Tax-free gratuity up to Rs 20 lakh: A HUGE RELIEF : The Tribune India

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Tax-free gratuity up to Rs 20 lakh: A HUGE RELIEF

Many people are not aware of a key component of their salary, which is gratuity.

Tax-free gratuity  up to  Rs 20 lakh: A HUGE RELIEF


Chetan Chandak 

Many people are not aware of a key component of their salary, which is gratuity. Therefore, many young salaried people often fail to benefit from it. On September 12, 2017, the Union Cabinet passed the Payment of Gratuity (Amendment) Bill 2017 which seeks to raise the threshold of exemption available for employees of formal sector from Rs 10 lakh to Rs 20 lakh. This amendment can provide huge tax relief to formal sector employees. For all those young salaried individuals who are not aware of gratuity and its benefits, let’s discuss what gratuity is.

Gratuity, just like PF, is one of the retirement benefits provided to employees by the employer. However, unlike PF, gratuity does not warrant contributions of employee but employer only. It is paid as a lump sum amount at the time of retirement. The provisions related to gratuity are covered under the Payment of Gratuity Act, 1972 which allows gratuity payment to all the permanent employees who are working in any office which have at least 10 or more than 10 employees and includes factories, mines, oilfields, plantations, ports, railway companies, shops, etc.

However, there is one important condition which an employee must satisfy to be eligible to claim gratuity. An employee must serve an employer for period of minimum five years. However, there are certain cases where the employee does not need to satisfy this condition to claim gratuity. 

If an employee has died or has developed a disability owing to accident or illness, gratuity can be claimed even if he did not serve his employer for five years. In case an employee dies, the amount of gratuity is paid to his nominee regardless of the tenure. Employees need to fill Form F to choose a nominee for gratuity. The amount of gratuity is paid to the nominee within 30 days from the date of being issued to the person entitled to it. In case there is any delay or default, the employer will have to pay interest on such amount.

Gratuity calculation

The following formula is used to calculate gratuity:

Gratuity = Last drawn salary (Basic + DA) × 15/26 × Number of years of service (rounded off to the full year)

Where 15/26 = 15 working days out of a total of 26 per month

In case it is proved that the employee’s service was terminated on the grounds of moral turpitude in the course of official business or any proven misconduct on the employee’s part, his gratuity amount can be forfeited by his employer. 

Gratuity is not entirely tax free but a certain amount is exempted from tax. Earlier, in April 2010 such exempted amount was Rs 3.5 lakh, but then it was increased to Rs 10 lakh. According to this, despite having stashed an amount greater than Rs 10 lakhs as gratuity, the amount of tax-free withdrawal cannot exceed Rs 10 lakh after which the taxes are deducted from the remaining amount, and the amount that is (if) left after deduction of taxes is paid to you under the head ‘income from salaries’.

Tax exemption is calculated on the lowest amount from the following:

1. Upper limit of tax-free gratuity

2. Actual gratuity received

3. Gratuity calculated as per the formula: Gratuity = Last drawn salary (Basic + DA) × 15/26 × Number of years of service (rounded off to the full year)

The Payment of Gratuity (Amendment) Bill, 2017 aims at increasing this exempted amount up to Rs 20 lakh tax-free gratuity. This would effectively mean that only the gratuity amount exceeding Rs 20 lakh will be subject to taxes. As a result, employees will pocket a higher amount of gratuity. Let us understand how it will impact your earnings.

We need to make an assumption first. Let’s say Mr Arindam received Rs 35 lakh as gratuity. His last drawn monthly salary was Rs 2.5 lakh and the average of his last 10 months salary is Rs 2.2 lakh. He has given his employer 22 years and 7 months of service. Now we can calculate his tax-free gratuity benefits under two scenarios:

1) Where the employee claims gratuity amount before the enhanced limit

2) Where the employee claims gratuity amount after the enhanced limit (see box above)

So, as you can see from the calculation, the increase in exemption limit can result in huge tax savings. Several young individuals are busy hopping jobs in their initial years of service which results in loss of gratuity benefits. In the long run, these benefits can accrue to offer you a huge sum of money.

The writer is Head of Tax research, H&R Block India. The views expressed in this article are his own

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