All About Gratuity
Calculation of the amount of gratuity payable

Your last paycheck before you retire or resign is the amount you should consider in your gratuity computation. Also, only your 'Basic' and 'Dearness Allowance (DA)' should be taken into consideration.

For example, assuming Anil retires this year after completing 30 years with his company and his last pay check looks like the following, let us calculate the amount of gratuity that Anil's company should pay him:
Basic: Rs 60,000
DA: Rs10,000
HRA: Rs 26,000
Education Allowance: Rs 5,000
Travel Allowance: Rs 15,000
Gratuity payable: (Last month's salary / 26) * 15 * Completed years of employment

Last month's salary to compute gratuity = Basic + DA = Rs 70,000.

Gratuity payable = (70,000 / 26) * 15 * 30 = Rs 12,11,538

Since there is a limit of Rs 10L, Anil is entitled to receive Rs 10L towards gratuity. If his company has a policy to pay gratuity up to an amount of Rs 15L, then Anil's gratuity benefit will be Rs 12.11L.

Tax treatment for gratuity

The amount of gratuity received by a person is taxed as salary income under the head 'income from salaries' on the income tax return. If you are a government employee, the gratuity amount paid is completely tax free. For non-government employees too there are tax exemptions equal to the lower of:
Amount of gratuity paid or
For every completed year of employment - Rs 3.50L (This is the current limit. It may be increased to Rs 10L in the near future)

Note that this limit is a maximum exemption for all your years of service. It applies to all the amounts of gratuity you will receive in your entire career from all your employers.

So, if you receive gratuity three times in your life and you exhaust the above limit within the first two times you receive gratuity, then the third time you are paid gratuity, it will be completely taxed according to your current tax slab rates.

How increase in gratuity limit will impact you

The government notified the Payment of Gratuity (Amendment) Act, 2010 on May 18, 2010, which increases the limit of gratuity payment to employees in the specified sectors/establishments covered under the Payment of Gratuity Act, 1972 (“Gratuity Act”).

After the amendment, these employees are eligible to receive gratuity up to Rs 10,00,000, which was earlier restricted to Rs 3,50,000. Thus, crores of workers will be benefited in establishments covered by the Gratuity Act.
Meaning of Gratuity
Gratuity refers to the emoluments received by an employee from his employer in gratitude for the services rendered. Such sum can be paid on retirement, resignation, superannuation, death or disablement.
Under the Gratuity Act, the sum can be paid only after an employee has rendered continuous service of not less than five years. Exceptions being termination of employment on account of death/disablement.

Taxability of Gratuity
From a tax perspective, gratuity received by an employee is taxable as salaries. The Income tax Act segregates the employees receiving gratuity on the following basis:
Government employees;
Non - Government employee covered under the Gratuity Act.
Non - Government employee and not covered under the Gratuity Act.

Based, on the above segregation, necessary exemptions from tax can be claimed on the gratuity received.

Exemption available for employees covered under the Gratuity Act
In case of employees covered under the Gratuity Act, exemption is limited to the extent of minimum of the following:
i) Gratuity actually received
ii) 15 days salary for every completed year of service or part thereof (i.e. services in excess of 6 months will be treated as full year service)
iii) Rs 3,50,000 (the maximum limit as provided in the Gratuity Act)

The increase in limit to Rs 10,00,000 in the Gratuity Act (from the erstwhile Rs 3,50,000) in a way indicates that the tax exemption may also increase.

Tax impact of the amendment
The tax impact can be explained by way of an example. Suppose, Mr A retires from a software company after servicing for 35 years and at the time of retirement his basic salary was Rs 50,000 per month.

Upon retirement, Mr A is eligible for a gratuity payout of Rs 10,00,000 and is covered under the Gratuity Act. The taxable amount of gratuity would be as under in different scenarios:

Taxable amount of gratuity in different scenarios.
When will you get gratuity payment?
Gratuity payment is a lump sum that your company will pay you as an acknowledgement of your loyalty to the company.
Naturally, gratuity becomes payable only after you have spent a certain number of years with the company. You will receive this benefit either at the time of retirement or when you resign from employment.

Let us take a look at how gratuity benefit is paid.

Conditions for receiving gratuity benefit

There are two conditions that must be satisfied in order to be eligible to get the gratuity benefit:
(i) Your organisation has a minimum of 10 people on payroll, i.e., at least 10 employees receiving salaries from the organisation. Note that people on contract are not considered.
(ii) You have completed at least 5 years with the organisation. If an employee dies during the tenure of his employment, the 5-year rule is relaxed. So, even if such employee's period of service is as little as 1 year, he/she will be eligible to receiving gratuity if the first condition is met.

Calculation of the amount of gratuity payable

According to the law, the amount payable as gratuity is equivalent of half month's salary for every full year of your employment or Rs 10 L, whichever is lower. This is the minimum amount payable under the law. Some companies may pay a higher amount. This upper limit depends upon the company's policy.
For example, if you have put in 10 years of service before you resign from the company, you are entitled to the lower amount of:

An amount equal to 5 months' salary or Rs 10L

However, if your company has a policy to pay its employees a maximum of Rs 20L as gratuity, the amount payable to you when you resign after 10 years of completed service will be the lower amount of:

An amount equal to 5 months' salary or Rs 20L.
Open issues
There are some open issues in terms of the date from which the higher limit is applicable and whether a separate clarification/notification will come from a tax perspective. The increase in limit has got the president recently and it seems that the open issues will get clarified soon.

The above amendment in the Gratuity Act is a welcome step by the government and will bring lots of cheer to employees across the private sector.
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