Gratuity – Condition, Calculation and Tax Implication

Financial Planning | admin | September 25, 2010 at 11:11 pm

Gratuity payment is a lump sum that your company will pay you as an acknowledgement of your loyalty to the company.

Naturally, gratuity becomes payable only after you have spent a certain number of years with the company. You will receive this benefit either at the time of retirement or when you resign from employment.

Let us take a look at how gratuity benefit is paid.

Conditions for receiving gratuity benefit

There are two conditions that must be satisfied in order to be eligible to get the gratuity benefit:

(i) Your organisation has a minimum of 10 people on payroll, i.e., at least 10 employees receiving salaries from the organisation. Note that people on contract are not considered.

(ii) You have completed at least 5 years with the organisation. If an employee dies during the tenure of his employment, the 5-year rule is relaxed. So, even if such employee's period of service is as little as 1 year, he/she will be eligible to receiving gratuity if the first condition is met.

Calculation of the amount of gratuity payable

According to the law, the amount payable as gratuity is equivalent of half month's calculation of gratuity salary for every full year of your employment or Rs 10 L, whichever is lower. This is the minimum amount payable under the law. Some companies may pay a higher amount. This upper limit depends upon the company's policy.

For example, if you have put in 10 years of service before you resign from the company, you are entitled to the lower amount of:

An amount equal to 5 months' salary

Rs 10L

However, if your company has a policy to pay its employees a maximum of Rs 20L as gratuity, the amount payable to you when you resign after 10 years of completed service will be the lower amount of:

An amount equal to 5 months' salary

Rs 20L

Calculation of the amount of gratuity payable

Your last paycheck before you retire or resign is the amount you should consider in your gratuity computation. Also, only your 'Basic' and 'Dearness Allowance (DA)' should be taken into consideration.

For example, assuming Anil retires this year after completing 30 years with his company and his last pay check looks like the following, let us calculate the amount of gratuity that Anil's company should pay him:

Basic: Rs 60,000

DA: Rs10,000

HRA: Rs 26,000

Education Allowance: Rs 5,000

Travel Allowance: Rs 15,000

Gratuity payable: (Last month's salary / 26) * 15 * Completed years of employment

Last month's salary to compute gratuity = Basic + DA = Rs 70,000.

Gratuity payable = (70,000 / 26) * 15 * 30 = Rs 12,11,538

Since there is a limit of Rs 10L, Anil is entitled to receive Rs 10L towards gratuity. If his company has a policy to pay gratuity up to an amount of Rs 15L, then Anil's gratuity benefit will be Rs 12.11L.

Tax treatment for gratuity

Tax on Gratuity The amount of gratuity received by a person is taxed as salary income under the head 'income from salaries' on the income tax return. If you are a government employee, the gratuity amount paid is completely tax free. For non-government employees too there are tax exemptions equal to the lower of:

– Amount of gratuity paid or

– For every completed year of employment – Rs 3.50L (This is the current limit. It may be increased to Rs 10L in the near future)

Note that this limit is a maximum exemption for all your years of service. It applies to all the amounts of gratuity you will receive in your entire career from all your employers.

So, if you receive gratuity three times in your life and you exhaust the above limit within the first two times you receive gratuity, then the third time you are paid gratuity, it will be completely taxed according to your current tax slab rates.

Source: Economic Times