Government Awareness

Good To Know: Government Raised Tax-Exempt For Gratuity Limit- Here Is What You Should Know

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November 6th, 2017


Gratuity is one of the most crucial components of income. It is the payment made by the employer to the employee either when he leaves the job or at the time of his retirement. Despite being an important constituent of income there is still a lot of confusion around how to claim gratuity, how is it calculated, who is eligible to claim gratuity, when can it be claimed and so on.


What is gratuity?

Gratuity is the one of the most misconceived and miscalculated components of one’s salary. Gratuity is considered as a retirement benefit which the employee is entitled to get only after his retirement or once he resigns. It is simply the employer’s way of thanking the employee serving the company.  An employee is entitled to receive gratuity as per the Payment of Gratuity Act, 1972 which is enforced by the Central Government and the designated establishments under its control.  

  • Does your company need to pay gratuity?

Every organisation which has more than 10 employees is obligated to pay gratuity to its employees. Further, once the organization hires more than 10 employees, the Act will continue to apply even when the number of employees gets reduced below the minimum requirement, i.e., 10.  Gratuity is also applicable to a factory, mines, oil fields, plantation, port, railway company and every shop and establishment. If your company fails to pay you gratuity, you can seek lawyer’s advice to claim your gratuity.

  • Eligibility for Gratuity

An employee who has rendered at least five years of continuous service to an organisation without any interpretation is entitled to receive gratuity. What does “continuous service” mean? It simply means no break by the employee from the date of the joining of the organisation. This, however, includes interruption on the basis of sickness, accident, leave, absence from work without leave, lay off, strike, or a lockout or cessation of work not due to the fault of the employee. This also covers a situation where the person is on maternity leave.

  • When are you entitled to receive gratuity?

Generally, gratuity is paid to the employee on his retirement. There are a couple of other instances, other than retirement when it has to be paid to the employee include-

  • On his superannuation. To superannuate means to retire from employment because of old age.
  • If he has resigned after serving the organisation for five years. While receiving his full and final settlement he is entitled to receive the gratuity.
  • On his death, even if the employee has not completed the mandatory five year period.
  • If he becomes disabled due to accident or disease even when the working period of five years is not completed.

How is gratuity calculated?

Gratuity is calculated as 15 day’s salary for each completed year of service. The salary includes your last drawn basic salary and dearness allowance but excludes all other allowances.

The formula for calculating gratuity is- Last drawn salary (basic salary plus dearness allowance) X number of completed years of service X 15/26.  The tenure for which the service is rendered is based on whether the firm is covered under the gratuity act or not.

Now, since the limit has been increased to Rs. 20 lakh, the least of the above will be – 11,53,846 and the employee will be liable to pay tax on the only balance of Rs. 46,000.

  • Are Contractual employees also entitled for gratuity?

In case, if you are receiving the gratuity from two or more employers in the same year then the exemption limit will stay the same.If the gratuity is received from a former employer and another employer thereafter, the limit of exemption will be reduced by the exemption limit taken earlier.

No, this benefit is only for those on the company’s regular payroll. No gratuity is granted to contractual employees.

In case of the organization is covered under the Act, the employee’s service tenure will be considered for a full year provided he has worked for more than six months but less than a year. In case if the organisation is not covered under the Act then the tenure of the employee whose services exceeds six months but is less than a year will not be considered as full year.

For instance, if the employee has worked in an organisation for 20 years, six months and one day. In this case, the tenure of his services will be considered as 21 years. In case if the organization was not covered under the Act, then the employee’s tenure will be taken as only 20 years.

  • Tax on gratuity

The cabinet has approved the bill seeking to raise tax-exempt gratuity limit to Rs 20 lakh from the current level of Rs 10 lakh. This brings cheers to those employees who are not covered under the Central Civil Services (Pension) Rules, as private sector employees, public undertakings, and employees.

The gratuity received by government employees is exempted and is not required to pay tax. For a non-governmental employee, the gratuity received in his entire working life is tax-free up to maximum limit of Rs. 10 lakh.

  • Calculation of gratuity exempted from tax-

Maximum exemption 10 lakh before the amendment.

Let’s say a person is covered under the gratuity act. He has completed his service for 20 years and four months. He received 12 lakhs as gratuity from the organisation and his last drawn salary is Rs.1 lakh. How much of this gratuity will be tax exempted?

As per the Act, the least of the following is exempted-

  • Tax-free limit -Rs.10 lakh
  • Actual gratuity received- Rs. 12 lakh
  • 15 days salary on the basis of last drawn salary- 15*20*1/ 26 = 11, 53, 846

Therefore, in this case, the tax exempted gratuity will be actual minus least of the above, i.e. Rs. 10 lakh. On the balance Rs, 2 lakh, the employee will be liable to pay tax as per his tax slab.



How does gratuity work?

An employer is required to offer gratuity out of the establishment’s funds or any approach an insurance employee 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 towards his gratuity funds.

When is gratuity paid

The employer shall arrange to pay the gratuity within 30 days from the date it became due, i.e., from the date the person retires or his resignation or the date he is terminated from his job.

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