Income Tax Returns: Tax exemption on gratuity comes with riders

Government employees and those employed in the organised sector receive gratuity at the time of retirement/death or on termination of services. Only those who have rendered service for continuous five years with the same employer are eligible for gratuity. Let us understand how gratuity is calculated and how it is taxed.

Who is eligible for gratuity

Anyone working in an establishment where more than 10 persons were employed during any day in a year is entitled to get gratuity, provided he has rendered continuous services for minimum five years as on the date of his retirement/termination of his employment. In case of death or disablement of the employee, gratuity is paid without the requirement of five years of continuous service.

Computation of gratuity

For central government employees, members of civil services, defence personnel, all India and state administrative services and state government employees gratuity is calculated as per pension rules made and applicable for such services.

For those who are not governed by separate pension rules, the pension is calculated as per provisions of Payment of Gratuity Act, 1972. Gratuity is to be computed at the rate of 15 days salary for each completed year of service. For the purpose of computing a year for gratuity purpose, a period of more than six month has to be treated as full year and, therefore, the period of service of less than six months is ignored. While computing salary for the 15-day period, salary drawn at the time of retirement is be divided by 26 and multiplied by 15. This is the minimum gratuity an employee is entitled to. Any employer who wishes, can pay higher sum as gratuity.

Taxation of gratuity

The gratuity received by government employees, employees of municipalities and defence forces is fully exempt from tax. For other employees the gratuity paid as calculated under the payment of Gratuity Act, 1972 is fully exempt. If the gratuity paid exceeds 15 days of salary for each completed year of service, the excess shall become taxable in the employee’s hands. For the purpose of computing the salary for 15 days, the salary drawn by the employee during the 10 months just before the date when the gratuity becomes due, is considered.

Salary for computing gratuity exemption shall include dearness allowance (DA) only. No other allowances including House Rent Allowance, Leave Travel Allowance is taken into account. So even if your employer computes gratuity on the basis of salary which includes other allowances and even if the amount is below Rs 20 lakh, for the purpose of tax exemption only basic salary and DA will be considered.

As per the recent amendment of Payment of Gratuity Act, 1972, gratuity up to Rs 20 lakh is exempt. Any gratuity received beyond this limit is taxable. The Rs 20 lakh limit is not for each incidence of gratuity, but is for all gratuities received by an employee during his lifetime. So in case you had received gratuity in the past and claimed exemption, that amount shall be reduced from the amount of gratuity eligible for exemption.

Employees who had paid tax due to it being in excess of Rs 10 lakh earlier, can claim the exemption for the enhanced balance of Rs 10 lakh now, whenever they receive further gratuity.

In case of multiple gratuities even if the gratuity received presently does not exceed 15 days of salary for each completed year of service, it will become taxable if it exceeds Rs 20 lakh, including the amount claimed exempt in the past.

By, Balwant Jain

(The writer is a tax and investment expert)

This article was published in DNA as 'Tax exemption on gratuity comes with riders'