Gratuity Exemption: a Term Explained in Detailed

Gratuity Exemption

Understand Gratuity Exemption most simplistically.

A retirement benefit is given to the employee upon completing 5 or more years in the organization. Specific regulations govern it and come with certain benefits and exemptions for employees’ post-retirement finance needs. The amount received by the employee is quite significant and valuable.

To explain the Gratuity exemption sections and related tax exemption and implications, we must understand Gratuity, its calculation, type of exemption and other underlying regulations.

The Concept of Gratuity: The Definition

Gratuity Act, 1972, in India, Gratuity gives statutory benefits to an employee provided by the Employer to pay a certain sum of money to the employee upon their resignation, retirement, or death while in employment, provided the employee has served the same Employer for minimum 5 continuous service years. The Gratuity Act has given a standard formula:

Gratuity = (Last drawn salary * years of service * 15) / 26

The Last Drawn Salary means Basic Salary, Dearness Allowance and commissions (if any). The years of service are those served in the company, including a fraction of the year if served over 6 months or more in the last year of service.

What is the Tax Exemption on Gratuity?

As per the Income Tax Act of 1961,  a total of Rs 20 Lakhs is exempted from the income tax for the amount received as Gratuity by the employee. The exemption limit on Gratuity has been subject to changes based on government regulations. If the gratuity amount exceeds the exempted limit, the excess amount is taxable as per the income tax slab applicable to the individual.

Am I eligible for a Gratuity Exemption?

  1. The Coverage of the Gratuity Act 1972: The employee is eligible for exemption if his Employer has followed the provision of the act’s amount calculation and payment.
  2. Completion of Five Years of Service: Other than death or permanent or partial disablement, an employee must complete 5 years for Gratuity eligibility and the exemption.
  3. Exemption Ceiling: A maximum of Rs 20 lakhs is the gratuity amount capped for exemption. Any amount over and above is taxable.

How does Gratuity Exemptions benefit employees?

Any tax-free income received is always welcomed for the extended services spent in the company. Employees retiring after long services and getting substantial money up to 20 Lakh tax-free is always welcomed.

Gratuity exemption is essential at this crucial age of life when expenses for medical care, the marriage of kids, investment, and post-retirement benefits are for steady income.

Gratuity Expenses for the Company

Gratuity is a compulsion and not a choice. So, the companies must ensure that gratuity provisions are taken adequately in the books and that no additional impact is made in the year of the payment. Primarily, the companies take a Gratuity Actuarial Valuer report that the ICAI accepts for reporting requirements.

Large enterprises create a fund through trust and invest the monies in Mutual Funds / FD to earn money on the amounts set aside for Gratuity. The fund receives the money from the company for investment, and at the time of payment, the Mutual fund and FD are liquidated, and dues are cleared.

The above is just a procedural part, and the Employer must ensure compliance, which does not impact employee gratuity disbursement.

Conclusion

A company like CFO Angle helps the employee and Employer with Gratuity and related compliances. We help employees complete the gratuity exemption under section 10 and help the Employer ensure that gratuity rules are followed for a better compliance structure.

Gratuity is a great way to keep benefiting when an employee or their descent gets substantial money. The longer an employee stays the better this money for him to accrue and receive. While filing the Income tax returns it is important for the employee to ensure gratuity exemption in ITR is understood well to maximize benefits.

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