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Tax exemption on gratuity comes with riders

RETIREMENT BENEFIT: Tax benefit is allowed only if gratuity includes basic salary, DA

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Government employees and those employed in the organised sector receive gratuity at the time of their retirement/death. Gratuity also becomes payable on termination of services. Only those who have rendered service for continuous five years with the same employer are eligible for gratuity.

While many of you may have received gratuity, you may not be aware as to how it is calculated. Let us understand how gratuity is calculated and how it is taxed.

Who is eligible for gratuity

Anyone working in an establishment where more than 10 persons were employed during any day in a year is entitled to get gratuity, provided he has rendered continuous services for minimum five years as on the date of his retirement/death or termination of his employment with the same employer. However, the requirement of five years of continuous service does not apply in case of death and disablement of the employee.

Computation of gratuity

For central government employees, gratuity is calculated with reference to the pension rules as applicable for them. Likewise calculation of pension for members of civil services, defence personnel, all India and state administrative services and state government employees are calculated as per the pension rules made and applicable for such services.

For those who are not governed by separate pension rules, the pension is calculated as per provisions of Payment of Gratuity Act, 1972. Gratuity is to be computed at the rate of 15 days salary for each completed year of service. For the purpose of computing a year for gratuity purpose, a period of more than six month has to be treated as full year and, therefore, the period of service of less than six months is ignored. While computing salary for the 15-day period, salary drawn at the time of retirement is be divided by 26 and multiplied by 15. This is the minimum gratuity an employee is entitled to. Any employer who wishes, can pay higher sum as gratuity.

Taxation of gratuity

The gratuity received by all government employees, employees of municipalities and defence forces is fully exempt from tax without any uppr monetary limits.

For other employees the gratuity paid as calculated under the payment of Gratuity Act, 1972 is fully exempt. If the gratuity paid exceeds 15 days of salary for each completed year of service, the excess shall become taxable in the employee's hands. For the purpose of computing the salary for 15 days, the salary drawn by the employee during the 10 months just before the date when the gratuity becomes due, shall only be considered.

Salary for the purpose of computing gratuity exemption shall include dearness allowance only, if the terms of employment provide so. No other allowances including House Rent Allowance, Leave Travel Allowance shall be taken into account. So even if your employer computes the amount of gratuity payable on the basis of salary which includes other allowances, for exemption purposes under income tax laws, only the basic salary and the dearness allowance will only be considered.

In absolute terms as per the recent amendment of Payment of Gratuity Act, 1972, gratuity up to Rs 20 lakh is exempt. Any gratuity received beyond this limit is taxable. It is not that the basic amount of exemption is Rs 20 lakh for each incidence of gratuity, but the limit of Rs 20 lakh is to be applied for all gratuities received by an employee during his lifetime. So in case you had received gratuity in the past and claimed exemption, the amount of such gratuity shall be reduced from the amount of gratuity eligible for exemption.

Since the amount of gratuity exempt in absolute terms has been increased very recently, employees who had paid tax on gratuity due to it being in excess of Rs 10 lakh earlier, will be able to claim the exemption for the enhanced balance of Rs 10 lakh now, whenever they receive further gratuity.

In case of multiple gratuities even if the amount of gratuity received presently does not exceed 15 days of salary for each completed year of service, it will become taxable if it exceeds Rs 20 lakh, including the amount claimed exempt in the past.

Also, in case the employer has paid you gratuity computed with reference to salary inclusive of allowance, the excess portion of gratuity relatable to such allowance shall be taxable and the employer shall deduct tax even if the overall gratuity is below the limit of Rs 20 lakh.

TAX RULES

  • Limit of Rs 20 lakh for tax exemption on gratuity includes all gratuities received by an employee during his lifetime
     
  • If gratuity exceeds 15 days of salary for each completed year of service, the excess is taxable

The writer is a tax and investment expert

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