What is Gratuity? How you calculate your own gratuity ?
What is Gratuity?
Gratuity is a part of salary that is received by an employee from his/her employer in gratitude for the services offered by the employee in the company
Gratuity is one of the least understood components of salary. InvestmentYogi explains everything about Gratuity and the tax implications for you.
Gratuity is a part of salary that is received by an employee from his/her employer in gratitude for the services offered by the employee in the company. Gratuity is a defined benefit plan and is one of the many retirement benefits offered by the employer to the employee upon leaving his job. An employee may leave his job for various reasons, such as - retirement/superannuation, for a better job elsewhere, on being retrenched or by way of voluntary retirement.
Eligibility
As per Sec 10 (10) of Income Tax Act, gratuity is paid when an employee completes 5 or more years of full time service with the employer(minimum 240 days a year).
How does it work?
An employer may offer gratuity out of his own funds or may approach a life insurer in order to purchase a group gratuity plan. In case the employer chooses a life insurer, he has to pay annual contributions as decided by the insurer. The employee is also free to make contributions to his gratuity fund. The gratuity will be paid by the insurer based upon the terms of the group gratuity scheme.
Gratuity is a part of salary that is received by an employee from his/her employer in gratitude for the services offered by the employee in the company. Gratuity is a defined benefit plan and is one of the many retirement benefits offered by the employer to the employee upon leaving his job. An employee may leave his job for various reasons, such as - retirement/superannuation, for a better job elsewhere, on being retrenched or by way of voluntary retirement.
Eligibility
As per Sec 10 (10) of Income Tax Act, gratuity is paid when an employee completes 5 or more years of full time service with the employer(minimum 240 days a year).
How does it work?
An employer may offer gratuity out of his own funds or may approach a life insurer in order to purchase a group gratuity plan. In case the employer chooses a life insurer, he has to pay annual contributions as decided by the insurer. The employee is also free to make contributions to his gratuity fund. The gratuity will be paid by the insurer based upon the terms of the group gratuity scheme.
Formula for Gratuity Payment for Employees who are not Covered under Gratuity
act- It is not compulsory to pay gratuity for companies that don’t fall under the gratuity act. But, an employer can always choose to give gratuity to the employee for their service. The gratuity given will be completely tax free. Even in this case, the employee can calculate the gratuity in advance even though the the formula is different for this one. Given below is the formula for the calculation of gratuity for employees who are not covered under the gratuity act.
Gratuity = One day Salary * 15* length of service
= (Average salary of last 10 months/30) * 15 * completed years
= Average Salary of last 10 months * Completed years * 15/30
= Average Salary of Last 10 months * completed years *1 /2
=Half of the 10 month average salary * Completed years
T
Gratuity Amount Exempt from Tax
The current ceiling on tax-free gratuity is Rs.10 lakh for private/unorganised sector employees. It was the same for central government employees under Central Civil Services (Pension) Rules, until the 7th Central Pay Commission rollout in January, 2017, when the ceiling was increased to Rs.20 lakh.
However, the central government recently approved the introduction of Payment of Gratuity (Amendment) Bill, 2017, in Parliament, seeking to double the tax-free gratuity amount for employees in the formal sector to Rs.20 lakh.
This amendment will put the maximum gratuity limit for private sector employees as well as those employed in autonomous government organisations and public undertakings, at the same level as those of employees of central government.
Government is considering increasing gratuity entitlement for all employees covered under the Payment of Gratuity Act, 1972, considering the fact that inflation and wage has increased in the case of private sector employees also. The Payment of Gratuity Act, 1972, applies to all organisations employing 10 or more than 10 people.
The main goal of this Act is to provide social security to employees after retirement, whether it’s because of superannuation rules, or physical impairment or a major disability.
- Here, salary = basic + DA + commission (if it’s a fixed % of sales turnover).
- ‘Completed year of service or part thereof’ means: full time service of > 6 months is considered as 1 completed year of service; < 6 months is ignored.
