What is Income Tax Exemption on Gratuity?

A gratuity is a payment of a lump sum amount made by an employer to his employees in recognition of their services to the organization. Earlier, it was not mandatory to pay gratuities to employees. It was paid voluntarily as a token of appreciation. However, with the introduction of the Payment of Gratuity Act 1972, certain companies are mandatorily required to discharge their obligation to pay a gratuity amount if the employee renders five years of continuous service. Gratuity is not required to be paid as a part of monthly salary but shall be paid on the occurrence of either of the following events:

• On superannuation (an employee is said to be on superannuation when he attains the age of retirement)
• On retirement or his resignation
• On his death or disablement due to disease or accident (5 years of continuous service is not mandatory where service termination was due to the employee’s death or disability).

Will the amount of gratuity received by an employee be treated as salary? Will it be offered to tax in the same manner as salary? Read on to find the answers to all your questions on gratuity.

Contents

• Taxability of gratuity
• Eligibility to Get Gratuity
• Payment of Gratuity in case of Death of the Employee
• Income tax exemption on gratuity
• Calculation as per Gratuity Calculator
• Illustrations

Budget 2024 Update

FM Nirmala Sitharaman has made two announcements for those opting for the new tax regime.

First, the standard deduction for salaried employees is proposed to be increased from Rs 50,000/- to Rs 75,000/-. Similarly, deduction on family pension for pensioners is proposed to be enhanced from Rs 15,000/- to Rs 25,000/-.

Second, in the new tax regime, the tax rate structure is proposed to be revised, as follows:

• 0-3 lakh rupees - NIL tax
• 3-7 lakh rupees - 5% tax
• 7-10 lakh rupees - 10% tax
• 10-12 lakh rupees - 15% tax
• 12-15 lakh rupees - 20% tax
• Above 15 lakh rupees - 30% tax

As a result of these changes, a salaried employee in the new tax regime stands to save up to Rs 17,500/- in income tax.

Taxability of gratuity

If any employee receives gratuity during his service, then it is fully taxable as income in his hands under the Income Tax Act, 1961 (‘the Act’). However, if gratuity is received in case of death, retirement, or resignation and certain other cases, then tax exemption is provided under section 10(10) of the Act.

Any amount received as a gratuity by an employee shall be treated as income of such person under the head 'Salaries.’ However, in case of the death of such an employee, the gratuity shall be paid to his nominee or his legal heir, as the case may be. Such an amount shall be treated as their income under the head 'income from other sources.'

Note: Every employee is compulsorily required to prescribe the name/s of their nominee after completing a year of service as per the Payment of Gratuity Act, 1972.

Eligibility to Get Gratuity

The eligibility criteria to receive gratuity are as follows:

• Employee-employer Relationship: To be eligible for gratuity, the individual must be an employee working under a contract of employment with the employer. This includes both permanent and fixed-term employees.
• Completion of Service: The employee must have completed a minimum of 5 years of continuous service with the employer. This period of service is calculated from the date of joining to the date of resignation, retirement, or termination of employment.
• Retirement or Superannuation: Gratuity is typically paid at the time of an employee's retirement, resignation, or voluntary separation after completing five years of service. In the case of the employee's death or disablement due to an accident or illness, gratuity can be paid even before completing five years of service.
• Termination Due to Death or Disability: If an employee's employment is terminated due to death or disability before completing five years of service, the gratuity amount is payable irrespective of the minimum service requirement.
• Minimum Employee Count: The Payment of Gratuity Act, 1972, is applicable to establishments with ten or more employees on any day of the preceding 12 months.

Payment of Gratuity in case of Death of the Employee

In the unfortunate event of the death of an employee, gratuity is still payable, even if the employee has not completed the minimum five years of continuous service required for normal gratuity eligibility. The Payment of Gratuity Act, 1972, makes provisions for gratuity payment in case of death or disability of an employee.

Here are the key points regarding the payment of gratuity in the event of the death of an employee:

• Minimum Service Requirement: If the employee has completed a minimum of one year of continuous service with the employer, gratuity becomes payable in the event of the employee's death.
• Nominee or Legal Heir: The gratuity amount is usually paid to the nominee appointed by the deceased employee. In the absence of a nominee, it is paid to the legal heirs of the deceased.
• Gratuity Calculation: The gratuity amount payable in case of the employee's death is calculated based on the completed years of service up to the date of death. For the purpose of calculation, any part of a year in excess of six months is considered as one year.
• Calculation Formula: The formula for calculating gratuity in this case is: (Last drawn salary × 15 days × completed years of service) / 26.
• Tax Implications: The gratuity amount received by the nominee or legal heir is exempt from income tax up to a maximum limit specified by the government. Any amount exceeding the exempted limit may be taxable.
• Prompt Payment: Employers are legally required to make the gratuity payment within 30 days from the date it becomes payable, i.e., the date of the employee's death.

If you have received a gratuity payment or are about to receive one and need expert help on whether it's taxable or not, you can use our tax advisory service here.

Income tax exemption on gratuity

The tax exemption on gratuity income provided under section 10(10) of the Act is available up to specified limits for income tax purposes, facilitating ease of income tax e-filing.

