There are varying components that constitute an individual’s gross salary with gratuity being one of them. Gratuity is a benefit that is owed to an employee by the employer under Payment of Gratuity Act issued in 1972.
The term Gratuity refers to the sum of money paid by an employer to his employee as a token of gratitude for the services imparted by the employee in the company. This payment is a benefit plan and a part of retirement benefit that an employer offers the employee while leaving the job for any of the reasons - retirement, voluntary retirement, or to work at a new company.
Gratuity, as explained under Section 10 of Income Tax Act, is only payable to the employees who have worked in a company for a period of five years or more. This payment can also be compared to an employer giving a tip to the employee for a job well done. Gratuity is influenced by culture and therefore different countries have different gratuities.
The employer may give the gratuity to the employee from either his own pocket or may take up a gratuity plan with an insurance company. In case if the insurance is acquired, the annual contribution is made towards the insurance plan by the employer. The employee too is free to contribute towards this gratuity amount if he/she wants to. The gratuity sum paid by the insurance company will depend upon the clauses mentioned in the group insurance scheme.
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Apart from these given companies, any other organizations are eligible under this act only if the company employs more than 10 employees
Listed below are the criteria for an employee to claim gratuity payment
The various components required to calculate the gratuity amount, depending upon the number of years served in the company and the salary last drawn are as follow
N = number of years an employee served in the company.
B = last drawn salary + DA (Dearness Allowances)
Gratuity will be = N X B X 15/26
If Rohit is an employee who has worked for an oil company XY for 16 years and had Rupees 35,000 as his last drawn basic salary plus DA amount.
Rohit’s payable Gratuity Amount = 16 X 35,000 X 15/26 = Rupees 3,23,076.9230.
An employer can even decide to pay an amount higher than the general gratuity value as gratuity is nothing but gratitude for service rendered by an employee. As per the Payment of Gratuity Act, the gratuity amount cannot be higher than Rupees 10 Lacs. Any value above Rupees 10 Lacs is considered as exgratia, which is a voluntary payment and not enforced by law.
The gratuity received by an employee is considered taxable when accounted under the ‘income through salary’. It also depends on the employee receiving the gratuity.
On this basis two cases arise for tax calculation on gratuity
The Steps involving Gratuity payment are as follows
As per the current Gratuity Act, employees are required to work at a company for a minimum of five years to be eligible to claim the benefits of gratuity.
The letter circulated by the Indian government on February 15th, 2017 proposed an amendment with regards to Payment of Gratuity Act. This appendix deals with increasing the maximum amount that can be exempted from the tax, which is Rupees 10 Lac to 20 Lacs as per Section 4 (3) of the Act.
The key points with regards to payment of gratuity to an employee by an employer are listed as follows:
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