UPDATE: Illustrating Gratuity’s Tax Treatment.

As we promised, here is a simple example that illustrates the taxability of Gratuity. If you have any doubts with this illustration or in general, please reach out to us at fintuned.in@gmail.com

 

Mr. X had been working with a private company since past 15 years, 7 months. He is retiring on 5th April, 2014. His current Basic Salary = Rs 60,000 pm, DA = Rs 8,000 pm. He is going to receive a gratuity amount of Rs 7 lakhs on retirement.

Note: Mr. X’s basic salary and DA have been the same since past 1 year.

Solution
Lets consider 2 situations here – (A) Mr. X is covered under Payment of Gratuity Act, 1972; and (B) Mr. X is not covered under Payment of Gratuity Act, 1972.

(A) Mr. X  is covered under Payment of Gratuity Act, 1972

Maximum exemption from tax is least of the 3 below:

(i) Actual gratuity received; – Rs. 7,00,000.00

(ii) Rs 10,00,000;

(iii) 15 days’ salary for each completed year of service or part thereof – 15/26*16*68000 = Rs. 6,27,692.00

 

Therefore Rs. 6,27,692.00 is the Gratuity amount which is exempted and the balance amount will be taxable as per the Income Tax slab  for the year in which the gratuity amount has been received by the employee.

 

(B) Mr. X is not covered under the payments of Gratuity Act, 1972

Maximum exemption from tax is least of the 3 below:

(i) Actual gratuity received; – Rs. 7,00,000.00

(ii) Rs 10,00,000;

(iii) Half-month’s average salary for each completed year of service (no part thereof) — 34000*15 = Rs. 5,10,000.00

 

Therefore Rs. 5,10,000.00 is the Gratuity amount which is exempted and the balance amount will be taxable as per the Income Tax slab  for the year in which the gratuity amount has been received by the employee.

Gratitude, At The Rate of 100 Percent Compounded Perennially!

This article has been contributed by our number cruncher Mr. Rohit Agarwal, with inputs from the entire team.

Do a small exercise. Just type “The importance of saying thank you” on Google. Surely, you will be amazed to see the multitude of articles that modestly unravel the significance of expressing gratitude. Wait, when did we become the philosophers of our generation?

To be honest though, these two words carry umpteen significance in our daily lives because they recognize the effort (Well, now you decide if you want to say thank you to Mr Rahul………..:P). However, I am not here to load my readers with all the mystical knowledge behind gratitude. In keeping with that notion, I will head straight to the discussion on the topic “Gratuity”.

gratuities_always_accepted_keepsake_box

Most of us have an idea (not like Abhishek Bachchan of course) that Gratuity is a retirement benefit, but are we absolutely aware of the tax implications of this benefit? If you answered that with a NO, then this post will change your answer in a few minutes.

To begin with, Gratuity is a part of salary that is received by an employee from his/her employer in gratitude for the services offered by the employee in the company (Saying thank you). Gratuity is a defined benefit plan and is one of the many retirement benefits offered by the employer to the employee upon leaving his job. An employee may leave his job for various reasons, such as – retirement/superannuation, for a better job elsewhere, on being retrenched or by way of voluntary retirement.

Establishments Covered Under Gratuity Act?

Well, it is extremely important to know if you are covered under the Gratuity Act or not. So, here is an overview of the establishments that are covered under the said act. [Don’t be worried about memorizing it. Just glance through ;)]

  • Every factory, mine, oil field, plantation
  • port, railways, shop & Establishments OR
  • educational institution

Employing 10 or more persons on any day of the preceding 12 months.

Eligibility

As per Sec 10 (10) of Income Tax Act, gratuity is paid when an employee completes 5 or more years of full time service with the employer (minimum 240 days a year). Please note, an employee means those who are on the company’s payroll. Trainees and interns are not eligible for this compensation.

Tax treatment of gratuity

And, here comes the real challenge.

Warning: If you are easily bored by tax laws or they perplex you every single time, then DO NOT just give it to “your CA”. Rather, prepare a good coffee and peruse through the diverse collection of Fintuned’s articles.

The gratuity so received by the employee is taxable under the head ‘Income from salary’. In case gratuity is received by the nominee/legal heirs of the employee, the same is taxable in their hands under the head ‘Income from other sources’.

The tax treatment for an employee varies as per their employers. Here’s a brief idea of the tax treatment of gratuity for each category of employees in detail.

For the purpose of calculation of exempt gratuity, employees may be divided into 3 categories –

(a) Government employees

(b) Non-government employees covered under the Payment of Gratuity Act, 1972

(c) Non-government employees not covered under the Payment of Gratuity Act, 1972

In case of government employees – they are fully exempt from tax on gratuity. So, they have the maximum tax benefit when it comes to gratuity and a good amount is credited in their bank accounts (I have no comments on their work style 😛) and not even a single piece of this pie needs to be shared with the government. (Are you thinking of a career change)

In case of non-government employees covered under the Payment of Gratuity Act, 1972 

Maximum exemption from tax is the least of the list given below:

(i) Actual gratuity received;

(ii) Rs 10,00,000;

(iii) 15 days’ salary for each completed year of service or part thereof

Note:

  • Here, salary = basic + DA + commission (if it’s a fixed % of sales turnover).
  • ‘Completed year of service or part thereof’ means: full time service of > 6 months is considered as 1 completed year of service; < 6 months is ignored.
  • Here, number of days in a month is considered as 26. Therefore, 15 days’ salary is arrived as = Salary * 15/26 (This is very very important)

In case of non-government employees not covered under the Payment of Gratuity Act, 1972 –

Maximum exemption from tax is least of the 3 below:

(i) Actual gratuity received;

(ii) Rs 10,00,000;

(iii) Half-month’s average salary for each completed year of service (no part thereof)

Note:

  • Well, the definition of salary is similar to the abovementioned one.
  • Completed year of service (no part thereof) means: full time service of > 1 year is considered as 1 completed year of service. < 1 year is ignored.
  • Average salary =10 months’ salary (immediately preceding the month of leaving the job)/10

Note: This Rs 10-lakh ceiling is a lifetime exemption limit, it will be reduced by the tax-free exemption claimed from any previous employment.

As you may have noticed, the calculation of maximum exemption seems a bit complex. However, since we are at your side, you need not be stressed. In order to resolve any doubts, we will come up with a calculated example ASAP (within a day) to give you a broader understanding on tax treatment of gratuity.

Is your coffee over?

While I am not sure of the coffee, this post is certainly over and I sincerely hope that you gained a better perspective on Gratuity. If there are any questions/doubts/comments, please reach out to fintuned.in@gmail.com. Or, litter the comments section 🙂

Cheers.