Is Gratuity Now Taxed at 30%? Seeking Clarity on Recent Rule Changes

Dear Seniors,

I understand from someone that now employees have to pay a tax of 30% on the Gratuity amount, whether it is less than the 10 L slab or above the 10 L slab. It seems like the government (six months ago) amended this rule. If anyone has any idea about this, please share.

I have searched for a copy of this amendment online on citehr, but no information is available on this case.

Thanks for your help.

Thanks,
Anil

Hi Buddy,

There is no amendment for the said matter as far as my knowledge goes.

With Regards,

Mr. Thumbs Up

Dear Anil,

Though your query is restricted to the taxable limit of gratuity in particular, I think it would not be out of context to provide some basic information on taxable limits of terminal benefits, including gratuity. So, let me summarize them below as far as I know:

Taxability of Terminal Benefits

The terminal benefits typically received by employees upon retirement are taxable under the head of "salaries" as "profits in lieu of salaries," as provided under section 17(3) of the Income Tax Act. However, exemptions are available from taxation for certain terminal benefits under section 10 of the Income Tax Act, either wholly or partially, as detailed below:

Gratuity - Sec. 10(10)

1. Any Death-cum-Retirement Gratuity received by employees of Central and State Governments, Defence Services, and Local Authorities.

2. Any gratuity received by individuals covered by the Payment of Gratuity Act, 1972, subject to:
- (a) At the rate of 15 days' salary last-drawn for every completed year of service.
- (b) Not exceeding Rs. 10 lakh.

3. In the case of other employees:
- (a) The calculation shall be limited to half month's salary based on the last 10 months' average for each year of completed service.
- (b) Rs. 10 lakh, whichever is less.

However, gratuity received by an employee upon resignation also qualifies for exemption under section 89(1) of the IT Act, subject to the above conditions. Similarly, gratuity payable in respect of a deceased employee to their widow or legal heirs is also exempt.

Commutation of Pension

1. The commuted value of pension for employees of Central and State Governments, Defence Services, and Corporations established under Central or State Acts.

2. For other employees receiving gratuity, one-third of the pension's commuted value is exempt.

Encashment of Leave

1. Encashment of leave during service is fully taxable.

2. Encashment of earned leave upon retirement for employees of the Central and State Governments is fully exempt.

3. For other employees, it is limited to the least of:
- (a) 30 days' salary per year of completed service.
- (b) 10 months' average salary.
- (c) Encashment actually received (Rs. 3 lakh for retirement after 02-04-1998).

4. Encashment of Privilege Leave for the legal heirs of deceased employees is not taxable.

Accumulations of Provident Fund

Fully exempt.

Sums Received from Any Approved Superannuation Fund

Fully exempt.

Retrenchment Compensation

Retrenchment Compensation at 15 days last drawn salary/wages is exempt from tax, subject to a limit of Rs. 5 Lakh.

Regards

We pay gratuity at 15 days' salary for each completed year of service up to 30 years and at 26 days' salary up to retirement. We deduct income tax for gratuity earned beyond 30 years even if the total gratuity paid is less than 10 lakhs. Are we right in doing so?

Dear Gautham, Your query pertains to a peculiar situation wherein the scheme of gratuity contemplated under the Payment of Gratuity Act, 1972, is clubbed with your own scheme of gratuity under the Contract of Employment in cases where the length of service crosses a certain limit. I think that it is certainly a better term of gratuity under the contract of employment, and as such, it cannot affect the right of an employee to it as per the saving clause under Section 4(5) of the PG Act, 1972. In such a case, therefore, the ceiling on the amount of gratuity imposed under Section 4(3) becomes inoperative.

Now, coming to the question of taxation, the taxability of the amount of gratuity is relaxed up to a certain limit based on the recognition of the principle that it is a lump sum paid only once to the employee on the termination of employment beyond a certain number of years of blemishless service. Since Section 4(5) permits the right to get better terms of gratuity under an award or agreement or contract with the employer, the relaxation of taxability does not get completely extinguished but remains subject to the ceiling only. To put it otherwise, even if the method of calculation for gratuity is different from what the PG Act prescribes, taxability arises only when the amount of gratuity thus arrived exceeds the ceiling for the reason that the method of calculation does not alter the status of gratuity of being a one-time terminal benefit.

In light of my foregoing observations, I am of the considered opinion that deducting income tax from gratuity earned beyond 30 years when the total gratuity paid is less than Rs. 10 lakh is not correct.

Hi,

Gratuity amount less than Rs. ten lacs is non-taxable, rightly explained by our learned colleague, Mr. Umakanthan. So, under the definition "taxable income," an exclusion provision exists that allows for gratuity up to a relaxed limit. You should cease the deduction of income tax as suggested above; otherwise, you may face legal cases for the recovery of dues from outgoing employees against the company.

Best wishes,

RDS Yadav
Labour Law Adviser
navtaranghrs@gmail.com