Income Tax Implications on Gratuity: A Comprehensive Guide

Gratuity is a significant part of an employee’s remuneration package. It is a payment made by an employer to an employee as an appreciation of service rendered by such employee. This article aims to provide a detailed understanding of the income tax implications on gratuity in India.

What is Gratuity?

Gratuity is a large amount of gift that is given to an employee by an employer on retirement/ death/ disablement/ resignation of the employee after serving the organization for a specified period. Unlike provident funds, Gratuity is entirely paid by the employer without any contribution from the employee.

Eligibility for Gratuity

An employee becomes eligible for gratuity under the following conditions:

1. Superannuation: An employee becomes eligible for gratuity when he or she reaches the age of superannuation. Superannuation is a retirement benefit offered to the employee by the employer. It is basically a pension plan made by the employer on behalf of the employee.

2. Retirement or Resignation: Gratuity is payable when an employee retires or resigns. After serving the organization for a certain number of years, the employee is entitled to a certain amount of money known as gratuity.

3. Death or Disablement due to Accident or Disease: Even if the employee has not completed 5 years of service, the legal heirs or nominees of the employee are entitled to gratuity if the employee dies or becomes disabled due to an accident or disease.

Minimum Service Requirement

The Payment of Gratuity Act, 1972 states that an employee is eligible to receive gratuity only if he or she has rendered continuous service for five years or more. However, the five-year requirement is not necessary if the employee’s contract of employment ceases due to death or disablement.

Taxability of Gratuity

The entire amount received as gratuity is taxable as per the Income Tax Act, 1961. However, exemptions are provided in certain cases.

Exemptions under Gratuity

1. Gratuity received during employment: If any employee receives gratuity during his service, then it is fully taxable as income in his hands under the Income Tax Act, 1961.

2. Gratuity received after retirement: If gratuity is received in case of death, retirement, or resignation and certain other cases, then tax exemption is provided under section 10(10) of the Act. The exemptions are as follows:

• For government employees, the gratuity received after retirement is fully exempt for tax purposes.

• For non-government employees, the exemption depends on whether the employer is covered under the Payment of Gratuity Act, 1972.

Calculation of Exemption

The calculation of exemption differs based on whether the employer is covered under the Payment of Gratuity Act, 1972. The exemption will be the least of the following:

• Actual gratuity received

• Rs.20,00,000

• 15 * last drawn salary * tenure of working / 26 (if the employer is covered under the Act)

• 15 * last drawn salary * tenure of working / 30 (if the employer is not covered under the Act)

Here, the tenure of working is the number of years or part thereof in excess of 6 months for which the employee provides service to the company.

Conclusion

Understanding the tax implications on gratuity is crucial for both employers and employees. It helps in effective tax planning and ensures compliance with the Income Tax Act, 1961.