News Analysis

Gratuity boost - what it means for you

Anand Kalyanaraman/BL Research Bureau | Updated on March 23, 2018

Ceiling of gratuity amount for central government employees was doubled to Rs 20 lakh after 7th Pay Commission.   -  Getty Images/iStockphoto

The Parliament passing the Payment of Gratuity (Amendment) Bill is sweet news for employees in the private sector. With this, the maximum limit on gratuity payment for private sector employees has been doubled from ₹10 lakh to ₹20 lakh - in line with the benefit provided to government employees in 2016.

Also, the Act now empowers the government to fix the amount of gratuity with an executive order, rather than the time-consuming process of going through Parliament. The Act now awaits the assent of the President and publication in the gazette.

Gratuity basics

Gratuity is 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 ₹20 lakh once the law is in force (₹10 lakh earlier). Amounts paid above this will be in the nature of ex-gratia. 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. Also, 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.

Tax benefits

The gratuity you get enjoys favourable tax treatment. If you are a government employee, 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 that 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) ₹20 lakh (₹10 lakh earlier).

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. Until now, the current cap on gratuity payable and tax exemption was ₹10 lakh. So, ₹10 lakh was tax exempt and the balance ₹5 lakh was taxed. But now, after the President gives his assent to the amended Act, the gratuity and tax-exempt cap will increase to ₹20 lakh. So, 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; earlier, they could 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 ₹20 lakh (₹10 lakh earlier.)

Published on March 22, 2018

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