Introduction

Income tax is a direct tax imposed by the Indian government on the income generated by individuals and businesses within a financial year. The amount of tax paid varies according to the income slab in which the individual or business falls, and is influenced by various factors such as age, mode of income, industry, and type of company.

Gratuity, on the other hand, is a monetary benefit given to employees by their employers as a token of appreciation for their long-term service. This benefit is typically awarded at the time of retirement, resignation, or in the unfortunate event of death or disability, recognizing the employee's dedication and contribution to the growth and success of the organization.

Understanding Gratuity

Definition of Gratuity

Gratuity is a monetary benefit provided by employers to their employees as a token of appreciation for their long-term service. It is typically awarded when an employee retires, resigns, or in the event of their death or disability. Gratuity serves as a reward for the employee's dedication and contribution to the organization's success over a significant period.

Historical Context of Gratuity

Historically, gratuity was a voluntary benefit given at the discretion of the employer. It was not mandatory and varied greatly across different employers and industries. The Payment of Gratuity Act, 1972, brought significant change by making it a statutory obligation for certain employers to pay gratuity to their employees. This act standardized the gratuity payment process and ensured that employees who dedicated a substantial part of their career to an organization received a fair monetary reward.

Criteria for Eligibility

To be eligible for gratuity, the following criteria must be met:

• The individual must be a salaried employee of the company or organization. Trainees and interns are not eligible for gratuity.
• The individual must have completed at least five years of continuous service with the same employer.
• Gratuity is paid upon the employee's retirement, resignation, or in the event of death or disability. In cases of death or disability, the five-year service requirement is waived.

These eligibility criteria ensure that gratuity serves its purpose as a reward for sustained and significant contributions to the employer.

Gratuity and Income Tax

Taxability of Gratuity Received During Service

Gratuity received by an employee during their service is fully taxable. It is considered part of the employee's income under the "salary" head and is subject to income tax according to the applicable income tax slab rates.

Tax Exemptions Under Section 10(10) of the Income Tax Act, 1961

Under Section 10(10) of the Income Tax Act, 1961, gratuity received by an employee is eligible for tax exemption under certain conditions. These exemptions are designed to reduce the tax burden on employees receiving gratuity at the end of their service.

Conditions for Tax Exemptions Based on Different Scenarios

1. Retirement or Resignation

For employees retiring or resigning, the tax exemption on gratuity is calculated based on specific conditions:

Government Sector Employees:

• Full exemption on the gratuity received at the time of termination, retirement, or superannuation.

Private Sector Employees:

• Covered Under the Payment of Gratuity Act, 1972:
  • Least of the following is exempted from tax:
    • Last drawn salary (Basic + DA) × number of years of employment × 15/26.
    • INR 20 Lakhs (as amended).
    • Actual gratuity received.
• Not Covered Under the Payment of Gratuity Act, 1972:
  • Least of the following is exempted from tax:
    • Average salary of the last 10 months (Basic + DA) × number of years of employment × 1/2.
    • INR 10 Lakhs.
    • Actual gratuity received.
• Death of the Employee

In the event of an employee's death, the gratuity amount is paid to the nominee or legal heir and is fully exempt from income tax, regardless of the amount received. This ensures financial support for the family of the deceased employee without any tax burden.

These conditions ensure that employees and their families receive the maximum possible benefit from gratuity payments, recognizing their long-term service and contribution to the organization.

Tax Exemption Details

Government Sector Employees

Employees in the government sector are fully exempt from paying income tax on gratuity received upon termination, retirement, or superannuation. This policy applies to all employees of the central and state governments, including members of civil services, defense personnel, and employees of local authorities. The complete tax exemption ensures that these employees can benefit entirely from the gratuity amount as a reward for their long-term service.

Private Sector Employees

For private sector employees, the tax exemption on gratuity depends on whether they are covered under the Payment of Gratuity Act, 1972.

Employees Covered Under the Payment of Gratuity Act, 1972

Private sector employees working for employers who fall under the Payment of Gratuity Act, 1972, are eligible for tax exemptions calculated as follows:

• Eligibility:Employers in factories, mines, oil fields, plantations, ports, railway companies, shops, or other establishments with ten or more employees on any day in the preceding twelve months are covered under the Act.
• Tax Exemption Calculation:The least of the following amounts is exempt from tax:
  • Last drawn salary (Basic + Dearness Allowance) × number of years of employment × 15/26.
  • INR 20 Lakhs (as amended).
  • Actual gratuity received.

