Gratuity payment is a lump sum that your company will pay you as an acknowledgement of your loyalty to the company. Naturally, gratuity becomes payable only after you have spent a certain number of years with the company.
You will receive this benefit either at the time of retirement or when you resign. Let us take a look at how gratuity benefit is paid.
There are two conditions that must be satisfied in order to be eligible to get the gratuity benefit
- Your organisation has a minimum of 10 people on payroll, i.e., at least 10 employees receiving salaries from the organization. Note that people on contract are not considered.
- You have completed at least 5 years with the organization. If an employee dies during the tenure of his employment, the 5 year rule is relaxed. So, even if such employee's period of service is as little as 1 year, he / she is eligible to receive gratuity if the first condition is met.
Calculation of the amount of gratuity payable
According to the law, the amount payable as gratuity is equivalent of half month's salary for every full year of your employment or Rs 10 lakh, whichever is lower.
This is the minimum amount payable under the law. Some companies may pay a higher amount. This upper limit depends upon the company's policy. For example, if you have put in 10 years of service before you resign from the company, you are entitled to the lower amount of:
An amount equal to 5 month's salary
or
Rs 10 lakh.
However, if your company has a policy to pay its employees a maximum of Rs 20 lakh as gratuity, then the amount payable to you when you resign after 10 years of completed service will be the lower amount of:
An amount equal to 5 month's salary
or
Rs 20 lakh.
Your last paycheck before you retire or resign is the amount you should consider in your gratuity computation. Also, only your 'basic' and 'dearness allowance / DA' should be taken into consideration.
For example, assuming Anil retires this year after completing 30 years with his company and his last pay check looks like the following, let us calculate the amount of gratuity that Anil's company should pay him:
Basic: Rs. 60,000
DA : Rs.10,000
HRA: Rs. 26,000
Education allowance: Rs.5000
Travel allowance: Rs. 15,000
Gratuity payable: Last month's salary / 26 (days) x 15 (days) x completed years of employment.
Last month's salary to compute gratuity = Basic + DA = Rs 70,000.
Gratuity payable = (70,000/26) x 15 x 30 = Rs 12,11, 538.
Since there is a limit of Rs 10 lakh, Anil is entitled to receive Rs 10 lakh towards gratuity. If his company has a policy to pay gratuity up to an amount of Rs 15 lakh, then Anil's gratuity benefit will be Rs 12.11 lakh.
Tax treatment for gratuity
The amount of gratuity received by a person is taxed as salary income under the head 'Income from salaries' on the income tax return. If you are a government employee, then according to the provisions of Section 10 (10) of the Income Tax Act, the gratuity amount paid is completely tax free.
Gratuity amount received by non government employees covered by the Payment of Gratuity Act is tax free up to the least amount of the following:
Amount of gratuity paid, or
15 days salary for every completed year of employment (salary is the amount of last salary drawn)
Rs 10 lakh
Where companies pay gratuity voluntarily to employees who are not eligible to receive gratuity under the Act, such amount is tax free up to the least amount of the following:
Amount of gratuity paid, or
Half month's salary for every completed year of employment (salary is average salary received in the last 10 months of service.)
Rs 10 lakh
Note that this limit is a maximum exemption for all your years of service. It applies to all the amounts of gratuity you will receive in your entire career from all your employers.
So, if you receive gratuity three times in your life and you exhaust the above limit within the first two times you receive gratuity, then the third time you are paid gratuity, it will be completely taxed according to your current tax slab rates.
