Gratuity benefit gets a leg-up

Last week, the Cabinet approved doubling the maximum limit on gratuity payment from ₹10 lakh to ₹20 lakh. Once the Bill to give effect to this is passed by Parliament, it can translate into big benefits for employees in both the private and public sector as well as autonomous organisations under the government.

The gratuity limit was doubled last year itself for government employees and there was a clamour to extend the benefit to employees of other entities too.

Gratuity is essentially a reward for employee loyalty. Stay on with your employer for five years or more, and you are entitled to receive gratuity when you retire, resign or are retrenched. This monetary reward to be paid by your employer in recognition of your years of service is mandated by the Payment of Gratuity Act, 1972. Most establishments employing 10 or more workers come under the Act. Roughly, you get half a month’s Basic and Dearness Allowance (DA) for every completed year of service as gratuity. Here’s how it is calculated: (Number of years of service) * (Last drawn monthly Basic and DA) *15/26. So, if you have served 30 years and draw monthly Basic and DA of ₹20,000 when you leave the job, you get gratuity of ₹3,46,154, calculated as (30 * 20,000 *15/26).

Your employer can choose to pay you more but the maximum amount of gratuity according to the Act cannot exceed ₹10 lakh as per current provisions. Amounts paid above this will be in the nature of ex-gratia. The government now proposes to double the maximum gratuity limit of ₹10 lakh to ₹20 lakh.

If you serve more than six months in the last year of employment, it is considered as a full year of service.

There are exceptions and legal rulings that relax the five-year continuous service rule. One, the rule is waived if an employee dies or is disabled. In Next, the Madras High Court in the Mettur Beardsell case has ruled that if an employee completes 4 years and 240 days in service, he will be eligible for gratuity.

The gratuity that you get enjoys favourable tax treatment. If you are a government employee, then the entire amount you get is exempt from tax. If you are not a government employee but are covered under the Act, you get tax exemption for an amount which is the lower of the following: a) Actual gratuity received; b) 15 days Basic and DA for each completed year of service or part thereof in excess of six months (according to calculations in the example above); c) ₹10 lakh (this is now proposed to be doubled to ₹20 lakh)

Say, in the example above, your employer paid you gratuity of ₹5,00,000, which is more than the ₹3,46,154 actually payable under the law. You will enjoy tax exemption on ₹3,46,154 and the surplus ₹1,53,846 will be subject to tax.

Consider another example in which the gratuity payable to you as per the formula comes to ₹15 lakh and the employer pays you the amount. But the current cap on gratuity payable and tax exemption is ₹10 lakh. So, ₹10 lakh will be tax exempt and the balance ₹5 lakh will be taxed. After the Bill is passed in Parliament and the gratuity and exempt cap is increased to ₹20 lakh, the entire ₹15 lakh that you get in the above example will become tax-exempt. Also, employers will be mandated to give the gratuity sum as per the calculations up to ₹20 lakh; now, they can restrict their payout to ₹10 lakh.

Note that the total tax exemption on gratuity amounts received, including those from previous employers in earlier years, cannot exceed ₹10 lakh now (this will increase to ₹20 lakh once the Bill is passed.)

Employees not covered under the Payment of Gratuity Act also get tax benefit if their employers give them gratuity. But in such cases, the tax exempt amount is the lower of the following: a) Actual gratuity received b) 15 days Basic and DA for each completed year of service calculated as (number of years of service) * (average monthly salary in the last 10 months of employment) * (15/30). c) ₹10 lakh ( this ₹10 lakh limit could also increase to ₹20 lakh with the change in the Payment of Gratuity Act).