Income from Salaries, Income Tax, Individuals

IncomeTax/Individuals/Salaried/Retirement Benefits/Gratuity

Tax treatment of gratuity can be classified as follows:

(A)     Gratuity received by Government employees and employees of local authority [Section10(10)(i)]

In case of a Government employee, any death-cum-retirement gratuity received is wholly exempt under section 10(10)(i). It should be noted that employees of statutory corporation will not fall under thiscategory.

Illustration (Government employee)

Mr. Kishan is a Central Government employee. He retired from his service in December 2012 and received gratuity of Rs. 8,40,000. In this case, entire amount of gratuity will be exempt from tax.

(B)   Gratuity received by non-Government employees:

This category will further be classified as follows :

  • Exemption in respect of gratuity in case of employees covered by the Payment of Gratuity Act,1972.
  • Exemption in respect of gratuity in case of employees not covered by the Payment of Gratuity Act,1972.

The detailed discussion in this regard is as follows :

(1)   Exemption in respect of gratuity in case of employees covered by the Payment of Gratuity Act, 1972 [Section10(10)(ii)]

Exemption in this case will be lower of the following amounts :

  1. 15 days’ salary (*) × years ofservice
    1. Maximum amount specified by the Central Government, i.e., Rs.10,00,000.
    1. Gratuity actuallyreceived.

Following points should be kept in mind :

  • 7 days instead of 15 days in case of employees of a seasonalestablishment
  • 15 days’ salary = Salary last drawn ×15/26
  • Salary for this purpose will include basic salary and dearness allowanceonly.

Illustration:

If Mr. Vinayak monthly salary at the time of his retirement is Rs. 8,484 and basic, Rs. 2,526 as dearness allowance, Rs. 1,848 as commission and Rs. 1,252 as bonus, then salary for aforesaid exemption will be Rs. 6,352, computed as follows:

Rs. 11,010 (Basic + DA) × 15/26 = Rs. 6,352 (rounded off)

  • Incaseofpieceratedemployee,d1a5ys’salarywillbecomputedonthebasisof average of total wages (excluding overtime wages) received for a period of three months immediately preceding the termination of hisservice.

Illustration:

If in the above Illustration, Mr. Vinayak is a piece-rated worker and salary drawn by him in three months preceding the retirement is Rs. 11,010

including Rs. 2,526 overtime (OT) wages, then salary for the aforesaid exemption will be Rs. 1,632 computed as follows:

Step 1 – Computation of three months’ salary

Three months’ salary will be Rs. 8,484 (Rs. 11,010– Rs. 2,526 being OT wages)

Step 2 – Computation of monthly salary

One month salary will be Rs. 2,828 (i.e., 8,484/3)

Step 3 – Computation of salary

Salary will be Rs. 1,632 (rounded off) (i.e., 2,828 × 15/26)

  • Part of the year, in excess of 6 months, shall be taken as one fullyear.

Illustration: If the period of service is 18 years and 8 months, then 19 years will be taken as duration of service. If the period of service is 18 years and 5 months, then duration of service will be taken as 18 years.

(2)   Exemption in respect of gratuity in case of employees not covered by the Payment of Gratuity Act, 1972 [Section10(10)(iii)]

In case of employees not covered by the Payment of Gratuity Act, 1972 exemption in respect of gratuity will be least of the following:

  1. Half month’s average salary for each completed year of service,i.e.,

[Average monthly salary × ½] × Completed years of service. (*).

  • Maximum amount specified by the Central Government, i.e., Rs.10,00,000
    • Gratuity actuallyreceived.

Following points should be kept in mind :

  • Average monthly salary is to be computed on the basis of average of salary for 10 months immediately preceding the month (not the day) ofretirement.

Illustration: Mr. Vidyut retires from service on 8-4-2010. In this case, average salary will be computed on the basis of salary for the period of 1-6-09 to 31-3-10 (i.e., 10 months preceding the month ofretirement).

  • Salary for this purpose will include basic salary, dearness allowance, if the terms of service so provide and commission based on fixed percentage of turnover achieved by theemployee.
  • While computing year of service, any fraction of year is to beignored.

Illustration: If duration of service is 18 years and 11 months, then 18 years will be considered for computation.

Illustration (Non- Government employee)

Mr. Agarwal retired from A Ltd. on 15-2-3013, after serving for a period of 25 years and 9 months. Following are otherdetails:

  • Basic salary per month during 10 months preceding the month of retirement (i.e., monthly salary from 1-4-12 to 31-1-13) : Rs.60,000.
  • Dearness allowance per month during 10 months preceding the month of retirement (i.e., monthly DA from 1-4-12 to31-1-13)
  • Forming part of salary for computing retirement benefits : Rs.60,000
  • Not forming part of salary for computing retirement benefits : Rs.10,000
  • Gratuity received at the time of retirement Rs.25,20,000.

