The Parliament recently approved the Payment of Gratuity (Amendment) Bill, 2018. The highlight of the Bill is that it will allow the government to raise the limit of tax-free gratuity whenever required, through an executive order. Under the 7th Pay Commission, the ceiling for government employees went up to Rs20 lakh. With the change in the Bill, the government has removed the Rs10 lakh limit, which will benefit private sector employees.
Kulin Patel, head of retirement, South Asia, Willis Towers Watson, said the government has “introduced words that basically say that the central government will now be able to notify a cap as and when required.” This will give them flexibility to change the cap on tax-free gratuity without having to change the primary legislation.
What is gratuity?
It is a defined benefit, which means that the payment, based on a defined formula, will be guaranteed if the basic conditions are met. In India, according to the Payment of Gratuity Act, 1972, gratuity is a benefit offered by organizations that employ more than 10 people, .
According to the law, an organization has to pay gratuity to an employee who has served it continuously for at least 5 years. For each year of service, it has to pay an amount equalling 15 days of last drawn salary. Salary here means basic salary plus dearness allowance and commission, if commission is a fixed percentage of sales. If a person has worked for over 6 months in the last year of service, it is considered as a complete year. For instance, if a person has 7 years and 6 months of continuous service, gratuity will be paid for 8 years.
A month of work means 26 days. So salary for 15 days is calculated as (monthly salary*15)/26. This number multiplied by the number of years in service will be the gratuity amount. A similar calculation applies for gratuity at retirement. Under the income-tax Act, gratuity is taxed as ‘income from salary’. The portion of salary received as gratuity can be exempt from tax under section 10(10) of the Act, depending on various factors. Gratuity of an employee of a central, state or local government agency is fully exempt when withdrawn on death or retirement.
What changes now?
Under the current regime (Payment of Gratuity Act) the least of the following received is tax exempt—Rs10 lakh; actual gratuity received; or 15 days’ salary based on the salary last drawn multiplied by number of years in employment.
“When the Gazette notification for this change is published, we expect it to mention what the new cap would be. The common assumption is Rs20 lakh,” Patel said.
“This change will put private sector employees at par with central government employees in taxation of gratuity,” said Sonal Arora, vice-president, Teamlease Services. She added that the government has been mulling gratuity portability, and reducing the gratuity eligibility limit to 3 years.
While there will be no immediate impact of the change in gratuity amount on take-home salaries, the move will benefit employees who have long stints with the same company.