Tax Treatment of Gratuity as per Income Tax Act,1961

Tax Treatment of Gratuity as per Income Tax Act,1961 is covered U/S 10(10) of the Act. In case of retirement, resignation or  termination, you have to consider Income Tax liability on propose receipt of Gratuity. If Gratuity is received by employee himself, it will be taxable under  head salary while if it is received by legal heir on death of employee, It will be taxable under “Income from other sources’ to the extent it is not chargeable to tax as per below mentioned provision.

Tax Treatment of Gratuity depends on type of employee viz;

1. Government Employee
2. Employee cover under Gratuity Act
3. Any other Employee

1. Government Employee:  Any death cum retirement  gratuity received by employee of Central Government, State Government or local authority ( Employee of statutory corporation are not covered ) is wholly exempt from tax.
2. Employee cover under Gratuity Act,1972  is exempt from tax to the extent of minimum of either of below three items;
   1. 15 day’s Salary ( 7 days per season  in case of employees of seasonal establishments )based on the salary last drawn for every completed year of service or part thereof in excess of 6 months
   2. Rs. 10,00,000 ( Rs. 3,50,000 up to 23^rd May,2010)
   3. Actual Gratuity received by employee

As per Gratuity Act,1972 , Gratuity shall be payable to an employee on termination of his employment after he has rendered continuous service for not less than 5 years on his retirement, resignation, superannuation, death, disablement due to accident or disease. In case of death or disablement continuous service of 5 years is not mandatory.

Employee can claim relief under section 89 of Income Tax in case of taxable gratuity.

Meaning of Salary: For computation of salary as per point 2(1)  as mentioned above means salary last drawn by the employee and includes dearness allowance but doesn’t include any bonus, commission, house rent allowance, overtime wages or any other allowance.  15 days salary can be calculated as under;

In case of monthly rated employees, to calculate 15 day’s salary, the number of days in month will be taken as 26 working days so monthly salary shall be divided by 26 and multiplied by 15.

       3.  Any another Employee: Any gratuity received by employee which is  not covered in above two points  on termination, retirement, death, resignation or on his becoming incapacitated prior to retirement, is exempt from tax  to the extent of minimum of either of below three items on due or receipt basis;

1. Half month’s average salary for each completed year of service. (Completed years include from existing employer plus previous employer) e.g 10 years 11 months 10 days. Half month’s average salary for 10 completed years can be considered.
2. Rs. 10,00,000 ( Rs. 3,50,000 up to 23^rd May,2010)
3. Actual Gratuity received by employee

Meaning of Average Salary: For computation of salary as per point 3(1)  as mentioned above means salary of 10 months immediately  preceding the month in which the person retires. e.g. if employee retires on 3^rd Jan,2013. An average salary will be taken from 01.03.2012 to 31.12.2012.

Salary mean last drawn salary by the employee and includes dearness allowance ( if terms of employment so provide) but doesn’t include any bonus, commission, house rent allowance, overtime wages or any other allowance.  If terms of employments provide commission for a fixed percentage of turnover achievement, same will be included in salary.

If gratuity received by employee from more than one employer in same financial year or different years, agreement maximum amount of gratuity cannot exceed Rs. 10 Lacs as mentioned in point 3(2) above.

Please note that gratuity received during the employment do not qualify for exemption from tax. Assessee can claim relief under section 89 of Income Tax Act.

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Original Post updated with changes.