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/superannuation - Gratuity 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 exempt, subject to certain conditions. The least of the following three possibilities are exempt from tax.
- Actual gratuity received
- Last salary (basic + DA) * number of years of employment * 15/26
- Rs.20 lakh (up from Rs.10 lakh according to the amendment)
In cases where the gratuity amount exceeds the exemption limit, it will be taxed as per prevailing conditions.
Illustration: Aditya’s last drawn salary is Rs.1.5 lakh per month (basic + DA). He has been employed for 19 years and 8 months. The gratuity payable to him is Rs.12 lakh.
Particulars | Previously | Latest Amendment |
Last drawn salary (Basic + DA) | Rs.1.5 lakh | Rs.1.5 lakh |
Number of years of employment | 20 (will be rounded off) | 20 (will be rounded off) |
Gratuity | 1,50,000*20*15/26 = 17,30,769 | 1,00,000*20*15/26 = 17,30,769 |
Maximum exemption allowed | Rs.10 lakh | Rs.20 lakh |
Gratuity actually received | Rs.17 lakh | Rs.17 lakh |
Amount of exemption (least of the above) | Rs.10 lakh | Rs.17 lakh |
Taxable gratuity | Rs.7 lakh | - |
Private sector employees not covered under the Act
Even if the Payment of Gratuity Act does not cover the company, there is no legal prohibition against an employer giving a gratuity to their employees. A half month's salary for each year that has been completed can be used to determine how much gratuity is due to the employee. The least of the following three possibilities are exempt is tax.
- Average salary (basic + DA) for the last 10 months * number of years of employment* ½
- Actual gratuity received
- Gratuity of Rs.10 lakh
Illustration: Aman’s average salary for the last 10 months is Rs.1 lakh. He has been employed for 24 years and 2 months. He received a gratuity of Rs.12 lakh.
Particulars | Amount |
Average salary for the last 10 months | Rs.1 lakh |
Number of years of employment | 24 (will be rounded off) |
Gratuity | 1,00,000*24*1/2 = 12,00,000 |
Maximum exemption allowed | Rs.10 lakh |
Gratuity actually received | Rs.12 lakh |
Amount of exemption (least of the above) | Rs.10 lakh |
Taxable gratuity | Rs.2 lakh |
FAQs on Income Tax Exemptions on Gratuity
- Who is eligible to receive a gratuity?
Employees who have been employed by the company for five years or more are eligible for gratuity benefits. The advantages of gratuity are always available to employees.
- Is gratuity subject to taxation?
Government employees receive a gratuity that is completely tax-free. Depending on whether they are covered under the Payment of Gratuity Act or not, employees in the private sector may qualify for tax exemptions.
- What is the maximum gratuity amount?
The Gratuity Act of 1972 states that employees are only eligible for loyalty benefits after five years of continuous employment. An employee may only receive a gratuity of up to Rs.20 lakh.
- Are contract employees or temporary employees eligible to receive a gratuity amount?
As long as they are regarded as employees of the organisation, temporary employees, contract workers, etc., are all eligible for the gratuity amount (with the exception of ‘apprentice’).
- Is there a nomination facility?
Yes, you may submit your nomination by completing Form ‘F’ during the new hire paperwork process when you join your company. In the event of the employee's demise, the gratuity amount will be given to the nominated family member/members.
- Does the employer have to deduct TDS when paying a gratuity?
If this amount is less than the exemption amount allowed by section 10(10) of the Income-tax Act, the employer is not required to deduct any TDS.
- Will I get an interest in gratuity?
Yes, if your employer fails to pay your gratuity on time, you receive simple interest from the due date of the payment.
- How do I declare my gratuity exemption on my tax return?
Whether you are covered under the Payment of Gratuity Act or not will determine the specific exemption that applies to you. The maximum exemption is Rs.20 lakh. First, put in the amount as income after deducting the exempted amount under the head ‘Income from Salaries’ on the ITR form.
Then, enter the same amount for verification in the 'Exempt Income' section.
- Can an employee receive extra gratuities?
Yes, if the employer so chooses, the employee may receive extra gratuity. However, this excess gratuity amount will be considered taxable income.
- Is gratuity included in the CTC?
Gratuity is not included in the CTC's contents. An employee's efforts and contributions to the organisation during their employment are recognised with a gratuity.
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