- Here, number of days in a month is considered as 26. Therefore, 15 days’ salary is arrived as = salary * 15/26
- In case of non-government employees not covered under the Payment of Gratuity Act, 1972 – Maximum exemption from tax is least of the 3 below:
- Actual gratuity received;
- Rs 20,00,000;
- Half-month’s average salary for each completed year of service (no part thereof)
- Here, salary = basic + DA + commission (if it’s a fixed % of sales turnover).
- Completed year of service (no part thereof) means: full time service of > 1 year is considered as 1 completed year of service. < 1 year is ignored.
- Average salary =10 months’ salary (immediately preceding the month of leaving the job)/10
Illustration
Let’s understand the above math clearly with an example:
Varun had been working with an IT company since past 10 years, 7 months. He is retiring on 15th April, 2010. His current Basic = Rs 40,000 pm, DA = Rs 5,000 pm. He is going to receive a gratuity amount of Rs 3 lakhs on retirement. Note: Varun’s basic and DA have been the same since past 1 year.
Lets consider 2 situations here – (a) Varun’s employer is covered under Payment of Gratuity Act, 1972; and (b) Varun’s employer is not covered under Payment of Gratuity Act, 1972.
• Salary = Basic + DA = Rs 40,000 pm + Rs 5,000 pm = Rs 45,000 pm
• Average salary = 10 months’ salary (immediately preceding the month of leaving the job)/10 = (Rs 45,000 pm * 10)/10 = Rs 45,000 pm. Therefore, half-month’s average salary is = Rs 45,000/2
Important points to remember
• Generally, only government employers give DA to their employees. Above example is only for illustrative purpose.
• The salary of the employee may differ over a period of time on account of change in basic, DA and/or other factors.
• In case gratuity is received from more than one employer during the previous year, maximum exemption allowed is up to Rs 10,00,000.
• Where employee has already claimed gratuity exemption in any previous year (s), the maximum exemption amount allowed for the current previous year i.e. Rs 10,00,000 will be reduced by the amount of deduction already claimed in the previous years.
• In case of an employee who is employed in a seasonal establishment ( not employed throughout the year), the gratuity exemption shall be for seven days wages for each season.
Let’s understand the above math clearly with an example:
Varun had been working with an IT company since past 10 years, 7 months. He is retiring on 15th April, 2010. His current Basic = Rs 40,000 pm, DA = Rs 5,000 pm. He is going to receive a gratuity amount of Rs 3 lakhs on retirement. Note: Varun’s basic and DA have been the same since past 1 year.
Lets consider 2 situations here – (a) Varun’s employer is covered under Payment of Gratuity Act, 1972; and (b) Varun’s employer is not covered under Payment of Gratuity Act, 1972.
• Salary = Basic + DA = Rs 40,000 pm + Rs 5,000 pm = Rs 45,000 pm
• Average salary = 10 months’ salary (immediately preceding the month of leaving the job)/10 = (Rs 45,000 pm * 10)/10 = Rs 45,000 pm. Therefore, half-month’s average salary is = Rs 45,000/2
Important points to remember
• Generally, only government employers give DA to their employees. Above example is only for illustrative purpose.
• The salary of the employee may differ over a period of time on account of change in basic, DA and/or other factors.
• In case gratuity is received from more than one employer during the previous year, maximum exemption allowed is up to Rs 10,00,000.
• Where employee has already claimed gratuity exemption in any previous year (s), the maximum exemption amount allowed for the current previous year i.e. Rs 10,00,000 will be reduced by the amount of deduction already claimed in the previous years.
• In case of an employee who is employed in a seasonal establishment ( not employed throughout the year), the gratuity exemption shall be for seven days wages for each season.
Important Points to Remember
- There will be no taxes levied on the gratuity amount for Government employees.
- For employees of private sector companies, there will be no tax on the gratuity, subject to a maximum of Rs.10 lakh.
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