Tax on gratuity: Know how to calculate it and the exemption rules
Gratuity is an important employee benefit. Paid to an employee if he/she works continuously for five years and more, it follows a formula to determine the amount. But do you have an idea how are gratuity payments taxed and how much exemption is available?
Kolkata: Gratuity is an important employee welfare benefit and it is protected by an Act of Parliament known as Payment of Gratuity Act, 1972. One is usually entitled to gratuity payment if one completes five years or more of continuous permanent service on the rolls of a company. Gratuity is paid according to an universally recognised formula. But it is important to know how will gratuity payment be taxed. In fact, every salaried person should be aware of it.
It is significant too note that those who are working for the formal sector -- both in the government and private sector -- are entitled to gratuity payments upon retirement or death or leaving an organisaiton after continuous service for five years or more. Gratuity is also payable to an employee even if he/she is terminated. It is enforceable in a company or organisation where there are at least 10 employees. It is to be noted that if an employee dies, the minimum service period of five years is not applicable.
The Payment of Gratuity Act, 1972 stipulates that an amount equivalent to salary of 15 days must be paid for each completed year of service. Now it is to be noted that while calculating the service period, if the fraction is more than six months, it is considered as a full year. Conversely, if the fraction has less than six months, it is rounded off to the full year lower than the full time period. For example six years and 4 months will be treated as six years.
Taxation of gratuity
The first point is gratuity paid to government employees, municipalities, and defense forces employees is completely free from tax. For employees in other organisations, the amount payable is determined by the Payment of Gratuity Act, 1972. It is exempt from tax.
There are exceptions. If an employee gets paid gratuity in excess of 15 days for each year of service, the excess amount will be taxed. Now comes the question of how much tax. Please note that the tax exemption is calculated based on the average salary for the 10 months before the date of gratuity payment.
Now arises the question, what will be considered as salary? Tax expert Balwant Jain pointed out that salary will include basic salary and DA, but only if DA is considered part of salary under the terms of employment. Also note that House Rent Allowance (HRA), Leave Travel Allowance (LTA) or any other allowances will not be treated as components of the salary to calculate gratuity.
Limits for exemption of gratuity
Gratuity payment up to Rs 20 lakh is tax free, says an amendment to the Payment of Gratuity Act. Any amount over and above this limit will be taxable. But there is an important qualification -- the Rs 20 lakh limit is for a whole lifetime. If an employee has received gratuity and has claimed exemption, that amount has to be deducted from the exemption limit for any new gratuity the individual might get in future.