Income Tax Exemptions on Gratuity

Gratuity is a form of financial ‘thank you’ that is provided by the employer to the employee on completion of 5 years of service. It is a financial component that is a part of the benefits package that can also be used as a retirement benefit.

An average individual works for around 30-35 years in his/her lifetime, typically retiring only after attaining a certain age. Given the amount of time put into work, it is natural for employees to expect certain recognition, recognition which could come in the form of a bonus on retirement. Gratuity is one such form of appreciation, thanking individuals for contributing to the growth and development of an organisation.

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Basic eligibility criteria to receive Gratuity

Gratuity is paid to an individual only if he/she satisfies a few basic criteria, as listed below.

  • Employee – An individual should be an employee drawing wages from an organisation. An apprentice is not eligible to receive gratuity.
  • Term – The employee should have put in continuous service for a minimum of 5 years.
  • Resignation/superannuationGratuity is payable only on resignation, superannuation or death of an employee, after completion of the requisite term.

Any organisation which has 10 or more employees at a given point of time is expected to pay gratuity to eligible candidates.

Payment of Gratuity

The Payment of Gratuity Act, 1972 provides the framework to streamline and implement gratuity in the country. Eligible individuals are paid their gratuity on retirement/resignation, while in the case of demise of eligible employees, their nominee will be paid the amount. The gratuity amount is calculated using defined formulae, with different methods adopted to calculate the gratuity for government and private sector employees.

Maximum amount payable as Gratuity

The Gratuity Act places a cap on the maximum amount one can receive as Gratuity, fixing it at Rs 10 lakhs. While this is the upper limit as per the Act, an employer could choose to increase the amount, terming it a bonus or performance incentive. The actual amount payable depends on the salary of an employee and the number of years of service rendered.

Income Tax applicable on Gratuity payment

Gratuity received by an individual will be viewed as a part of his/her salary component, making it a taxable entity as per existing laws. This tax, is however limited, for the government offers tax exemptions on the gratuity received, subject to certain conditions. In case of gratuity received by a nominee/heir on the demise of an employee, the amount received is liable to be taxed, falling under the “Income from other sources” heading.

IT exemptions on Gratuity received by government employees

According to existing laws, the gratuity received by government employees on their superannuation/retirement/termination is exempt from tax. This extends to employees of both State and Central Government employees, employees from the defence sector and those working in any local authority.

IT exemptions on Gratuity received by private sector employees:

Tax exemptions on gratuity for private sector employees depend on whether they fall under ambit of the Payment of Gratuity Act of 1972. Differential tax treatment is provided based on this criteria.

Private sector employees covered under the Act:

Gratuity received by employees who are covered under the Act is tax exempted, subject to certain conditions. The least of the following three possibilities are exempt from tax.

  • Gratuity amount of Rs 10 lakhs or
  • Salary equivalent to 15 days of service for each year completed or
  • Actual gratuity received

In cases where the gratuity amount exceeds the exemption limit, it will be taxed as per prevailing conditions.

Private sector employees not covered under the Act:

Employees who do not fall under the ambit of the Payment of Gratuity Act are also eligible for certain exemptions, subject to these exemptions being the least of the following.

  • Actual gratuity received
  • Gratuity of Rs 10 lakhs
  • Amount equivalent to half month salary for every year of service

Any amount exceeding the aforementioned minimum limit is liable to be taxed.

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