• Retirement gratuity received by members of the Defence Service under the Pension Code Regulations is entirely exempt from tax.
• Employees of Central and State Government/local authority or Members of Civil Services: Any death cum retirement gratuity is entirely exempt from tax under section 10(10)(i).
• Other employees:
  i) Private sector employees covered by the Payment of Gratuity Act, 1972
  The Payment of Gratuity Act 1972 prescribes gratuities for employees of certain organizations. The employees of the following organizations are entitled to gratuity:
  
  • - Factory, plantation, mine, oilfield, port and railway company
  • - Shops, establishments, or educational institutions having ten or more employees on any day during the preceding twelve months

  Points to be note:

  • Once the Act becomes applicable to an organization, gratuity shall continue to be applicable for it even if the employees' count falls below ten.
  • The service duration is approximated to the nearest full year.
    **Salary for this section means basic salary and dearness allowance (if it is given in the terms of employment for retirement benefits that form part of salary)

  ii) Private sector employees not covered by the Payment of Gratuity Act, 1972:

  The Payment of Gratuity Act of 1972 mandates certain organizations to make gratuity payments. However, other organizations are free to make a voluntary payment of gratuity to their employees. There are no restrictions on making such payments of gratuity.

  Tax exemption limit for such employees is the least of the following:

  A. Rs.10 lakhs
  b. Actual gratuity amount received
  c. The formula: 1/2x(last 10 months average salary)/10 x number of years of employment

  Note: The service duration is approximated to the nearest full year.

  Calculation as per Gratuity Calculator

  The gratuity calculator is used to compute the gratuity amount using the below-provided formula:-

  Gratuity Formula: (15 * your most recent wage * your length of service) / 26.

  Calculate your gratuity amount using the gratuity calculator here

  

  Illustrations

  Mr. A retired on 28.7.2020 after completing 25 years and six months of service and received a gratuity of INR 15,00,000. During retirement, his salary was:

  • Basic Salary: INR 40,000 p.m.
  • Dearness Allowance: INR 15,000 p.m. (of which 60% is for retirement benefits)
  • Commission: 1% of turnover (in the last 12 months, turnover was INR 1,20,00,000)
  • Bonus: INR 30,000 p.a.

  Computation of his taxable gratuity assuming:

  (a) He is a private sector employee and covered by the Payment of Gratuity Act 1972.

  Particulars	Amount (in INR)
  Gratuity received at the time of retirement	15,00,000
  Less: Exemption under section 10(10)(ii) Least of the following: i) Statutory limit= INR 20,00,000 ii) Gratuity received= INR 15,00,000 iii) As per formula: (salary last drawn x number of years of employment x15/26) (40,000+9000) x 26 x15/26= INR 7,35,000	7,35,000
  Taxable Gratuity	7,65,000

  (b) He is a private sector employee and not covered by the Payment of Gratuity Act 1972.

  Particulars	Amount (in INR)
  Gratuity received at the time of retirement	15,00,000
  Less: Exemption under section 10(10)(iii) Least of the following: i) Statutory limit= INR 10,00,000 ii) Gratuity received= INR 15,00,000 iii) As per formula: 1/2x(last 10 months salary)/10 x years of employment. 1/2x ([(40,000x10)+(15,000x60% x10)+(1% x1,20,00,000 x 10/12)])/10x 25= INR 7,37,500	INR 7,37,500
  Taxable Gratuity	7,65,000

  (c) He is a Government employee.

  Particulars	Amount (in INR)
  Gratuity received at the time of retirement	15,00,000
  Less: Exemption under section 10(10)(i) [fully exempt]	15,00,000
  Taxable Gratuity	Nil

  e filing income tax return sometimes seems complex when you have a lot of exemptions to be claimed; one such exemption is gratuity, which you receive at the time of retirement or resignation from the organization. If you received a gratuity and don’t feel confident during income tax filing, our team of tax experts will help you file your ITR with maximum refund and save taxes so you can keep more of what you earn. Don’t wait till the last date of the ITR filing. Book eCA Today!

  Frequently Asked Questions

  Q - What is gratuity?

  Gratuity is a monetary benefit provided by an employer to an employee as a form of gratitude for the services rendered. It is typically paid at the time of retirement, resignation, or death of the employee.

  Q - Is gratuity mandatory for all employers to provide?

  The Payment of Gratuity Act 1972 makes it mandatory for employers with ten or more employees to provide gratuities to eligible employees. However, employees need to complete a minimum of 5 years of continuous service to be eligible for gratuity, except in the case of death or disability.

  Q - What is the eligibility criteria for gratuity?

  To be eligible for gratuity, an employee must have completed a minimum of 5 years of continuous service with the employer. However, gratuity becomes payable even if an employee has completed a minimum of one year of service in the event of their death or disability.

  Q - How is gratuity calculated?

  The gratuity amount is calculated based on the employee's last drawn salary and the number of years of completed service. The formula for calculating gratuity is: (Last drawn salary × 15 days × completed years of service) / 26.

  Q - Can an employer deny gratuity to eligible employees?

  No, it is a statutory benefit, and employers are legally obligated to pay gratuity to eligible employees as per the provisions of the Gratuity Act.

  Q - Is gratuity taxable?

  Gratuity received by government employees is fully exempt from income tax. For non-government employees, gratuity is partially exempt. The exempted amount is subject to a maximum limit set by the government, and any amount exceeding the limit may be taxable.

  Q - Can the employee nominate someone to receive gratuity in case of their death?

  Yes, an employee can nominate a person as their nominee to receive the gratuity amount in case of their death. If there is no nominee, the gratuity is paid to the legal heirs of the deceased.

  Q - Is there a time limit for gratuity payment?

  Employers are required to make the gratuity payment within 30 days from the date it becomes payable, i.e., the date of retirement, resignation, or death of the employee.

  Q - Can an employee claim gratuity if they resign before completing 5 years of service?

  No, an employee must complete a minimum of 5 years of continuous service to be eligible for gratuity, except in the case of death or disability.

  Q - Is gratuity applicable to contract or temporary employees?

  Yes, gratuity is applicable to all employees, including contract or temporary employees, who have completed the minimum eligible service period.