Income Tax Exemption on Gratuity

When an employer offers a bonus payment to an employee in appreciation of the work the employee has done for the business, it is termed gratuity. Suppose an employee works for a specific organisation for at least half a decade without a break. In that case, they are paid at the moment of retirement or resignation with a gratuity amount. In rare cases, the five-year service gratuity rule is waived, such as those involving death or disability.

We have you covered if you need a clear understanding of India’s income tax exemption guidelines for gratuity payments. This informative piece will help you fully comprehend every facet of the situation, from what is a gratuity payment to eligibility criteria. 

So, without further ado, read what you can anticipate from gratuity if you are qualified to receive gratuities from your former workplace. Along with the gratuity statute, the blog encapsulates employee eligibility requirements, a gratuity calculator, and gratuity exemption. 

Eligibility Criteria to Receive Gratuity

Now that you know what a gratuity is in terms of income tax let’s consider the eligibility requirements. The employer is bound to pay a gratuity amount only when an employee satisfies the fundamental requirements. The prerequisites are as follows:

  1. An Employee: An individual who earns a salary from the business. Additionally, apprentices are not eligible for this benefit.
  2. Term: At a minimum, the employee must have served the organisation for five years without any break. 
  3. Resignation or Superannuation: The amount is only paid upon the employee’s resignation, retirement, or death following the expiration of the required term. 

Furthermore, this benefit will be available to qualified candidates from any business that employs at least ten or more individuals at any given moment.

Income Tax Exemption Rules on Gratuity 2022

The new labour law became operative for all companies and organisations from July 1, 2022. Following the new labour law, there are certain reductions in the working hours, Provident Fund (PF), along with the in-hand salary. This law will most impact the take-home pay.

Employers must ensure that base pay constitutes 50% of an employee’s CTC (cost to the firm) and that the remaining 50% consists of overtime, housing expenses, and employee allowances per the new gratuity policy for 2022. Additionally, any other allowances and exemptions provided by the company that exceed 50% of the CTC will be considered compensation.

The law restricts the maximum basic pay to 50 per cent of CTC, which raises the gratuity bonus that must be given to employees, according to the new criteria for gratuities for 2022. The gratuity amount paid to an employee is based on a significant wage basis that comprises basic pay and allowances. 

Employees who work overtime, such as for fifteen minutes or longer, are compensated.

Employees Falling Under the Payment of Gratuity Act

Everyone who works in a factory, mine and oil fields, port, plantation, outlets, railways or educational institution with at least ten employees on any given day in the previous 12 months is eligible for gratuity.

Once the Act applies to an employer, gratuity will be provided to the employees if the number of employees decreases to less than ten. 

Calculation of Gratuity Exemption Amount from Tax 

The following are all tax-exempt to the extent possible:

  • Last drawn salary (basic plus DA) * no. of employment years * 15/26;
  • INR 20 lakhs (earlier, the amount was limited to INR 10 lakh, and after amendment, it was increased to INR 20 lakh); 
  • The actual gratuity amount received 

Let’s consider an example to grasp better this: Ritik’s most recent salary was INR 1 lakh/ month, i.e., basic plus DA. He is eligible for an 11 lakh rupee gratuity. He has served the organisation for 19 years and seven months. 

Specifics Earlier After Amendment 
Last Drawn Salary, i.e., Basic plus DA One Lakh One Lakh
Number of Employment Years 20 Year (rounded off) 20 Years (rounded off)
Gratuity 1,00,000*20*15/26 

Which is equal to 1153846


Which is equal to  1153846

Maximum Possible Exemption Ten Lakhs Twenty Lakhs (as amended)
Gratuity actually received Eleven Lakh Eleven Lakh
Exemption Amount (least of the above) Ten Lakh Eleven Lakh
Taxable Gratuity One Lakh NIL

Points to remember:

  • Fifteen days of pay, depending on the latest wage received each year of service completed, or a portion thereof, or 15/26.
  • The amount of service years are rounded up to the next full year.

Employees Not Falling Under the Payment of Gratuity Act 

Even though the Payment of Gratuity Act does not cover the company, there is no legal prohibition on an employer giving a gratuity to their staff. Half a month’s wage for each year completed might be used to determine how much gratuity is due to the employee.

