Income Tax Exemption and Calculation Process

Shubham Chauhan

05 Dec, 2019

What is Gratuity?

Gratuity is the monetary benefit given by an employer to its employee at the time of his retirement. It is a form of financial “thank you” provided by the employer to the employee on the completion of 5 years of service. Mostly an average individual works for around 30-35 years in his lifetime. Such an extended period of services given by an individual to the Company demands some recognition or bonus at the time of retirement. Gratuity is one such appreciation thanking individuals for their diligent services towards the growth and development of the organization. This benefit of Gratuity calculation is payable under the Payment of Gratuity Act, 1972.

Eligibility criteria to Receive Gratuity

Gratuity is paid to an individual on fulfilling the following criteria’ :

• An individual should be an employee receiving a salary from the organisation. An apprentice is not eligible to receive gratuity.
• To receive gratuity, an employee must have given continuous services for a minimum of 5 years.
• Gratuity is payable only on the resignation or death of an employee, post the completion of the requisite term.

Calculation of Gratuity Exempted from Tax

An organisation having ten or more employees on any day in the preceding 12 months is entitled to pay gratuity to eligible candidates. Once the Act becomes applicable to an employer after that gratuity is applicable even if the number of employees goes below 10.  Several components go into the making of the gratuity amount. The gratuity amount depends on the time one has served in the company and the amount of salary last drawn.

Let us understand through an example:

Let’s assume S= number of years served in the company

                         A=Basic last salary drawn + DA

Therefore, Gratuity= S*A*15/26

An employee who has worked with an organization for 20 years and has INR 25,000 as his last drawn salary+ DA amount

Then Gratuity= 20*25,000*15/26

                       =INR 2,88,461.5

Points to be considered

 Since gratuity is a sort of tip, the employer could pay a higher amount as per his wish. However, the amount should not exceed INR 10 lakhs.

• An amount above 10 lakhs is called ex-gratia. This amount is not imposed by law and is a voluntary contribution.
• The time span of more than 6 months, of the last year of employment, is rounded off to the next number. However, if the time span of the last year of employment is less than 6 months, it is not rounded off to the following number. For example, if an employee has worked for 6 years and 7 months, he is liable to 7 years gratuity, whereas if he has worked for 6 years and 4 months, he is liable for 6 years gratuity only.

Taxation Process of Gratuity

The Taxation process of gratuity depends upon the receiver of the gratuity amount. The process of calculation of gratuity amount exempted has different cases as follows:

Exemptions on Gratuity received by government employees: For employees working under the state or central government or local authority, gratuity amount is exempted from income tax.

Exemptions on Gratuity received by private-sector employees covered under the Act: If the employer is covered under the Gratuity Act, in such cases 15 days salary as per employees last drawn salary is exempted from tax

Exemption on Gratuity received by private employees not covered under the Act: Employees those who do not fall under the limits of Payment of Gratuity Act are eligible to certain exemptions as follows:

• Actual gratuity received
• Gratuity up to 1o lakh rupees
• An amount equivalent to half month salary of every year of service.

Any amount exceeding the above-mentioned limit is not exempted from tax.

The payment process of Gratuity

Initiation: The employee should send an application to the employer for his gratuity owned by a company.

Calculation: Once the employer receives the application, the next step is for the Company to calculate the amount of gratuity. Further, after the calculation of the amount, the company has to provide notice to the employee and controlling authority with the specified amount.

Disbursal: This is the final step of the payment process, in which the employer has a period of 30 days for paying the gratuity amount.

Important Rules on Gratuity

Forfeiture: The employer has the authority to forfeit the payment of gratuity, as per the Payment of Gratuity Act of 1972. This can happen in a case where the employee got terminated because of his disorderly conduct at the time of service. If an employee gets charged with physical abuse, he loses the opportunity of receiving the gratuity amount.

If an employee dies, the gratuity amount should be paid to the nominee mentioned by the employee.

*Important Note: According to the amendment made by the Central Board of Direct Taxes (CBDT), the maximum limit of gratuity has been increased. Now, the tax exemption amount has been increased from 10 lakhs to 20 lakh rupees. This amendment comes under section 10(10) of the Income Tax Act.

Also, Read: Avail the Gratuity Money it’s your Legal Right!