Gratuity – Section 10(10) of Income tax act

Gratuity is a payment made by the employer in appreciation of past services of employee. It can be paid at the time of retirement or resignation or termination of employee from his employment. Income tax act provides exemption for the amount an employee receives as gratuity from his employer. After this exemption the rest will be taxable in the hand of employee under the head SALARY.

Gratuity received after death of the employee will be taxable in the hands of their legal heir who receives it. The legal heir has to file income tax return after taking out the exemption available to employee. Such amount received will be taxable under the head “Income from Other Sources”. If the gratuity amount becomes due and received after the death of the employee then the entire amount will be tax free in the hands of legal heir. For examples if gratuity amount becomes due on 1^st of January and the employee died on 31^st December then the amount received as gratuity will be exempted in the hands of legal heir. 

When you are eligible

You will be eligible for gratuity if you have completed your 5 years or more years of services under your employer.

Who will pay you gratuity

After completing your 5 or more years of services with your employer, your employer will pay you gratuity as a gift or appreciation of your long services with them. Your employer may pay this amount from there own resources or they may have an insurance company to pay it to you on there behalf.

Income tax Benefits

As we discussed above the gratuity amount received by an employee will be taxable under the head salary in the hands of the employee who receives it. However exemptions under income tax act is available and you as an employee can claim this benefit of exemption and the rest left out after exemption will be taxable.

Exemption for a Government Employee

Gratuity received by a government employee will be fully exempted from income tax.

Exemption when Gratuity Received Under the Payment of Gratuity Act, 1972

Gratuity act 1972 is applicable to an establishment where 10 or more employees are employed during the financial year. If on a single day, an establishment has employed more than 10 or more employees then this gratuity act will be applicable to them. Once gratuity act 1972 is applicable it will continue to be applicable even though numbers of employees are reduced below 10.

In case the employee is covered under gratuity act 1972, the least of the followings will be exempted and gratuity in excess of the exemption limit will be taxable in the hands of employee.

1. Gratuity actually received
2. Rs. 10, 00,000
3. 15 days of salary for every completed year of service or part there of in excess of 6 months (15/26 * last drawn salary * length of service)

Relevant Points to be considered while calculating Gratuity in the above case

• Salary for the above purpose is basic salary + DA + Commission as a fixed percentage on turnover
• While calculating completed year of service any fraction of year greater than 6 months should be considered as a full complete year.

Exemption when Employee is not covered under payment of Gratuity Act

In other cases, where the employee receive gratuity due to his retirement, death, termination, resignation or being incapacitated prior to his death then the least of the followings will be exempted;

1. 10, 00,000
2. Half months average salary for each completed year of service
3. Gratuity actually received

After the above exemption if anything left out then that amount will be taxable under the head salary in the hand of employee who received it.

Relevant points to be considered while calculating Gratuity in the above case

• Salary = Basic salary + DA + Commission as a fixed percentage on turnover
• Completed year of service means complete one year. Fraction of the year in months will be ignored.
• Average salary = 10 months average salary preceding the month before retirement. For example: If you retired on 5^th January then the 10 month calculation will start from December (i.e. March to December).

If you have received gratuity from more than one employer during the financial year then the maximum amount of exemption of gratuity will be restricted to Rs. 10, 00,000 and the balance amount will be taxable.

Any gratuity exemption claimed earlier will get reduced from the above limit of Rs. 10, 00,000 if you have recently received gratuity from your present employer and planning to claim exemption for it.