Calculation of Gratuity Exemption Amount from Tax 

The following are all tax-exempt to the extent possible:

  • Last ten month’s average wage (basic plus DA)* no. of employment years * 1/2;
  • INR 10 lakhs (the amended amount, i.e. INR 20 lakhs, does not apply to employees who are not subject to the Payment of Gratuity Act)
  • The actual gratuity amount received. 

Here’s how gratuity exemption would be computed for such employees: 

Ritik has been serving an organisation for 25 yrs and two months. For the past ten months, his average salary has been INR 90,000. The gratuity amount he receives equates to 11 Lakhs.

Specifics  Amount (in Rupees)
Average salary of last ten months  INR 90,000
Number of employment years 25 Years (rounded off)
Gratuity 90,000*25*1/2 

Which equates to INR 11,25,000

Maximum Possible Exemption  Ten Lakhs
Gratuity actually received Eleven Lakhs
Exemption Amount (least of the three) Ten Lakhs
Taxable Gratuity One Lakh

Points to remember:

  • An average wage for the last ten months will be taken into consideration.
  • The total years in service will be rounded off to the nearest full year. 

Gratuity Exemption for Government Employees

A gratuity received by government employees upon retirement, termination, or superannuation is currently tax-free, but it should be noted that India does have foreign income taxation. This rule applies to local, state, and federal government employees and those working in the defence industry and other professions.

What Is a Gratuity Gratuity?

Gratuity is a monetary reward the employer provides but is not included in the employee’s regular monthly salary. Gratuity provisions are subject to the Payment of Gratuity Act, 1972, and it is paid upon the occurrence of any of the below-depicted circumstances.

  • At the time of superannuation, i.e., when the employee attains retirement age.
  • Upon leaving a job or retiring 
  • Upon death or incapacity brought on by an illness or accident. To be eligible for gratuity, an employee must have worked for the company for at least five years. However, interns and contract workers are not permitted to use it. 

Usually, the business gets group insurance or deducts the gratuity from its budget to provide employees with the gratuity amount. Contrary to the employee provident fund (EPF), which also includes the employee’s contribution, the employer pays the gratuity.

According to the 1972 Payment of Gratuity Act, a specified percentage of the wage is calculated and put down in a gratuity account that would be due later. The perk serves as a superannuation advantage for departing employees. All companies having more than ten employees fall under the Act.

An employer makes a gratuity payment in the event of

  • Resignation
  • Retirement or Superannuation
  • Layoff or Voluntary Retirement
  • Death
  • Disability
  • Termination. 

However, the money will be paid to the employee’s nominee in the event of death.

What Is a Gratuity Calculator?

The gratuity calculator is a high-tech tool that provides quick results. Using the formula for calculating gratuities, the gratuity calculator would determine the amount of the gratuity. 

Gratuity calculation:

(15 * most recent wage * employment years) / 26.

The amount you would receive as a gratuity if you left the organisation after 5-years of employment can be calculated using a gratuity calculator. It’s a valuable tool for figuring out the gratuity you’ll receive if you leave the company. You must enter the last payment received and the term of continuous employment with the company to compute results in split seconds. 

Your most recent drawn salary consists of your basic pay, dearness allowance (DA), and sales commission. The gratuity calculator would show the gratuity amount in a matter of seconds. There is no cap on who can use it or how frequently they can use it.

Frequently Asked Questions (FAQs)

Is gratuity completely tax-exempted?

Government personnel are not liable for paying taxes on any gratuities they get from the government. The tax on gratuities upon retirement and the tax on gratuities upon an employee’s death are other situations in which taxes are excused.

How are taxable gratuities determined?

The calculation of taxable gratuities is based on a half-month’s wage for each year the employee has worked for the company.

After five years, are gratuities taxable?

The amount of money a person receives, not the number of years, determines whether or not a gratuity is taxed. However, as per the most recent modifications, gratuity tax is exempted up to INR 20 lakh for any individual serving tenure. The cap on gratuity exemption is INR 20 lakh.

Are gratuities and PF from the employer taxable?

No, the EPF funds and gratuity are tax-free, especially for a government employee. However, gratuities and Employee Provident Fund are taxable for private employees. Gratuities for private employees are only exempt from taxes under one circumstance: either at the time of retirement or if the employee is no longer working.

Urban Money