What is Income Tax Exemption on Gratuity?

Taxability of gratuity

If any employee receives gratuity during his service, then it is fully taxable as income in his hands under the Income Tax Act, 1961 (‘the Act’). However, if gratuity is received in case of death, retirement, or resignation and certain other cases, then tax exemption is provided under section 10(10) of the Act.

Any amount received as a gratuity by an employee shall be treated as income of such person under the head 'Salaries.’ However, in case of the death of such an employee, the gratuity shall be paid to his nominee or his legal heir, as the case may be. Such an amount shall be treated as their income under the head 'income from other sources.'

Note: Every employee is compulsorily required to prescribe the name/s of their nominee after completing a year of service as per the Payment of Gratuity Act, 1972.

Eligibility to Get Gratuity

The eligibility criteria to receive gratuity are as follows:

• Employee-employer Relationship: To be eligible for gratuity, the individual must be an employee working under a contract of employment with the employer. This includes both permanent and fixed-term employees.
• Completion of Service: The employee must have completed a minimum of 5 years of continuous service with the employer. This period of service is calculated from the date of joining to the date of resignation, retirement, or termination of employment.
• Retirement or Superannuation: Gratuity is typically paid at the time of an employee's retirement, resignation, or voluntary separation after completing five years of service. In the case of the employee's death or disablement due to an accident or illness, gratuity can be paid even before completing five years of service.
• Termination Due to Death or Disability: If an employee's employment is terminated due to death or disability before completing five years of service, the gratuity amount is payable irrespective of the minimum service requirement.
• Minimum Employee Count: The Payment of Gratuity Act, 1972, is applicable to establishments with ten or more employees on any day of the preceding 12 months.

Payment of Gratuity in case of Death of the Employee

In the unfortunate event of the death of an employee, gratuity is still payable, even if the employee has not completed the minimum five years of continuous service required for normal gratuity eligibility. The Payment of Gratuity Act, 1972, makes provisions for gratuity payment in case of death or disability of an employee.

Here are the key points regarding the payment of gratuity in the event of the death of an employee:

• Minimum Service Requirement: If the employee has completed a minimum of one year of continuous service with the employer, gratuity becomes payable in the event of the employee's death.
• Nominee or Legal Heir: The gratuity amount is usually paid to the nominee appointed by the deceased employee. In the absence of a nominee, it is paid to the legal heirs of the deceased.
• Gratuity Calculation: The gratuity amount payable in case of the employee's death is calculated based on the completed years of service up to the date of death. For the purpose of calculation, any part of a year in excess of six months is considered as one year.
• Calculation Formula: The formula for calculating gratuity in this case is: (Last drawn salary × 15 days × completed years of service) / 26.
• Tax Implications: The gratuity amount received by the nominee or legal heir is exempt from income tax up to a maximum limit specified by the government. Any amount exceeding the exempted limit may be taxable.
• Prompt Payment: Employers are legally required to make the gratuity payment within 30 days from the date it becomes payable, i.e., the date of the employee's death.

If you have received a gratuity payment or are about to receive one and need expert help on whether it's taxable or not, you can use our tax advisory service here.

Income tax exemption on gratuity

The tax exemption on gratuity income provided under section 10(10) of the Act is available up to the following limits:

• Retirement gratuity received by members of the Defence Service under the Pension Code Regulations is entirely exempt from tax.
• Employees of Central and State Government/local authority or Members of Civil Services: Any death cum retirement gratuity is entirely exempt from tax under section 10(10)(i).
• Other employees:
  i) Private sector employees covered by the Payment of Gratuity Act, 1972
  The Payment of Gratuity Act 1972 prescribes gratuities for employees of certain organizations. The employees of the following organizations are entitled to gratuity:
  
  • - Factory, plantation, mine, oilfield, port and railway company
  • - Shops, establishments, or educational institutions having ten or more employees on any day during the preceding twelve months
  Any death and retirement gratuity is exempt from tax to the extent of the least of the following: (a) Rs. 20 lakhs (hiked from Rs. 10 Lakh as per the amendment)
  (b) Actual gratuity amount received
  (c) Total salary amount should be a sum of 15 days of services for every completed year or part thereof in excess of six months.i.e. 15/26.

Points to be note:

• Once the Act becomes applicable to an organization, gratuity shall continue to be applicable for it even if the employees' count falls below ten.
• The service duration is approximated to the nearest full year.
  **Salary for this section means basic salary and dearness allowance (if it is given in the terms of employment for retirement benefits that form part of salary)

ii) Private sector employees not covered by the Payment of Gratuity Act, 1972:

The Payment of Gratuity Act of 1972 mandates certain organizations to make gratuity payments. However, other organizations are free to make a voluntary payment of gratuity to their employees. There are no restrictions on making such payments of gratuity.

Tax exemption limit for such employees is the least of the following:

A. Rs.10 lakhs
b. Actual gratuity amount received
c. The formula: 1/2x(last 10 months average salary)/10 x number of years of employment

Note: The service duration is approximated to the nearest full year.

Calculation as per Gratuity Calculator

The gratuity calculator is used to compute the gratuity amount using the below-provided formula:-

Gratuity Formula: (15 * your most recent wage * your length of service) / 26.

Calculate your gratuity amount using the gratuity calculator here

Illustrations

Mr. A retired on 28.7.2020 after completing 25 years and six months of service and received a gratuity of INR 15,00,000. During retirement, his salary was:

• Basic Salary: INR 40,000 p.m.
• Dearness Allowance: INR 15,000 p.m. (of which 60% is for retirement benefits)
• Commission: 1% of turnover (in the last 12 months, turnover was INR 1,20,00,000)
• Bonus: INR 30,000 p.a.

Computation of his taxable gratuity assuming:

(a) He is a private sector employee and covered by the Payment of Gratuity Act 1972.

(b) He is a private sector employee and not covered by the Payment of Gratuity Act 1972.

(c) He is a Government employee.