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Tax Treatment of ‘Gratuity’

 

Tax treatment of gratuity can be classified as follows:

 

(A) Gratuity received by Government employees and employees of local authority [Section 10(10)(i)]

In case of a Government employee, any death-cum-retirement gratuity received is wholly exempt under section 10(10)(i). It should be noted that employees of statutory corporation will not fall under this category.

 

Illustration (Government employee)

Mr. Kishan is a Central Government employee. He retired from his service in December 2012 and received gratuity of Rs. 8,40,000. In this case, entire amount of gratuity will be exempt from tax.

 

(B) Gratuity received by non-Government employees :

This category will further be classified as follows :

 

(1)       Exemption in respect of gratuity in case of employees covered by the Payment of Gratuity Act, 1972.

 

(2)       Exemption in respect of gratuity in case of employees not covered by the Payment of Gratuity Act, 1972.

 

The detailed discussion in this regard is as follows :

 

(1) Exemption in respect of gratuity in case of employees covered by the Payment of Gratuity Act, 1972 [Section 10(10)(ii)]

Exemption in this case will be lower of the following amounts :

 

1.         15 days’ salary (*) × years of service

2.         Maximum amount specified by the Central Government, i.e., Rs. 10,00,000.

3.         Gratuity actually received.

 

(*) Following points should be kept in mind :

 

        7 days instead of 15 days in case of employees of a seasonal establishment

        15 days’ salary = Salary last drawn × 15/26

        Salary for this purpose will include basic salary and dearness allowance only.

 

Illustration: If Mr. Keshav’s monthly salary at the time of his retirement is Rs. 8,484 and basic, Rs. 2,526 as dearness allowance, Rs. 1,848 as commission and Rs. 1,252 as bonus, then salary for aforesaid exemption will be Rs. 6,352, computed as follows:

Rs. 11,010 (Basic + DA) × 15/26 = Rs. 6,352 (rounded off)

 

        In case of piece rated employee, 15 days’ salary will be computed on the basis of average of total wages (excluding overtime wages) received for a period of three months immediately preceding the termination of his service.

 

Illustration: If in the above Illustration, Mr. Keshav is a piece-rated worker and salary drawn by him in three months preceding the retirement is Rs. 11,010 including Rs. 2,526 overtime (OT) wages, then salary for the aforesaid exemption will be Rs. 1,632 computed as follows:

 

Step 1 - Computation of three months’ salary

Three months’ salary will be Rs. 8,484 (Rs. 11,010– Rs. 2,526 being OT wages)

 

Step 2 - Computation of monthly salary

One month salary will be Rs. 2,828 (i.e., 8,484/3)

 

Step 3 - Computation of salary

Salary will be Rs. 1,632 (rounded off) (i.e., 2,828 × 15/26)

 

        Part of the year, in excess of 6 months, shall be taken as one full year.

 

Illustration: If the period of service is 18 years and 8 months, then 19 years will be taken as duration of service. If the period of service is 18 years and 5 months, then duration of service will be taken as 18 years.

 

(2) Exemption in respect of gratuity in case of employees not covered by the Payment of Gratuity Act, 1972 [Section 10(10)(iii)]

In case of employees not covered by the Payment of Gratuity Act, 1972 exemption in respect of gratuity will be least of the following :

 

1.         Half month’s average salary for each completed year of service, i.e.,

[Average monthly salary × ½] × Completed years of service. (*).

 

2.         Maximum amount specified by the Central Government, i.e., Rs. 10,00,000

 

3.         Gratuity actually received.

 

(*) Following points should be kept in mind :

 

        Average monthly salary is to be computed on the basis of average of salary for 10 months immediately preceding the month (not the day) of retirement.

 

Illustration: Mr. Keshav retires from service on 8-4-2010. In this case, average salary will be computed on the basis of salary for the period of 1-6-09 to 31-3-10 (i.e., 10 months preceding the month of retirement).

 

        Salary for this purpose will include basic salary, dearness allowance, if the terms of service so provide and commission based on fixed percentage of turnover achieved by the employee.

 

        While computing year of service, any fraction of year is to be ignored.

 

Illustration: If duration of service is 18 years and 11 months, then 18 years will be considered for computation.

