Taxability of Gratuity in India: Rules for Government & Private Employees

Gratuity is a reward for an employee’s long-term service. While it’s a gesture of gratitude, not everything is taxable. Gratuity is completely exempt for government employees in India. There are specific limits for private sector employees under the Income Tax Act 1961. Accurate knowledge will ensure that you take advantage of legitimate tax benefits. Let us discuss the Taxability of Gratuity in India.

What is a Gratuity?

An employer’s payment given to employees as a token of appreciation for their contributions to the company is known as a gratuity.  It was given voluntarily as a token of appreciation earlier. After five years of continuous work, some enterprises are required by the Payment of Gratuity Act of 1972 to fulfill their gratuity responsibilities to their employees. Gratuities are paid out apart from the monthly salary and are granted in the following circumstances:

• When an employee reaches retirement age, he is automatically enrolled in supplemental pension insurance
• After resignation or retiring
• When he passed away or became disabled as a result of a disease or accident (five years of continuous service are not required if the employee’s death or disability caused the working relationship to end).

Is Taxability of Gratuity in India?

A gratuity that an employee receives while working is fully taxable as income in their possession under the Income-tax Act of 1961. However, gratuities paid in the event of a death, retirement, resignation, or under specific other circumstances are free from tax under Section 10(10) of the Income Tax Act.

Gratuities are a part of an employee’s pay and are reported under the “Salaries” category. Nonetheless, the gratuity will be given to the employee’s nominee or legal heir in the event of their death. This amount is included in their “income from other sources” as their income.

Exemption from Income Tax on Government Gratuities

Gratuities paid by government employees upon their retirement, termination, or retirement are not subject to tax under current legislation; nevertheless, it should be noted that foreign income is subject to tax in India. This applies to employees in the defense sector, as well as those employed by the federal, state, and local governments, among others.

Gratuity taxes do not apply to employees of the federal government, state governments, or local authorities. The Statutory Corporation’s employees are not eligible for this exemption.

Is Gratuity Taxable for Private Employees?

Whether or not private sector employees are exempt from paying taxes depends on whether the Payment of Gratuity Act of 1972 applies to them. 

Employees covered by the Gratuity Act

Gratuities received by employees covered by the Gratuity Act are exempt from tax at least to the extent of:

• 15 days’ pay (basic + DA) for every completed year of service or part of a year exceeding 6 months;
• Rs 20,00,000 (up from Rs 10,00,000); or
• Amount of gratuity actually received.

Employees not covered by the Gratuity Act

Gratuities received by employees not covered by the Gratuity Act are exempt from tax to the extent of at least the following:

• Half a month’s pay (basic + DA) for each completed year of service based on the average pay of the last 10 months;
• Rs 20,00,000 (up from Rs 10,00,000); or
• Amount of gratuity actually received.

Requirements for Obtaining Gratuities 

The eligibility for gratuity is as follows-

• The employee has to qualify for the pension fund. 
• The employee ought to leave the company. 
• The employee has at least five years of continuous employment history with the company.

Rules for Income Tax Exemption on Gratuities

Typically, the firm purchases a group insurance plan or pays gratuities out of its budget. Unlike the employee pension fund, which incorporates the employee’s contribution, the company pays the gratuity.

According to the Payment of Gratuity Act 1972, a set percentage of the pay is computed and put toward a gratuity that is due later. For employees who depart the company, it functions as a retirement benefit. All companies with more than ten employees are subject to the law.

Gratuities are paid upon resignation, retirement or superannuation, layoff or voluntary retirement, death, reduction, disability, or termination. In the event of the employee’s death, funds are receivable to the nominee.

Maximum Amount of Gratuity

Employees are eligible for loyalty incentives only after five years of continuous service, according to the Gratuity Act of 1972. Up to ₹20,000 may be received as a gratuity to an employee.

Where to Show Gratuity Exemption in Income Tax Return?

The steps to show gratuity exemption in ITR are-

• Form Selection: Select the appropriate ITR form according to your revenue sources. Employees typically use ITR-2 or ITR-1.
• The report found under the heading “Salaries”: Put the entire gratuity amount under the “Salaries” heading, including the taxable and exempt components.
• Type the Exempt Amount in: Under “Income exempt under section 10,” enter the portion of the gratuity that is exempt.
• Refer to Form 16: The gratuity that was received and the amount of the exemption are shown in the Form 16 that your employer sent you. Make use of it when reporting accurately.
• Documentation: To make future tax queries and verifications easier, keep track of all relevant documentation, including gratuity computations and receipts.

Conclusion

Gratuity is a lump sum that an employee receives from a company when they leave after five years of continuous service. This is only one of the numerous advantages of retirement. Moreover, the gratuity may only be subject to taxation if its total exceeds the exemption amount determined by Section 10(10) of the Income Tax Act.

In case of any query regarding the Taxability of Gratuity in India, a team of expert advisors from Legal Window is here to assist you at every step. Feel free to reach us at admin@legalwindow.in.