Gratuity Formula & Calculation
Gratuity is a type of payment made by the employer to an employee for long services rendered by him. Gratuity may be received by an employee on his retirement or on his becoming incapacitated prior to such retirement or on termination of his employment. Gratuity received by Central and State Government Employees are fully exempt from Income Tax. Gratuity received by private sector employees are exempt from Income Tax for upto Rs.10 lakhs.
The Payment of Gratuity Act of 1972 applies to the establishments and entities that have employed 10 or more individuals as employees. However, it is essential that an employee completes a minimum of 5 years in the relevant organisation in order to claim the gratuity amount.
You can use the following formulas to calculate gratuity in India:
Private Employees covered under the Payment of Gratuity Act, 1972
For private sector employees covered under the Payment of Gratuity Act, 1972, gratuity is calculated using the following formula:
Formula: Salary at the time of retirement ÷ 26 × 15 × Completed year of service.
While calculating completed year of service, if part of the month is more than 6 months, then round off higher. For example, if the duration of service is 18 years 7 months. Completed year of service will be 19 years. If the duration of service is 18 years 6 months. Then, completed years of service will be 18 years.
Private Employees Receiving Gratuity as per Employment Contract
For private sector employees receiving gratuity as per terms of employment (not covered under the Payment of Gratuity Act, 1972), the following formula can be used for calculating gratuity:
Formula: Average salary ÷ 30 × 15 × Completed year of service.
While calculating average salary, compute the average salary of last 10 months immediately preceding the month of retirement. Also, as discussed above, while calculating completed years of service, ignore the part of months.
Income Tax on Gratuity
Gratuity is taxable on the following basis in India (Read the latest Amendment to Gratuity Act)
Any death-cum retirement gratuity received by an employee of the Central Government, State Government or local authority is wholly exempt from income tax. Professors and teachers of University established under an Act of Parliament or State Legislature as well as college affiliated to such University or Constituent college of such University is treated as Government employee for this purpose.
In case gratuity is received by an employee covered by the Payment of Gratuity Act, 1972 – the same is exempt from income tax to the extent of:
i) 15 days salary (7 days in the case of employees of seasons establishment) based on the salary last drawn for every completed year of service or part thereof in excess of 6 months;
ii) Rs.20,00,000 (Rs.10,00,000 before March 29, 2018, Rs.3,50,000 from September 24, 1997 to May 23, 2010); or
iii) Gratuity actually received, whichever is lower.
Gratuity received more than the exempted limit is subject to income tax.
Employees NOT Covered
Any other gratuity received by an employee on retirement, death, termination, resignation or on an employee becoming incapacitated prior to retirement, is exempt from tax to the extend of the least of:
i) Rs. 10,00,000;
ii) Half-month salary for each completed year of service;
iii) Gratuity actually received.
Income Tax Exemption
Any amount of gratuity received by Central and State Government Employees including Defence personnel is fully exempt from Income Tax. On the other hand, private sector employees enjoy a maximum life-time exemption of Rs.20 lakhs or Rs.10 lakhs per annum or the actual amount received – as detailed above.
Any gratuity received in excess of the aforesaid limits is taxable in the hands of the employee on due or receipt basis. The assessee can, however, claim relief under Section 89.
Finally, any gratuity paid to an employee while he/she continues to remain in service is not exempt from tax, though the assessee can claim relief under Section 89.
Gratuity Bill, 2017
The Government increased the tax-free limit of gratuity received by an employee to Rs.20 lakhs by introducing the Payment of Gratuity Bill, 2017. The increase in the tax-free limit for gratuity will help higher salary employees. Employees in both Government and Private sector will benefit from the tax-free gratuity limit increase. In a span of an employee’s career, the tax-free gratuity amount that is claimable as an exemption under the Income Tax Act cannot exceed Rs.20 lakhs in total, from all the employers considered collectively. Employers can pay more than the stipulated Gratuity amount and any amount paid as a gratuity by the employer over Rs.20 lakhs shall be taxable.
In addition to the increase in tax-free gratuity amount, the Payment of Gratuity Bill, 2017 has also provided powers to the Central Government for determining maternity leave. Under the new provisions, expectant mothers can enjoy a maternity leave period of 26 weeks and the period of maternity leave would be deemed to be in continuous service.