 

Illustration (Non- Government employee)

Mr. Kaushal retired from A Ltd. on 15-2-3013, after serving for a period of 25 years and 9 months. Following are other details:

 

        Basic salary per month during 10 months preceding the month of retirement (i.e., monthly salary from 1-4-12 to 31-1-13) : Rs. 60,000.

        Dearness allowance per month during 10 months preceding the month of retirement (i.e., monthly DA from 1-4-12 to 31-1-13)

 

(a)        Forming part of salary for computing retirement benefits : Rs. 60,000

 

(b)       Not forming part of salary for computing retirement benefits : Rs. 10,000

 

        Gratuity received at the time of retirement Rs. 25,20,000.

 

Compute the amount of exemption in respect of gratuity under section 10(10)(ii)/(iii), considering :

 

(i)         Mr. X is covered by the Payment of Gratuity Act, 1972

(ii)        Mr. X is not covered by the Payment of Gratuity Act, 1972.

 

 

(i) When Mr. X is covered by Payment of Gratuity Act, 1972

As per section 10(10)(ii), exemption in respect of gratuity received by non-Government employee (covered by the Payment of Gratuity Act, 1972) is least of the following:

 

Particulars

(Rs.)

1. 15 days’ salary for each completed year of service or part in excess of 6 months (Note 1)

19,50,000

2. Maximum amount specified by the Central Government

10,00,000

3. Actual amount received

25,20,000

 

Amount of exemption under section 10(10)(ii) will be Rs. 10,00,000, being least of above. Thus, taxable amount of gratuity will be Rs. 15,20,000 (Rs. 25,20,000 – Rs. 10,00,000)

 

Note 1: Computation of 15 days’ salary for each completed year of service or part in excess of 6 months:

 

Following points should be considered:

 

        Part of year in excess of six months will be considered as a full year.

        Salary for the aforesaid purpose will be last drawn salary.

        Salary for the aforesaid purpose will include basic salary and any dearness allowance (i.e., whether or not forming part of salary while computing retirement benefits).

        While computing 15 days’ salary, we will divide monthly salary by 26 days.

 

Based on above, computation will be as follows:

 

        Monthly salary will be Rs. 1,30,000 (Rs. 60,000 + Rs. 60,000 + Rs. 10,000).

        15 days’ salary will be Rs. 75,000 (Rs. 1,30,000/26 × 15).

        Duration of service is 25 years and 9 months, i.e., it will be taken as 26 years (for computation of exemption).

 

Thus, total amount of salary will be Rs. 19,50,000 (Rs. 75,000 × 26 years).

 

(ii) When Mr. X is not covered by the Payment of Gratuity Act, 1972

As per section 10(10)(iii), exemption in respect of gratuity received by non-Government employee (not covered by the Payment of Gratuity Act, 1972) is least of the following :

 

Particulars

(Rs.)

1. Half month’s salary for each completed year of service (Note 2)

15,00,000

2. Maximum amount specified by the Central Government

10,00,000

3. Actual amount received

25,20,000

 

Amount of exemption under section 10(10)(iii) will be Rs. 10,00,000, being least of above. Thus, taxable amount of gratuity will be Rs. 15,20,000 (Rs. 25,20,000 - Rs. 10,00,000).

 

Note 2: Computation of half month’s salary for each completed year of service :

Following points should be considered in this regard:

 

        While computing duration of service, any part of year will be ignored.

        Salary for the aforesaid purpose will be average salary for 10 months preceding the month (not the day) of retirement.

        Salary for this purpose will include basic salary, dearness allowance forming part of salary while computing retirement benefits and commission based on fixed percentage of turnover achieved by the employee.

        Half month’s salary will be computed by dividing average salary by 2.

 

Based on above, salary will be computed as follows:

 

Particulars

(Rs.)

Basic salary per month, for 10 months immediately preceding the month of retirement

60,000

(+) Dearness allowance per month (forming part of salary while computing retirement benefits), for 10 months immediately preceding the month of retirement

60,000

Total monthly salary for the purpose of computing exemption

1,20,000

There is no need to convert aforesaid monthly salary of Rs. 1,20,000 into average monthly salary, since there is no change in salary during past 10 months.

 

Based on above, computation will be as follows:

 

 Half month’s salary will be Rs. 60,000 (i.e., Rs. 1,20,000/2).

 Duration of service will be 25 years (part of year will be ignored).

 

Thus, total amount of salary will be Rs. 15,00,000 (Rs. 60,000 × 25 years).
 
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