Employees Not Covered Under the Payment of Gratuity Act, 1972

Certain private sector employees work for employers not covered by the Payment of Gratuity Act. These employers may voluntarily pay gratuity, and the tax exemption for such employees is calculated differently:

• Eligibility:Employers not meeting the criteria of the Payment of Gratuity Act but choosing to pay gratuity voluntarily.
• Tax Exemption Calculation:The least of the following amounts is exempt from tax:
  • Average salary of the last ten months (Basic + Dearness Allowance) × number of years of employment × 1/2.
  • INR 10 Lakhs.
  • Actual gratuity received.

These provisions ensure that private sector employees receive tax benefits on their gratuity payments, acknowledging their contributions and providing financial security upon retirement or resignation.

Private Sector Employees Covered Under the Act

Applicability

• The Payment of Gratuity Act, 1972, applies to employers in specific industries such as factories, mines, oil fields, plantations, ports, railway companies, shops, or other establishments that have at least 10 employees on any day during the preceding twelve months.
• Once an employer is covered under the Act, the provisions remain applicable even if the number of employees falls below 10.

Tax Exemption Calculations

• Last Drawn Salary (Basic + DA) × Years of Service × 15/26:This formula determines the maximum amount of gratuity exempt from tax. The "15/26" fraction accounts for 15 days of salary for every completed year of service.
• INR 20 Lakhs Limit (as amended):The tax exemption limit has been increased to INR 20 Lakhs, meaning any gratuity amount up to this limit is exempt from tax.
• Actual Gratuity Received:The actual gratuity amount received by the employee.

Example Calculation

• If an employee's last drawn salary (Basic + DA) is INR 50,000 and they have completed 20 years of service:
  • Gratuity = 50,000 × 20 × 15/26 = INR 5,76,923 (approx.)
  • Since this amount is less than INR 20 Lakhs, it is fully exempt from tax.

Private Sector Employees Not Covered Under the Act

Voluntary Gratuity Payment

• Employers not covered under the Payment of Gratuity Act may choose to pay gratuity voluntarily to their employees.

Tax Exemption Calculations

• Average Salary of the Last 10 Months (Basic + DA) × Years of Service × 1/2:This formula determines the maximum amount of gratuity exempt from tax for employees not covered under the Act.
• INR 10 Lakhs Limit:The tax exemption limit for such employees is INR 10 Lakhs.
• Actual Gratuity Received:The actual gratuity amount received by the employee.

Example Calculation

• If an employee's average salary of the last 10 months (Basic + DA) is INR 40,000 and they have completed 20 years of service:
  • Gratuity = 40,000 × 20 × 1/2 = INR 4,00,000
  • Since this amount is less than INR 10 Lakhs, it is fully exempt from tax.

Recent Amendments and Their Impact

Increase in Tax Exemption Limit

• The tax exemption limit for gratuity has been increased from INR 10 Lakhs to INR 20 Lakhs.
• This change is beneficial for employees, especially those in the private sector, as it provides a higher tax-free amount of gratuity, enhancing their financial well-being upon retirement or resignation.

Positive Implications for Employee Financial Well-Being

• The increased limit allows employees to retain more of their gratuity amount, providing better financial security.
• It acknowledges the long-term contributions of employees, ensuring they are rewarded adequately without a significant tax burden.

Factors Affecting the Applicability of Gratuity Benefits

• Number of Employees:The Payment of Gratuity Act applies to employers with at least 10 employees. This determines whether the specific tax exemption calculations and limits apply.
• Employee Status:The eligibility for gratuity and the applicable tax exemptions depend on the employee's status (e.g., salaried employee) and their years of continuous service.
• Industry:Specific industries are mandated to comply with the Payment of Gratuity Act, impacting the applicability of gratuity benefits.

These amendments and conditions ensure that employees across various sectors receive fair and substantial financial benefits upon their retirement or resignation, recognizing their valuable service to their organizations.

Recent Amendments and Their Impact

Increase in Tax Exemption Limit

• The tax exemption limit for gratuity has been increased from INR 10 Lakhs to INR 20 Lakhs.
• This amendment allows employees to benefit from a higher tax-free gratuity amount, providing greater financial security upon retirement or resignation.

Positive Implications for Employee Financial Well-Being

• Enhanced Financial Security:Employees can retain a larger portion of their gratuity payment without incurring tax liabilities, which helps in ensuring better financial stability post-retirement.
• Increased Disposable Income:Higher tax exemptions mean more disposable income for employees at the time of receiving gratuity, which can be used for essential expenses, investments, or savings.
• Motivation and Retention:The increased exemption limit can serve as a motivational tool, encouraging employees to stay longer with an organization knowing that their long-term service will be financially rewarded.

