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Tax Treatment of ‘Gratuity’

Gratuity is a payment made by the employer to an employee in appreciation of the past services rendered by the employee. Gratuity can either be received by:

  1. the employee himself at the time of his retirement; or

  2. the legal heir on the event of the death of the employee.

Gratuity received by an employee on his retirement is taxable under the head "Salary" whereas gratuity received by the legal heir of the deceased employee shall be taxable under the head "Income from other sources".

However, in both the above cases, according to section 10(10) gratuity is exempt upto a certain limit. Therefore, in case gratuity is received by employee, salary would include only that part of the gratuity which is not exempt under section 10(10) as discussed in the Table below :

Government employees & employees of local authority

Employees covered under Gratuity Act. Any other Employees
Fully Exempt

Minimum of the following 3 limits:

  1. Actual gratuity received, or

  2. 15 days salary for every completed year, or part thereof exceeding 6 months 7 days salary for each season in case of employee in seasonal establishment; or

  3. ₹. 10,00,000

Meaning of Salary:

  1. Basic salary plus dearness allowance.

  2. Last drawn salary. Average salary for preceding 3 months in case of piece rates employees

  3. No. of days in a month to be taken as 26

Minimum of the following 3 limits:

  1. Actual gratuity received

  2. Half months average salary of each completed year of service.

  3. ₹. 10,00,000

Meaning of Salary:

  1. Basic Salary plus D.A. to the extent the terms of employment so provide Commission, if fixed percentage of turnover.

  2. Average salary of last 10 months preceding the month in which event occurs.

  3. Only completed year of service is to be taken.

Important Points :

  1. Where an employee had received gratuity in any earlier year(s) and had claimed exemptions under section 10(10) in respect of the gratuity received earlier also, he will still be entitled to this exemption but the limit which at present is Rs. 10,00,000 shall be reduced by the amount of exemption(s) availed in the earlier year(s). There will be no change in the other two limits.

  2. The words "completed service" occurring in section 10(10) should be interpreted to mean an employee's total service under different employers including the employer other than the one from whose service he retired, for the purpose of calculation of period of years of his completed service, provided he was not paid gratuity by the former employer.

  3. Any gratuity paid to an employee, while he continues to remain in service with the same employer is taxable under the head "Salaries" because gratuity is exempt only on retirement or on his becoming incapacitated or on termination of his employment or death of the employee. In this case, however the assessee can claim relief under section 89.

  4. The expression "termination of employment" would cover an employee who has resigned from the service.
  5. How to determine 15 days’ salary -
  6. Salary of 15 days is calculated by dividing salary last drawn by 26, i.e., maximum number of working days in a month. For instance, if monthly salary at the time of retirement is Rs. 2,500, 15 days’ salary would come to Rs. 1,442.31 [i.e., Rs. 2,500 × 15÷26].

  7. How to determine 15 days’ salary for each year of service in the case of a piece-rated employee -

    In the case of a piecerated employee, daily wages shall be computed on the average of the total wages received by him for a period of three months immediately preceding the retirement. For this purpose, the wages paid for any overtime work shall not be taken into account.

 Important Links....for calculating Salary Income

(A). Salary -Definition & Meaning
(B). Provident Fund
(C). Allowance
(D). Perquisites
(E). Profit in lieu of Salaly
(F). Retirement Benefits
(G). Deductions
(H). Table Presentation of Salary Income (Section 15 to 17)
 
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