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.
- Gratuity received during the period of service is fully taxable
- When gratuity is received from two or more employers in the same year, the exemption limit for tax will remain the same.
- 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.