average*)/30 = Rs. 11 lakh

*Average salary: Rs. 11 lakh/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 Rakesh will have to pay tax as per his tax slab.

Additional Reading: How To Calculate Your Income Tax

Scenario 2: 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 Rakesh will be required to pay tax on the balance of Rs. 1 lakh only.

Scenario 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

Hope we’ve cleared the air around gratuity and how it will impact you. Here are some points to note down.

  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

If you’re sitting on a chunk of gratuity, it may be wise to invest it in our Mutual Funds.

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4 thoughts on “Gratuity Act And Its Impact

  1. chaand

    Hi,
    If a person is given retirement from company on completion of 4 years three months (joining 1st Jan 2013 & retirement 31st March 2017).
    In this case, is the employee entitled to get the gratuity.

    Secondly, prior to this work tenure of 4 yrs three months period this employee also worked for the same company for three years. But there was a break after that for almost a year before joining company again.

    Thus total cumulative service period is almost seven years but with a break after three years.
    1st tenure = 3 years,
    2nd tenure = 4 yrs 3 months,
    gap between both tenures = almost a year

    Please share your valuable inputs.

    Thank you
    chaand

    Reply
    1. Team BankBazaar

      Hi chaand,

      If this person was still in service and had just taken leave during that break, he or she should be able to get gratuity. As you know, the rules state that one needs to complete 5 years of continuous service to be eligbile for gratuity.

      Cheers,
      Team BankBazaar

      Reply
      1. Chaand

        Hi Bankbazaar team,
        Thanks for your reply. But my query seems not completely answered.
        1. Person refered worked 4.3 yrs in second inning with same company. When he was advised to take retirement because of hiis health issues.
        (Although his DOB is July 1958, according to that employee was already 58 yrs 8 month old in March 17. When he was offered to retire. But the company had plans of giving retirement only when employer is not willing or capable to discharge his work duty as specified verbally on many occassions. AND THAT IS WHY, HE WAS ELEVATED TO HIGHER PROMOTION AND TRANSFERED TO HO, DELHI IN NOV’ 16. At age 58 yrs 3 months age.). Now, this employee wanted to continue till December ’17 in order to become eligible for gratuity but on management’s assurance for paying equal gratuity amount on accepting retirement in April/may17 while on sick leaves, he agreed for immediate retirement.
        But now management declined gratuity on ground that 5 yrs service not completed.

        Here other angle of previous employment in same company for 3 yrs record is available with employee but the communication record of break of almost a year is not available with this employee.
        Secondly, the next tenure of 4 yrs 3 months was initiated as new appointment with fresh appointment letter. And w/o reference to past employment of 3 yrs tenure.

        In above circumstances, can you get us an expert advise over claim of gratuity.

        Thankyou
        Chaand

        Reply
        1. Team BankBazaar

          Hi Chaand,

          The gratuity rules state that one needs to be employed for 5 continuous years with an organisation to be eligible for gratuity. We suggest that you get in touch with your legal counsel for further assistance since the organisation has promised gratuity to its employees.

          Cheers,
          Team BankBazaar

          Reply

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