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Gratuity is a benefit given by the employer to the employee. A recently approved amendment by the Centre has increased the maximum limit of gratuity, to be exempted from tax to Rs. 20 Lakhs from the existing ceiling of Rs. 10 Lakhs. This will be applicable to private sector and public sector employees. Calculations for exemption of gratuity under the Income Tax Act is covered under section 10(10).

Through this article we intend to help you understand the impact of this amendment in comparison with the previous provisions.

Income Tax Gratuity

1. Understanding the Basics of Gratuity

Gratuity is a monetary benefit given by the employer to his employee on occurence of any of the following events:

  • On superannuation (means an employee who attains the age of retirement is said to be in superannuation);
  • On retirement or resignation;
  • On death or disablement due to accident or disease (the time limit of 5 years shall not apply in the case of death or disablement of the employee)

It is mandatory for the employee to have completed minimum five years in service to be able receive gratuity. It is not applicable to interns/ temporary employees. Gratuity is not paid as part of your regular monthly salary; it is only payable on the occurrence of any of the above events.

The provisions of gratuity are governed by the Payment of Gratuity Act, 1972.

2. Employees Covered Under the Payment of Gratuity Act

Every person working in a factory, mine, oil field, port, railways, plantation, shops & establishments, or educational institution having 10 or more employees on any day in the preceding 12 months is entitled to gratuity.

Once the Act becomes applicable to an employer – even if the number of employees goes below 10, gratuity is still applicable.

Calculation of amount of gratuity exempted from tax

The least of the following is exempt from tax:

  • Last salary (basic + DA)* number of years of employment* 15/26;
  • 20,00,000 (which has been hiked from Rs. 10 Lakh as per the amendment);
  • Gratuity Actually received

Let us understand this impact through an illustration:

The last salary drawn by Rohan is Rs.1 Lakh per month (basic + DA). He is entitled to receive a gratuity of Rs. 11 Lakhs. He has been in employment for the last 19 years and 7 months.

Sr. No. Particulars Previously As Amended
1 Last drawn salary (Basic + DA) 1,00,000 1,00,000
Number of years of employment 20 (will be rounded off) 20 (will be rounded off)
Gratuity 1,00,000*20*15/26 = 11,53,846 1,00,000*20*15/26 = 11,53,846
2 Maximum exemption allowed 10,00,000 20,00,000(as amended)
3 Gratuity actually received 11,00,000 11,00,000
Amount of exemption (least of the above) 10,00,000 11,00,000
Taxable gratuity 1,00,000


Points to note:

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

3. Employees Not Covered Under the Payment of Gratuity Act

There is no law that restricts an employer from paying gratuity to his employees even if the organisation is not covered under the Payment of Gratuity Act. The amount of gratuity payable to the employee can be calculated based on half month’s salary for each completed year.

Calculation of amount of gratuity exempted from tax

The least of the following is exempt from tax:

    • Last 10 month’s average salary (basic + DA)* number of years of employment* 1/2;
    • 20,00,000 (which has been hiked from Rs. 10 Lakh as per the amendment);
    • Gratuity actually received

Let us understand this impact through an illustration:

Raghav has been in employment for 25 years and 2 months. The average salary for the last 10 months is Rs. 70,000. The actual gratuity received by him is Rs. 11 Lakhs.

Sr. No. Particulars

Previously

As Amended

1 Average of last 10 month’s salary

90,000

90,000

Number of years of employment

25 (will be rounded off)

25 (will be rounded off)

Gratuity

90,000*25*1/2 = 11,25,000

90,000*25*1/2 = 11,25,000

2 Maximum exemption allowed

10,00,000

20,00,000                (as amended)

3 Gratuity actually received

11,00,000

11,00,000

Amount of exemption (least of the three)

10,00,000

11,00,000

Taxable Gratuity

1,00,000

Points to note:

  • Average salary of previous 10 months is considered
  • Number of years in service is rounded off to the nearest full year

4. Government Employees

Gratuity paid by the government to government employees is fully exempt from tax.

5. Impact of the Amendment

The impact of the amendment is evident from the example. A hike in the ceiling limit of maximum exemption, helps reduce the taxable gratuity amount.

Although in the short run this amendment is going to benefit those earning higher salaries. However, if you have long time left before your retirement, this amendment will benefit most employees.

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