How gratuity is taxable under income tax act, 1961

Gratuity is a retirement benefit to the workman who has rendered long and unblemished service to the employer. Its a reward for long and meritorious service. In 1972 the government of India, passed The Payment of Gratuity Act which made it mandatory for all employers with more than 10 employees to pay gratuity.

For the purpose of exemption of gratuity under sec.10 (10) the employees are divided under three categories:

What is Gratuity1. Any death cum retirement gratuity received by Central and State Govt. employees, Defense employees and employees in Local authority shall be wholly exempt from income tax.

2. Any gratuity received by persons covered under the Payment of Gratuity Act, 1972 shall be exempt to the extent of:-

  • For every completed year of service or part thereof, gratuity shall be paid at the rate of fifteen days wages based on the rate of wages last drawn by the concerned employee; or
  • The amount of gratuity as calculated above shall not exceed Rs. 10,00,000/-; or
  • Gratuity actually received,

In case of any other employee, gratuity received shall be exempt to the extent of the least of

  1. Rs. 10, 00, 000
  2. Half month salary (based on last 10 months average) for each completed year of service
  3. Gratuity actually received

Gratuity in excess of the aforesaid limits is taxable in the hands of employee on due or receipt basis. The tax payer can however claim relief under section 89.

While calculating the completed year of service, any fraction of the year shall be ignored.

Average monthly salary is calculated on the basis of the salary of 10 months immediately preceding the month in which the person retires, etc. Salary for this purpose means basic salary and includes dearness allowance, if the terms of the employment so provide, but excludes all other allowance and perquisites.

If however, under the terms of employment, commission is payable at a fixed percentage of turnover achieved by an employee, such commission would partake of the character of salary.

Gratuity payment to a widow or other legal heirs of any employee who dies in active service shall be exempt from income tax subject to provisions mentioned above Circular No. 573 dated 21.08.90.

Gratuity received by an employee on his retirement is taxable under the head “Salary” and gratuity received by the legal heir is taxable under the head” Income from Other Sources”.

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