Factors Affecting the Applicability of Gratuity Benefits

• Number of Employees:The Payment of Gratuity Act applies to employers with at least 10 employees. The Act's provisions and the related tax benefits are applicable if this criterion is met.
• Employee Status:The eligibility for gratuity and the tax exemptions depend on whether the employee is a salaried worker and has completed the requisite five years of continuous service.
• Industry:Specific industries, such as factories, mines, and oil fields, are mandated to comply with the Payment of Gratuity Act, which influences the applicability of gratuity benefits.

Conclusion

Importance of Gratuity as a Reward for Long-Term Service

• Gratuity serves as a significant reward for employees who have dedicated a considerable portion of their professional life to an organization. It acknowledges their contribution and provides financial support in their post-service life.

Benefits of Recent Amendments in Enhancing Employee Financial Security

• The increase in the tax exemption limit from INR 10 Lakhs to INR 20 Lakhs has been a constructive change, enhancing the financial security of employees. It allows employees to receive a more substantial amount without tax deductions, thereby improving their post-retirement financial health.

Advice for Employees to Understand and Utilize Gratuity Benefits Effectively

• Stay Informed:Employees should stay updated with the latest amendments and provisions related to gratuity to maximize their benefits.
• Plan Financially:Proper financial planning should be done considering the gratuity amount to ensure it is utilized effectively for future needs.
• Consult Professionals:Employees can seek advice from financial advisors to understand the tax implications and benefits of gratuity and to plan their finances accordingly.

By understanding the nuances of gratuity and staying informed about legislative changes, employees can make the most of this significant benefit, ensuring their long-term financial well-being and recognition of their service.

FAQs

What is gratuity?

Gratuity is a monetary benefit given to employees by their employers as a token of appreciation for their long-term service. It is typically paid upon retirement, resignation, or in the event of death or disability.

What is the Payment of Gratuity Act, 1972?

The Payment of Gratuity Act, 1972, mandates the payment of gratuity to employees in certain industries and organizations with at least 10 employees. It ensures that employees receive a fair monetary reward for their long-term service.

Who is eligible for gratuity?

An employee is eligible for gratuity if they have completed at least five years of continuous service with the same employer and are employed in an organization covered by the Payment of Gratuity Act.

Is gratuity taxable?

Gratuity received during service is fully taxable. However, gratuity received upon retirement, resignation, or death is eligible for tax exemptions under Section 10(10) of the Income Tax Act, 1961.

What is the tax exemption limit for gratuity?

The tax exemption limit for gratuity has been increased from INR 10 Lakhs to INR 20 Lakhs.

How is the tax exemption calculated for employees covered under the Payment of Gratuity Act?

For employees covered under the Act, the tax exemption is the least of the following:

Last drawn salary (Basic + DA) × number of years of service × 15/26.

INR 20 Lakhs.

Actual gratuity received.

How is the tax exemption calculated for employees not covered under the Payment of Gratuity Act?

For employees not covered under the Act, the tax exemption is the least of the following:

Average salary of the last 10 months (Basic + DA) × number of years of service × 1/2.

INR 10 Lakhs.

Actual gratuity received.

Are government sector employees fully exempt from tax on gratuity?

Yes, employees in the government sector are fully exempt from paying income tax on the gratuity they receive upon termination, retirement, or superannuation.

What happens to the gratuity in the event of the employee's death?

In the event of an employee's death, the gratuity amount is paid to the nominee or legal heir and is fully exempt from income tax.

Can gratuity be paid before completing five years of service?

Generally, gratuity is not payable if the employee has not completed five years of continuous service. However, this requirement is waived in the event of the employee's death or disability.

How is gratuity calculated?

Gratuity is calculated based on the employee’s last drawn salary and the number of years of service. The formula varies depending on whether the employee is covered under the Payment of Gratuity Act or not.

What industries are covered under the Payment of Gratuity Act, 1972?

Industries such as factories, mines, oil fields, plantations, ports, railway companies, shops, and other establishments with at least 10 employees are covered under the Act.

Is gratuity a part of the monthly salary?

No, gratuity is not a part of the monthly salary. It is a lump sum payment made at the time of retirement, resignation, or death.

Can an employer withhold gratuity?

An employer cannot withhold gratuity if the employee meets the eligibility criteria. However, gratuity can be withheld if the employee is terminated for reasons such as misconduct.

How can employees plan financially for gratuity?

Employees should stay informed about the gratuity provisions, seek advice from financial advisors, and include expected gratuity in their retirement planning to ensure they maximize their benefits and utilize the gratuity effectively for future needs.