Section 10(10) of the Income Tax Act, defines Gratuity as a payment made to an employee either at the time of retirement or leaving from job. However, it is given to an employee once he/she has completed 5 years of continuous service. It is considered to be a monetary reward for being in service with the company. Simply, it proves to be a retirement benefit to the employees.

The Payment of Gratuity Act was enacted in 1972. Earlier tax free limit on receipt of gratuity was Rs. 10 lakhs which the Central Government has now increased to Rs. 20 lakhs for private sector employees in an amended bill – the Payment of Gratuity (Amendment) Bill, 2017.

The amendment will be applicable from 1st January, 2016 in line with the norms set for Government employees. Basic exemption limit for Central Civil Services (Pension) Rules, at par with central government employees, which is Rs. 20 lakh.  Before implementation of the 7th Central Pay Commission, the ceiling was Rs.10 lakh.

Revised Rules for Gratuity Taxation as per Section 10(10) of Income Tax Act 

Gratuity paid to Government sector employees is exempt from Tax.

Impact of Tax Benefit

Employees covered under the Payment of Gratuity Act, 1972.

Mr. Ashish has worked for his organisation for more than 20 years now. He has received Rs. 16 lakhs as a gratuity payment.  His last drawn basic salary was Rs. 1.25 lakhs. How much of gratuity should be exempted?

As per the act, least of the following with be exempted.

1. Rs. 10,00,000
2. Actual Gratuity Received – Rs. 16,00,000
3. Last drawn salary*15/26*Number of years of service – (1,25,000 x 15/26 x 20) = Rs. 14,42,308/-

Hence, Rs. 10 lakhs will be subject to exemption and Mr. Ashish would have to pay his tax on balance Rs. 6 lakhs.

As per the new rules proposed in Payment of Gratuity (Amendment) Bill, 2017, least of the following will be exempted.

1. Rs. 20,00,000
2. Actual Gratuity Received – Rs. 16,00,000
3. Last drawn salary*15/26*Number of years of service – (1,25,000 x 15/26 x 20) = Rs. 14,42,308/-

As per the new amendment, Rs. 14,42,308/- lower of the above three will be subject to exemption. Taxable amount deducted from actual gratuity received Rs. 16 lakhs would be Rs. 1,57,692.

For employees not covered by the Payment of Gratuity Act, 1972.

Taking cue from the similar example, let’s calculate if Mr. Ashish’s organisation is not covered under the Act, least of the following will be exempted.

1. Rs. 10,00,000
2. Actual Gratuity Received – Rs. 16,00,000
3. Average Salary * (1/2*Number of years of service) – Rs. 12,50,00/-

Hence, Rs. 10 lakhs will be subject to exemption and Mr. Ashish would have to pay his tax on balance Rs. 6 lakhs.

As per the new rules proposed in Payment of Gratuity (Amendment) Bill, 2017, least of the following will be exempted.

1. Rs. 20,00,000
2. Actual Gratuity Received – Rs. 16,00,000
3. Average Salary * (1/2*Number of years of service) – Rs. 12,50,00/-

As per the new amendment, Rs. 12.5 lakhs will be exempt from tax. Taxable amount will be (Rs. 16 lakhs less Rs. 12.5 lakhs) = Rs. 3.5 lakhs.

– Jinay Savla