written by | June 2, 2022

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What is Income Tax Exemption on Gratuity?

Gratuity is receivable at the time of your retirement or when you have resigned from an organisation. A gratuity is receivable only after working continuously for 5 years in either case.

Earlier, an employer didn't need to reward his employee when he retired or resigned. But in 1972, the Government passed the Payment of Gratuity Act and made it mandatory for all the employers with more than ten employees to pay gratuity.

A part of this gratuity can be taxable depending on how much money you have received.

As per current law, gratuity received by a government employee is fully exempt from tax. The maximum amount they can receive is ₹20 lakhs per the amendment made following the 7th Pay Commission recommendation.

This article highlights the Basics of Gratuity and explains which all employees come under gratuity and which all don't. 

Did You Know?

The Interim Budget 2019 was presented by Mr Piyush Goyal, interim finance minister. He announced that the tax-free gratuity limit would be incremented to ₹30 lakhs.

What is Gratuity?

If we talk about what is gratuity in income tax, it refers to the financial benefit an employer gives employees in return for their services. The centre has raised the gratuity taxable exemption limit to ₹20 lakhs, which is an increase of ₹10 lakhs from the previous one. The new exclusion limit of ₹20 lakhs applies to employees in case of retirement/death/resignation or disablement on or after 29th March 2018.

The 1972 Payment of Gratuity Act will govern gratuity. Because it is not part of the monthly salary, it is not paid regularly. You can only get it in the case of the following:

  1. Superannuation: An employee who reaches retirement age.
  2. Resignation or Retirement
  3. Accidental death or disability resulting in death (the time limit for the employee's disablement or death is not applicable)

Notice: Employees must have worked for the company for at least five years before being eligible for gratuity.

In the next section, you will understand the basics of gratuity. 

Also Read: How To Save Income Tax on Income From Salary For Individuals

Understanding the Basics of Gratuity

Gratuity is a one-time amount paid to an employee from the company after leaving the company after serving consistently for five years. This gratuity definition is widely accepted, and it is also among the numerous retirement benefits. Additionally, tax applies to gratuities only if greater than the Exemption Amount, as determined under section 10(10) in the Income Tax Act.

It is calculated using two elements: 

  1. The number the employee spends with the organisation.
  2. The last salary paid by the business. 

The salary is given through the organisation to an employee upon completing five years of service.

Do you know how income tax on gratuity works? Check the next section to know the complete details. 

Income Tax Exemption on Gratuity

Gratuity taxable exemption is according to the following rules for India:

Employees Covered Under the Payment of Gratuity Act

In case the gratuities are received by an employee covered under the Payment of Gratuity Act, 1972, the amount is exempt from taxation on income in the amount of:

  1. 15 days' salary as per the salary last drawn for each completed year of service, or a portion of it that exceeds six months;
  2. ₹20,00,000 (₹10,00,000 before 29/3/2018, ₹3,50,000 from 24/9/1997 to 23/5/2010); or
  3. The amount of gratuity paid or received, whichever is less.

Anything more than the exemption limit is subject to taxation on income.

If you have questions about the eligibility criteria to receive gratuity, read the following section. 

Eligibility Criteria to Receive Gratuity

Now that you know about what is gratuity in income tax let’s cherish the eligibility criteria. The employer must pay the amount only when the employee meets the basic requirements. These are the requirements:

  • An employee - An employee must be the one who receives a wage from an employer, and apprentices aren't qualified to be eligible for this benefit.
  • Term - The employee should have been on continuous service for at least five years.
  • Resignation/superannuation is payable only on an employee's resignation, superannuation, or death after completion of the requisite term.

Furthermore, any company that employs 10 or more people at any given point in time will be able to provide this benefit to eligible applicants. Also, if your business needs more social media engagement, be sure to read the best Instagram Business Tips that’ll skyrocket the traffic flow in your business.

Employees Not Covered Under the Payment of Gratuity Act

Any other form of gratuity paid to an employee upon the occasion of death, retirement ousting, resignation or upon an employee becoming incapacitated before retirement is tax-free in case it's at a minimum of:

  1. ₹10,00,000;
  2. Half-monthly pay for each year;
  3. The actual amount of gratuity received.

