look news india
For employed employees, resignation or retirement from a company after working continuously for 5 years or more is a big milestone financially. During Full and Final Settlement (F&F), along with encashment of salary, PF and leaves, lump sum gratuity amount also comes into the account. This big question arises in the minds of many employees whether the entire amount of gratuity received after leaving the job will have to be paid income tax or is it completely tax-free? Under the Income Tax Act 1961, gratuity is considered a part of income from salary, but the government has made a provision for huge tax exemption on it under Section 10(10). However, this discount is subject to certain rules, service period and a certain limit.
If you are an employee of the Central Government, State Government, Defense Services or Local Authority (Municipal Corporation etc.), then the entire gratuity amount received at the time of termination, retirement or resignation is 100% tax-free. There is no legal monetary ceiling on this exemption for government employees.
At the same time, employees of Public Sector Undertakings (PSUs) and government banks are considered at par with the private sector in income tax rules and a maximum limit of ₹ 20 lakh is applicable for them.
Tax exemption on gratuity for private sector employees is calculated under the ‘Payment of Gratuity Act, 1972’. According to Section 10(10) of the Income Tax Act, for employees of companies covered under this law, only the lowest of the following three amounts will be tax-free:
-
Actual Gratuity Received
-
Maximum legal limit: ₹20,00,000 (20 lakh rupees)
-
Amount decided as per formula:
$$\frac{15}{26} \times \text{Last Basic Pay + DA} \times \text{Total Service Years}$$
(Note: In calculating the service year, if there is more than 6 months in a year, then it is counted as 1 full year; like 8 years and 7 months will be considered as 9 years.)
Suppose the last basic salary (Basic Salary) and Dearness Allowance (DA) of an employee of a private company was ₹ 1,00,000 per month. He completed 20 years of continuous service in the company and resigned.
The company gave him ₹15,00,000 (Rs 15 lakh) as gratuity. Now the tax exemption will be calculated as follows:
-
Actual Gratuity: ₹15,00,000
-
Government maximum limit: ₹20,00,000
-
Amount from formula: $\frac{15}{26} \times 1,00,000 \times 20 \approx ₹11,53,846$ (approximately ₹11.54 lakh)
The least amount among these three ₹11.54 lakh Therefore, the employee will get tax exemption only on ₹ 11.54 lakh. The remaining additional amount i.e. ₹3,46,154 (₹15 lakh – ₹11.54 lakh) His salary for the current financial year will be added to his income and will be taxed as per his income tax slab.
If an employee works in a private organization which does not come under the purview of the Gratuity Act of 1972, then there also the maximum exemption limit remains ₹ 20 lakh. But for the calculation, half month’s salary is multiplied by the service years of the average pay (Basic + DA) of the last 10 months:
$$\text{Exemption amount} = \frac{1}{2} \times \text{Average salary of last 10 months} \times \text{Complete service years}$$
In this category, periods of more than 6 months are not rounded off to the next year, only the completed years are counted.
According to tax experts, the most important thing is that this tax-free limit of ₹ 20 lakh is not for a single job, but for the entire career of the employee (Lifetime Aggregate Limit). For example, if you have claimed tax exemption on gratuity of ₹6 lakh at the time of leaving your job from your first company, then you will be left with a lifetime tax exemption of only ₹14 lakh (₹20 lakh – ₹6 lakh) on gratuity received from your second or third company in future.
According to legal rules, under normal circumstances, gratuity is eligible only when the employee has completed at least 5 years of continuous service in the same organization. This condition of 5 years is waived only in case of death of the employee or permanent disability due to any accident. If a company voluntarily gives any money as ex-gratia before completion of 5 years, then it is not considered as legal gratuity and the entire amount becomes 100% fully taxable for the employee.