Gratuity is a retirement benefit paid by an employer to an employee for the services rendered during the period of employment. The payment of gratuity is governed by the Payment of Gratuity Act, 1972, and is mandatory for all employers who have 10 or more employees. In this article, we will discuss everything you need to know about gratuity and tax implications.
What is Gratuity?
Gratuity is a lump sum amount paid to an employee as a retirement benefit. It is paid by an employer as a gesture of gratitude for the services rendered by the employee during the period of employment. The Payment of Gratuity Act, 1972 governs the payment of gratuity in India.
Eligibility for Gratuity
To be eligible for gratuity, an employee must have completed at least five years of continuous service with the employer. However, in case of death or disablement of the employee, the gratuity is payable even if the employee has not completed five years of service.
Calculation of Gratuity
The amount of gratuity payable to an employee is calculated as follows:
Gratuity = (Last drawn salary x Number of completed years of service x 15)/26
In this calculation, the employee’s basic salary and dearness allowance at the time of retirement or resignation are referred to as “Last drawn salary.” The number of years and months an employee has worked for an employer is referred to as the “Number of completed years of service” refers to the length of time an employee has worked for a company. Rounding to the nearest integer is used for the year-fraction. The 15/26 factor is used to determine the gratuity.
Tax Implications on Gratuity
Gratuity received by an employee is taxable under the head “Income from Salaries.” However, there are certain exemptions available for the tax calculation of gratuity.
Exemption Limit The exemption limit for gratuity is Rs. 20 lakhs. Any amount received as gratuity up to Rs. 20 lakhs is exempt from tax. However, if the gratuity amount exceeds Rs. 20 lakhs, the excess amount will be taxable.
Calculation of Exemption The exemption for gratuity is calculated based on the following formula:
Exemption = (Last drawn salary x Number of completed years of service x 15)/26
In this formula, the “Last drawn salary” and “Number of completed years of service” are the same as used for the calculation of gratuity. The factor of 15/26 is also the same.
However, the exemption limit of Rs. 20 lakhs is applicable to the total amount of gratuity received by an employee from all employers during the period of service. For example, if an employee has worked for two employers during the period of service and received a gratuity of Rs. 10 lakhs from each employer, the total gratuity received by the employee is Rs. 20 lakhs. Therefore, the entire amount of gratuity is exempt from tax.
Tax Treatment for Government Employees
For government employees, the exemption limit for gratuity is different. The exemption limit is Rs. 20 lakhs plus the amount of gratuity received by the employee during the entire service period. For example, if a government employee has received a gratuity of Rs. 15 lakhs during the service period, the exemption limit for gratuity is Rs. 35 lakhs.
Tax Deduction at Source
(TDS) If the gratuity amount exceeds the exemption limit of Rs. 20 lakhs, TDS is applicable. The TDS rate for gratuity is the same as the income tax slab rate applicable to the employee. However, if the employee does not have taxable income in the year of receipt of
gratuity, the TDS will not be applicable. If the gratuity amount exceeds the exemption limit, the employer will deduct TDS at the time of payment of gratuity.
Also know about: Is gratuity mandatory for all employees?
Payment of Gratuity
Gratuity is payable to an employee at the time of retirement or resignation. However, in case of death or disablement of the employee, the gratuity is payable immediately. The employer must pay the gratuity within 30 days from the date it becomes payable. If the gratuity is not paid within 30 days, the employer is liable to pay interest at the rate specified by the government.
Gratuity for Contract Employees
Contract employees are also eligible for gratuity if they have completed five years of continuous service with the employer. However, the calculation of gratuity for contract employees is slightly different. The amount of gratuity for contract employees is calculated as follows:
Gratuity = (Last drawn salary x 15 x Number of completed years of service)/30
In this formula, the factor of 15/30 is used to calculate the gratuity for contract employees.
Gratuity is an important retirement benefit for employees, and it is mandatory for employers to pay gratuity to their employees. The calculation of gratuity and the tax implications of gratuity can be complex, and it is important for employees to understand the rules and regulations related to gratuity. By understanding the rules related to gratuity, employees can ensure that they receive the correct amount of gratuity and avoid any issues related to taxation.