Government Employees

Any death-cum-retirement gratuity paid to an employee of an organisation such as the Central Government, State Government or local authority is exempt from taxation on income. Teachers and professors of Universities established according to any Act of Parliament or State Legislature, colleges affiliated to the University or constituent college of the University are classified as government employees to this end. 

Income Tax Exemption on Gratuity

Gratuities received from Central, or State Government Employees, including Defence personnel, are completely exempt from income tax. However, private-sector employees are entitled to the maximum lifetime exemption in the amount of ₹20 lacs or ₹10 lacs annually or the actual amount they receive in the above manner.

Any gratuity that is more than the limits mentioned above is tax-deductible on the part of the employee on a due basis upon receipt. The person assessed can claim the exemption following Section 89.

Additionally, any gratuity given to an employee who remains in employment is not tax-free; however, the tax assessor is entitled to the relief provided following Section 89.

Maternity Leave

Alongside the increase in gratuities tax-free, the Payment of Gratuity Act 2017 also empowers the Central Government to determine maternity leave. In the new legislation, pregnant mothers are entitled to a maternity leave of 26 weeks, and the duration of maternity leave will be considered to be in continuous service.

Gratuity Payment

Gratuity payments are handled in three steps. These are:

  • Initiation: A person or an authorised individual must submit a request to an employer for the company's gratuity that they are owed.
  • Disbursal: After the employer has sent the acknowledgement, the employer has 30 days to pay the gratuity amount.
  • Acknowledgement of application and calculation: The company that owes gratuity calculates the amount and provides notice to the individual and controlling authority.

A Few Important Points About Gratuity

Here are some important points regarding gratuity payments by employers to employees.

  • The employer can accept a gratuity paid by an employee to exceed ₹10 lakh. The tax exemption will then be determined according to the taxation points.
  • If an employee is asked to quit their job due to misconduct, the employer can refuse gratuity payment.
  • The gratuity amount is paid to the nominee or heir in the event of death. This tax is applied to the recipient under Income from Other Sources.
  • The Interim Budget 2019 was presented by Mr Piyush Goyal, interim finance minister. He announced that the tax-free gratuity limit would be increased to ₹30 million.

Also Read: What is Ex Gratia Payment?

Can I Get Gratuity if I Quit a Company After 4.5 Years of Service? 

To receive gratuity, you must have served at least five years in a company. According to a Madras High Court ruling, gratuity can be claimed if you have served 240 days in the fifth year. This should be discussed with your HR department. The legal heir will pay the gratuity amount if someone is killed while still in service. The amount received by a nominee/heir is not subject to tax.

Conclusion

Gratuity is paid out in conjunction with or shortly before/after the total and final settlement is made. The law requires employers to pay the balance in 30 days. 

If there is a delay in the payment, the gratuity employer must pay interest at a simple rate on the amount starting from the date of due until the day that the payment has been made. 

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FAQs

Q: What Amount of Gratuity Do I Receive Each Month?

Ans:

An employee is entitled to take a maximum of 57.69% of their monthly salary as a gratuity. To find out how much gratuity you will receive, you will need to calculate the amount of gratuity using the calculator.

Q: What Is the Gratuity Formula?

Ans:

Gratuity may be calculated using the formula (15* the last month's salary* length of time off work) multiplied by 26, where 26 is considered the number of workdays each month.

Q: How Much Is the Income Tax Exemption on Gratuity?

Ans:

For the whole employment that an employee has, the highest amount that is exempt from taxes is ₹20 Lakhs.

Q: What Pay Is Taken Into Account When Formulating Gratuities?

Ans:

In formulating gratuity, the most recently paid amount of salary paid to the worker is considered.

Q: When Can an Employee Demand Gratuities?

Ans:

An employee can solicit their employer to make gratuity payments after five consecutive years of employment.

Q: What Is the Meaning of Gratuity?

Ans:

The gratuity definition is very simple. It’s a lump sum payment made by an employer to an employee in appreciation of their services to the company.

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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.