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How to calculate Gratuity, Exemption and their Tax liability?

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Introduction:

Gratuity is a monetary benefit given by employer to his employee after rendering a service of minimum of 5 years or more in his establishment. Gratuity act applies where 10 or more persons are employed or were employed on any day of the preceding 12 months. Once Gratuity act applies, the employer can’t escape from liability by reducing the number of employees.

 
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Eligibility- An employee is eligible for gratuity in case of
  1. Retirement or Resignation
  2. Superannuation
  3. On Death or Disablement due to accident or disease.

If he has completed 5 years of complete service with the company. There is one exception, if an employee has expired or disabled, the time period of 5 years not applicable and he would be eligible for every one year completed of his service.

   
Calculation of Gratuity-

1. In case of employee covered under payment of Gratuity Act 1972

        Gratuity = Last drawn salary x 15/26 x No. of completed years of service.

  • Gratuity is payable at the rate of 15 days salary for every completed year of service or part thereof in excess of six months.

For example

if you have completed 6 years 7 months in an organization, you are eligible for 7 years Gratuity. But if you have completed 6 years 5 months in an organization, you are eligible for 6 years Gratuity.
  • Working days in a month will be considered of 26 days
  • Salary means last salary drawn i.e. Basic Salary + Dearness Allowance
   

2. In case of employee not covered under payment of Gratuity Act 1972, if paid the calculation is as under.

Gratuity = Average salary *  ½  * No. of years of service

  • Gratuity is payable at the rate of 15 days salary for complete year of service.

For example

if you have completed 6 years 7 months in an organization, you are eligible for 6 years Gratuity. But if you have completed 6 years 5 months in an organization, you are eligible for 6 years Gratuity.
  • Working days in a month will be considered of 30 days
  • Average Salary means Average of last 10 months salary i.e. Basic Salary + Dearness Allowance.
 
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Exemption and Tax liability:

If employees get Gratuity at the time of Resignation, Retirement, or Superannuation. There are 3 categories under Gratuity Act--

1. Gratuity Received by Govt. Employees

Section 10 (10) (i) grants exemption for gratuity received by govt. employees is fully exempt.

 

2. Gratuity Received by Non Govt. Employees covered under payment of Gratuity Act 1972

Section 10 (10) (ii) grants exemption for gratuity received, in case of employee covered under payment of Gratuity Act, least of the following-

  • Last drawn salary * 15/26 * No. of completed years of service.
  • 20,00,000 In Budget 2019, The Gratuity limit has increased to Rs. 30 lakh w.e.f 01.04.2019.
  • Actual Gratuity received

For Example:

Mr. Shyam has worked for 15 years 8 month in ABC Pvt. Ltd. At the time of retirement he received a Gratuity of Rs. 8,00,000. His basic salary was Rs. 50,000, Dearness Allowance was Rs. 10,000. What amount is exempted under Income Tax?

Answer:

1. Last drawn salary * 15/26 * No. of completed years of service

= (15 * 60,000 * 16)/26 = Rs. 5,53,846

2. Or  Rs. 20,00,000 In Budget 2019, The Gratuity limit has increased to Rs. 30 lakh w.e.f 01.04.2019.

3. Or   Rs. 8,00,000 (which is least)

So, Rs. 5,53,846 is exempt and balance Rs. 2,46,154 is taxable

   
Note:
  • In case of employees of seasonal establishment- 7 days salary will be taken into consideration instead of 15 days
  • 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.

3. Gratuity Received by Non Govt. Employee not covered under payment of Gratuity Act 1972-

Section 10 (10) (iii) grants exemption for gratuity received, in case of employee not covered under payment of Gratuity Act, least of the following-

  • Average salary x  ½  x No. of years of service
  • 20,00,000 In Budget 2019, The Gratuity limit has increased to Rs. 30 lakh w.e.f 01.04.2019.
  • Actual Gratuity received.

For Example:

Mr. X has worked for 15 years & 8 month in ABC Pvt. Ltd.At the time of retirement he received a Gratuity of Rs. 8,00,000. His average salary of last 10 months was Rs. 50,000, Dearness Allowance was Rs. 10,000. What amount is exempted under Income Tax?

Answer:

Average salary x  ½  x No. of years of service

= (15 * 60,000 * 15)/30,  = Rs. 4,50,000

Or  Rs. 20,00,000 In Budget 2019, The Gratuity limit has increased to Rs. 30 lakh w.e.f 01.04.2019.

Or   Rs. 8,00,000 (which is least)

So, Rs. 4,50,000 is exempt and balance Rs. 3,50,000 is taxable   

 

In case of Death of Employee, Gratuity received by his wife or his legal heirs are fully exempt in their hands.

   
Forfeiture of Gratuity:

If an employee’s services are terminated due to any act, willful omission or negligence causing damage or loss to or destruction of property of the employer, the employee’s gratuity shall be forfeited to the extent of damage or loss.

The full amount of gratuity can be forfeited if an employee’s services have been terminated due to:

  1. His riotous or disorderly conduct or any other violent act;
  2. Committing an offense involving moral turpitude.




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