Tax on Gratuity, Exemption Limit and Calculation [AY 2018-19]

Gratuity refers to the money received by an employee from his employer at the time of:

1. Retirement
2. Resignation
3. Termination
4. Death

Gratuity is payable only to persons who have been employed for 5 years or more with the employer. In case of death, disease or accident, the time limit of 5 years is not applicable.

Income tax rule is different for government employees and non-government employees. This money is fully exempted in the hands of central or state government employees. [Discussed in detail]

In this article, we will cover the taxation of gratuity in detail, its exemption, and calculation.

Gratuity Received by Government Employee [u/s 10(10)(i)] 

The gratuity received by employees of the following are exempted from income tax:

1. State government
2. Central government
3. Local Authority like Municipality

This exemption is not available to the employees of a statutory corporation like Airport Authority of India (AAI), NHAI, FCI etc.

Further, in case of the death of government employees, the gratuity received by the widow or dependent children shall not be fully exempted. [covered under section 10(10)(iii)]

Gratuity Received by Non-Government Employee  

Income tax rule further divided non-govt employees into two part:

1. Covered under Payment of Gratuity Act, 1972
2. Not covered under Payment of Gratuity Act, 1972

From 29th March 2018, gratuity up to Rs.20 lakh is exempted in the hands of private and public sector employees. Previously it was Rs. 10 lakh.

1. Gratuity Exemption Limit for Non-Government Employee Covered under Gratuity Act [u/s 10(10)(ii)]

Employees of a factory, mine, oilfield, plantation, port, and railway company, shop and other establishments with 10 or more employees at any time during preceding 12 months are covered under the Payment of Gratuity Act.

Once an establishment is covered, this act will apply even if the number of employees falls below 10.

In this case, gratuity will be partially exempted and the remaining amount will be taxed as Salary Income.

The exemption, in this case, will be lower of the following amounts:

1. Last drawn Monthly Salary (Basic+DA) x no. of years of employment* x 15**/26
2. 20,00,000/- [When gratuity received on or after 29-03-2018]
3. 10,00,000/- [When gratuity received before 29-03-2018]
4. Gratuity actually received

*Number of the year of employment should be rounded off to the nearest years. Example: For 20 years 7-month service takes employment years as 21 years.

**7 days instead of 15 days in case of employees of a seasonal establishment.

Example:

Mr. Rajan a brick factory worker draws 3 months’ salary of Rs.12,000 (including 3000 as overtime salary). He has completed 18 years 2 months of employment.

On 31^st March 2018, he retired and received Rs.80,000/- as the gratuity.

Find the exempted and taxable gratuity value for AY 2018-19.

Solution:

*Mr. Rajan is paid for each brick he produces i.e he is a piece-rated employee. In this case, the monthly salary will not include the bonus amount received. Monthly salary = (12000-3000)/3 = Rs.3,000/-

2.Gratuity Exemption Limit for Non-Government Employee Not-Covered under Gratuity Act [u/s 10(10)(iii)] 

Many employers provide gratuity benefits to their employees voluntarily.

In this case, the income tax exemption formula is different. It is lower of the following amount:

1. Last 10 month’s average Salary*(Basic+DA+ fixed % of commission on sale) x 0.50 x no. of years of employment**
2. 20,00,000/- [This value is for gratuity received on or after 29-03-2018]
3. 10,00,000/- [This value is for gratuity received before 29-03-2018]
4. Gratuity actually received

*Last 10 months doesn’t include the month of retirement, termination or death.

*Number of the year of employment should not be rounded off to the nearest years. Example: For 20 years 7-month service takes employment years as 20 years.

Note for section 10(10)(iii):

The above formula also applies to the gratuity received by the widow, children or dependents of the dead employee.

For calculating exemption, in this case, the status of the dead employee is irrelevant.

The un-exempted portion of gratuity value will be taxable in the hands of the recipient as Income from other sources.

Recommended to Read: How to file Tax Return for Salary Income

Frequently Asked Question [FAQ]

Ques 1: Is Gratuity amount taxable?

Answer: Yes, gratuity received by an employee is taxable as salary income. However, few exemptions are provided by the law under section 10(10) of income tax act. Example: Gratuity is not taxable for government employees.

Ques 2: What is the eligibility for gratuity?

Answer: As per the payment of gratuity act, employees completing 5 yrs or more of service of the following establishments are eligible for gratuity:

1. Factory, mine, oilfield, plantation, port and railway company
2. Shops or educational institutes with 10 or more employees at any time during past 12 month

Ques 3: Is gratuity added before or after taxes?

Answer: While calculating income tax, taxable gratuity is added to salary income i.e added before taxes. Whereas the exempted gratuity is just disclosed as the exempted income under section 10(10).

Ques 4: I retired from a Public sector Undertaking and received gratuity on 1st December 2017. As the Govt. has increased the maximum exemption limit from 10 to 20 lakh on 29th March 2018, can I take the benefit of it?

Answer: No, the increased limit is applicable for gratuity received on or after 29th March 2018. As you are not a government employee, section 10(10)(ii) will define the gratuity exemption limit. [Notification] 

Happy Learning!