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2021

Payment of Gratuity and its Tax Treatment in India

Payment of Gratuity and its Tax Treatment in India

 

Gratuity is a lump sum amount that employers pay their employees as a sign of gratitude for the services provided. It is paid as a reward for the employee’s long service rendered. Gratuity is generally paid at the time of retirement but one can also ask for it while moving jobs after a certain length of service (5 years).

In India, all matters related to gratuity are governed under the Payment of Gratuity Act, 1972. The act was passed by the Parliament on 21st August 1972 and came into force on 16th September the same year.

All central and state government departments, defense, and local governing bodies are covered under this act. Private organisations can come under its purview subject to fulfillment of certain conditions.

The key idea behind the introduction of this Act was to provide monetary benefit to employees who have provided an extended term of service to a single employee.

Applicability of Gratuity:

Organisations with a workforce of 10 employees on a single day in the preceding 12 months are liable to pay gratuity.
Once gratuity provisions are applicable to any organization, it shall remain applicable to it in future even if number of employees are less than 10.

Time of Payment of Gratuity:

An eligible employee will receive gratuity on following events:

  • Retirement;
  • Resignation;
  • Demise;
  • Disablement due to an accident or a disease;
  • VRS;
  • Termination;
  • Lay off due to retrenchment.

Note:

  • To be eligible, an employee has to render his/her services for 5 continuous years.
  • However, this condition is not taken into consideration in situations of demise or disablement of an employee.

Computation of Continuous Service:

The following rules apply to the calculation of continuous service under the Payment of Gratuity Act, 1972.

Time of Continuous Service

Types of Business Establishment

Mines & Quarries

an establishment that works for less than 6 days in a week

In case of any other establishment

Required No. of days to be considered as 1 year of continuous employment:

190

190

240

Required No. of days to be considered as 6 months of continuous employment:

95

95

120

Notes:

  • In case of seasonal establishment, attendance is required for more than 75% of the days when the establishment is functional.
  • Disablement leave, earned leave and maternity leave are counted as days worked in the calculation mentioned above.

Computation of Gratuity:

  • 15 days of wages (Basic + DA) of each year of completed service is considered for calculation.
  • The wages drawn by an employee in the last month of employment shall be taken for computation of 15 days wages.
  • As per the Gratuity Act, the amount of gratuity cannot be more than Rs 20 lakh. Any excesses would be treated as ex-gratia.

Computation of Gratuity when employer is covered under the Gratuity Act:

Step 1: Determine Tenure of Service of an Employee:

  • The very first step is to determine the tenure of service of the employee for the purpose of gratuity.
  • If an employee has worked for more than 6 months during the last year of employment, then it will be considered as full year of service for the purpose of gratuity.
  • Suppose the tenure of service is 6 years 7 months, then you receive the gratuity for 7 years. If tenure of service is 6 years and 4 months than tenure of service shall be taken as 6 years only.

Step 2: Compute 15 days Wages:

  • We know that 15 days of wages (Basic + DA) of each year of completed service is considered for calculation. This 15 days of wage amount is computed based on the salary drawn by the employee in the last month of employment.
  • To compute wages of 15 days of employment, divide salary of the last month of employment with 26 and multiply the amount with 15.

15 days Salary = 15 * Salary of Last Month of Employment / 26

Step 3: Determine Gratuity Payable:

  • The amount of gratuity payable by the employer to the employee is determined by multiplying 15 days salary with number of years of service. This implies that an amount equal to 15 days of salary is allowed as gratuity for every completed year of service.
  • The formula for computation of amount of gratuity is as follows:

Amount of Gratuity = Number of Years of Service * 15 * Salary of Last Month of Employment / 26

Computation of Gratuity when employer is not covered under the Gratuity Act:

  • Where an employer is not covered under Gratuity Act, the gratuity shall be calculated as per above steps only except that number of days in a month are taken as 30 days instead of 26 days.
  • The formula would be as follows:

Amount of Gratuity = Number of Years of Service * 15 * Salary of Last Month of Employment / 30

Example:

 

Particulars

Employer covered under Gratuity Act

Employer not covered under Gratuity Act

A

Last drawn monthly salary of the employee

50,000

50,000

B

Tenure of Service

10

10

C

Per Day Salary of the Employee

(A/26) =1923

(A/30) = 1667

D

15 Days Salary for Gratuity Computation (C * 15)

28,846

25,000

E

Amount of Gratuity payable to the employee (B * D)

2,88,462

2,50,000

 

Treatment of Gratuity under Income Tax:

  • The tax treatment of the gratuity amount depends on the type of employee who has to receive the gratuity.
  • Government Employee: The amount of gratuity received by any government employee (whether central/state/local authority) is exempt from the income tax.
  • Private Sector Employee: Where the employer is covered under the Gratuity Act, least of the following amounts shall be exempt from Income Tax:

Lease of the following amount is exempt from tax:

  1. Rs. 20 Lakhs;
  2. The actual amount of gratuity received;
  3. The eligible gratuity.

Example: A private sector employee has received Rs. 10 Lakh as gratuity from his employer. The eligible gratuity amount is Rs. 4,00,000. In this case, the lowest of the three figures is Rs 4,00,000 which is exempt from tax. Employee must pay tax on the remaining amount of Rs 6,00,000 as per income tax slab.

 

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