Income Tax Exemption on Gratuity with Examples

Gratuity means the reward of the service of the employee by the employer in the way of money. Gratuity can be one of the constituent of one’s salary. It is added to the income under head salary.  It is fully taxable i.e. some part of the gratuity is exempt under section 10(10) of the income tax act. It is paid as per the rules and regulations of the Payment of Gratuity Act 1972.

As per The Payment of Gratuity Act 1972 ,the workers employed in every factory, mine, oil field, plantation, port, railway, shop & establishment or educational institution employing 10 or more persons on any day of the preceding 12 months are eligible to receive gratuity. A shop or establishment to which the act has become applicable shall continue to be governed by the act even if the number of the employees employed falls below 10 in any subsequent year.

The maximum amount of exemption for Gratuity received is Rs.10,00,000 under section 10(10) but it cannot be more than actual Gratuity received.

Only employees are eligible to receive gratuity i.e. an intern or trainee is not eligible to receive gratuity and only whose employees who has completed five years of continuous service with the same company are eligible to receive gratuity.

Earlier the payment of Gratuity was not compulsory for employer to pay gratuity but after passing of the Payment of Gratuity act 1972 it is compulsory for the employer (on whom it applies) to pay gratuity to the employees.

Gratuity is payable on:

  • Resignation
  • Retirement
  • Death
  • Disablement
  • Retrenchment
  • Voluntary Retirement

If the employee services are terminated due to any misconduct, the employer has the right to reject payment of Gratuity.

In case of death there is no condition of continuous of service of 5 years.

In case the employee is receiving gratuity from more than one employer in the same previous year or I different previous years the aggregate maximum amount of exemption under section 10(10) for gratuity will be same i.e. Rs.10,00,000.

In case the employee had rendered service to any other employer then period of service with such employer shall also be included while calculating the amount of exemption.

income tax exemption on gratuityIncome Tax treatment on Gratuity received by

Government Employee: The gratuity received by any government employee of central government, state government or local authority received on death or retirement is wholly exempt from tax obligation.

A professor/teacher of a university established under an act of Parliament/State legislature (as weel as college affiliated to such university or constituent college of such university) is treated as Government employee for this purpose. 1

Employee where Employer is covered by Payment of Gratuity Act: The least of the following will be exempt:

Any gratuity received by an employee covered by the Payment of Gratuity Act, 1972, is exempt from tax to the extent of

(i) 15 days’ salary (7 days in the case of employees of seasonal establishments) based on the salary last drawn for every completed year of service or part thereof in excess of 6 months;

(ii) Rs. 20,00,000 (Rs. 10,00,000, before March 29, 2018, Rs. 3,50,000 from September 24,1997 to May 23, 2010), or (iii) gratuity actually received, whichever is less.

Note:

  • If an employee has worked for 10 years and 5 months then, number of completed years shall be taken as 10 years but if the employee has worked for 10 years and 7 months then, numbers of years shall be taken as 11 years.
  • This is amount of exemption which means from the total gratuity received this amount is deducted and remaining is taxable under the head Salaries.
  • In case of seasonal establishments 15 days is taken as 7 days
  • Salary does not include commission, bonus or any other allowance for this purpose.

Example illustrating the above:

Mr.A has worked for a company for 8 years and 8 months. The employer is covered by the Payment of Gratuity Act. At the time of his retirement, his monthly salary consists of Basic Pay was Rs.15,000 & D.A. was Rs.8,000 (50% forming part) & Commission Rs.5,000. He is received Rs.6,00,000 as Gratuity from employer.

Calculation of the amount of exemption

Least of following is exempt:

  • 15/26*23,000*9=Rs.119,423
  • 10,00,000
  • Actual Gratuity received= Rs. 6,00,000

Last drawn salary = Basic + D.A.(full)

= 15000+8000=23,000

The amount of exemption will be Rs.119,423. Hence the taxable amount of gratuity will be Rs.4,80,577 (6,00,000-1,19,423)

Rs.4,80,577 will added in the taxable income of Mr.A under the head Salaries

Employee where the employer is not covered by Payment of Gratuity act: Least of following will be exempt:

  • ½ * average salary of last 10 months preceding the month of retirement * completed year of service (part of the year is not considered)
  • 10,00,000
  • Actual Gratuity received

Salary means Basic pay and D.A. (forming part of retirement benefits) and commission based on turnover.

Note:

If an employee has worked for 10 years and 8 months then, the completed years shall be taken as 10 years & in case the employee has worked for 10 years and 3 months then also the completed years shall be taken as 10 years.

Example illustrating above

Mr. Ali has worked for a company for 10 years and 11 months. His employer is not covered under Payment of Gratuity act. At the time of retirement, his monthly salary consists of basic pay Rs.50,000 & D.A. Rs.16,000 (50% forming part of retirement benefits) & Commission of Rs.12,000 as 1% of total turnover. He receives Rs.3,00,000 as Gratuity at the retirement.

Calculation of the amount of exemption

Least of following is exempt:

  • ½ *70,000*10=Rs.3,50,000
  • 10,00,000
  • Actual Gratuity received= Rs.3,00,000

Average salary of last 10 months= {50000+8000 (16000*50%) +12000}*10/10

The amount of exemption will be Rs.3,50,000 but the actual gratuity received is Rs.3,00,000. Hence entire amount received as gratuity will be exempt. No taxable portion in gratuity.


About the Author

arpit goyalArpit Goyal is pursuing CA and B.com & also working as an article assistant in Gurgaon. He has an immense interest in Taxation. He loves to use technology to spread knowledge about taxation & accounts.

  1. Ram Kanwar Rana v. ITO

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