Tax Planning
How to calculate gratuity, and are you liable to pay tax on it?

How to calculate gratuity, and are you liable to pay tax on it?

If you are one of those individuals who have received a gratuity from their ex-employer during the current financial year and are now wondering whether they have to pay tax on the entire amount or any part of it and whether any exemption is available on gratuity, then please read the entire article, as we will be clearing all your doubts about gratuity, its calculation, and taxability.

So, before discussing the calculation & taxability of gratuity, let us first understand “What is Gratuity?”

What is Gratuity?

Gratuity is a financial benefit provided by an employer to its employee for the services rendered by him/her in compliance with the provisions of the Payment of Gratuity Act, 1972. Gratuity shall be payable at the time of retirement or resignation, provided that the employee has completed at least 5 years of continuous service before leaving the organization.

However, in the case of death or disablement, the criteria of at least 5 years of continuous service will not be considered.

How to Calculate Gratuity?

Given below is the formula for calculation for gratuity-

A.    If the Employer is covered under the Payment of Gratuity Act

An employer would be covered under the act if he has employed more than 10 employees in a single day during the past 12 months

Gratuity = t*s*15 / 26

Where t = Tenure of service completed in the organization

S = Last drawn Salary (Salary = Basic Pay & Dearness Allowance (D.A.), only)

Example: Mr. Shyam Tiwari worked for ABC Corp Pvt. Ltd. for a tenure of 11 years and 7 months. His last drawn salary was Rs. 75,000 per month (Basic Pay = Rs. 37,500, D.A. = Rs. 2,500, HRA = Rs. 30,000, and Other Allowances = Rs. 5,000). Calculate Gratuity.

Total amount of Gratuity = (12*40,000*15)/26 = Rs.2,76,923

Points to note:  For the purpose of calculating gratuity, if an employee works in an organization for part of the year after completion of 5 years of continuous service, then that part of the year will be rounded to the nearest full-year figure. Like in the example above, we have rounded 11 years & 7 months to 12 years for the calculation of gratuity.

 

B.     If the Employer is not covered under the Payment of Gratuity Act

An employer would not be covered under the act if he had not employed more than 10 employees in a single day during the past 12 months. However, an organization can still pay gratuities to its employees.

Gratuity = t*s*15 / 30

Where t = Tenure of service completed in the organization

S = Average of Last 10 months’ Salary (Salary = Basic Pay + Dearness Allowance (D.A.) + Commission of Turnover, if any)

Example: Mr. Anuj Verma worked in Max Alfa Associates for a tenure of 8 years 9 months. His average last 10 months salary was Rs. 35,000 per month (Basic Pay = Rs. 17,500, D.A. = Rs. 2,500, HRA = Rs. 10,000, and Other Allowances = Rs. 5,000). Calculate Gratuity.

Total amount of Gratuity = (8*20,000*15)/30 = Rs.80,000

Points to note:  For the purpose of calculating gratuity, if an employee works in an organization not covered under the Payment of Gratuity Act, only fully completed years of service will be considered for payment of gratuity. For instance, in the example above, we considered 8 years & 9 months as 8 years only, for the calculation of gratuity.

 

Taxation of Gratuity

Section 10(10) of the Income Tax Act, 1961, lays down the provision for taxability of gratuity in the hands of employees. The said section has divided employees into three broad categories for taxation on gratuity.

Given below is the summary of such classification and tax implications for each class of employee for the financial year 2021-22-

Category of Employee Tax on Gratuity
Central/ State Government Employee

Defense Employee

Employees of any local bodies

The entire amount will be exempt from tax.
Employees working for employers covered under the Payment of Gratuity Act, 1972 A Minimum of following is exempt from income tax-

·Actual Gratuity Amount Received

· Rs. 20 Lakhs

· (15 X Last Drawn Salary X Number of Completed years of service) /26

Employees working for Employers not covered under the Payment of Gratuity Act, 1972 A Minimum of following is exempt from income tax-

· Actual Gratuity Amount Received

· Rs. 10 Lakhs

· (15 X Average of Last 10 months’ Salary X Number of Completed years of service) /30

 

 Lastly, the maximum exemption limit of Rs. 20 lakhs is a cumulative exemption granted to a person for the total gratuity received during lifetime, whether in a single fiscal year or in multiple fiscal years.

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