Compute the amount of exemption in respect of gratuity under section 10(10)(ii)/(iii), considering :

  • Mr. X is covered by the Payment of Gratuity Act,1972
  • Mr. X is not covered by the Payment of Gratuity Act,1972.

**

(i)   When Mr. X is covered by Payment of Gratuity Act,1972

As per section 10(10)(ii), exemption in respect of gratuity received by non-Government employee (covered by the Payment of Gratuity Act, 1972) is least of the following:

Particulars
(Rs.)
1. 15 days’ salary for each completed year of service or part in excess of 6 months (Note 1)
  19,50,000
2. Maximum amount specified by the Central Government
10,00,000
3. Actual amount received
25,20,000

Amount of exemption under section 10(10)(ii) will be Rs. 10,00,000, being least of above. Thus, taxable amount of gratuity will be Rs. 15,20,000 (Rs. 25,20,000 – Rs. 10,00,000)

Note 1: Computation of 15 days’ salary for each completed year of service or part in excess of 6 months:

Following points should be considered:

  • Part of year in excess of six months will be considered as a fullyear.
  • Salary for the aforesaid purpose will be last drawnsalary.
  • Salary for the aforesaid purpose will include basic salary and any dearness allowance (i.e., whether or not forming part of salary while computing retirementbenefits).
  • While computing 15 days’ salary, we will divide monthly salary by 26 days. Based on above, computation will be asfollows:
  • Monthly salary will be Rs. 1,30,000 (Rs. 60,000 + Rs. 60,000 + Rs.10,000).
  • 15 days’ salary will be Rs. 75,000 (Rs. 1,30,000/26 ×15).
  • Duration of service is 25 years and 9 months, i.e., it will be taken as 26 years (for computation ofexemption).

Thus, total amount of salary will be Rs. 19,50,000 (Rs. 75,000 × 26 years).

(ii)   When Mr. X is not covered by the Payment of Gratuity Act,1972

As per section 10(10)(iii), exemption in respect of gratuity received by non-Government employee (not covered by the Payment of Gratuity Act, 1972) is least of the following :

Particulars
(Rs.)
1. Half month’s salary for each completed year of service (Note 2)
15,00,000
2. Maximum amount specified by the Central Government
10,00,000
3. Actual amount received
25,20,000

Amount of exemption under section 10(10)(iii) will be Rs. 10,00,000, being least of above. Thus, taxable amount of gratuity will be Rs. 15,20,000 (Rs. 25,20,000 – Rs. 10,00,000).

Note 2: Computation of half month’s salary for each completed year of service : Following points should be considered in this regard:

  • While computing duration of service, any part of year will beignored.
  • Salary for the aforesaid purpose will be average salary for 10 months preceding the month (not the day) ofretirement.
  • Salary for this purpose will include basic salary, dearness allowance forming part of salary while computing retirement benefits and commission based on fixed percentage of turnover achieved by theemployee.
  • Half month’s salary will be computed by dividing average salary by2. Based on above, salary will be computed asfollows:
Particulars
(Rs.)
Basic salary per month, for 10 months immediately preceding the month of retirement
60,000
(+) Dearness allowance per month (forming part of salary while computing retirement benefits), for 10 months immediately preceding the month of retirement
    60,000
Total monthly salary for the purpose of computing exemption
1,20,000

There is no need to convert aforesaid monthly salary of Rs. 1,20,000 into average monthly salary, since there is no change in salary during past 10months.

Based on above, computation will be as follows:

  • Half month’s salary will be Rs. 60,000 (i.e., Rs.1,20,000/2).
  • Duration of service will be 25 years (part of year will be ignored). Thus, total amount of salarywill be Rs. 15,00,000 (Rs. 60,000 × 25years).

Pension

Pension can be in any of the following forms:

  • Uncommuted pension is a periodic payment received afterretirement.

Illustration: Mr. Karandikar receives pension of Rs. 25,200 per month after his retirement from Shyamal Ltd.

  • Commuted pension is a lump sum payment in lieu of periodicpension.

Illustration : At the time of retirement, Mr. Karandikar received a lump sum payment of Rs. 2,52,000 towards commuted pension (i.e., in lieu of monthlypension).

  • An employee may (depending upon his service rules) partly commute his pension and receive the balance as periodic payments (i.e.uncommuted).

Illustration: Mr. Karandikar decided to commute 84% of his pension for Rs. 2,11,680 and continue to receive the balance in periodic payments (i.e. uncommuted). In this situation, Rs. 2,11,680 is called as commuted pension and Rs. 2,52,000 (Rs. 2,11,680 ÷ 84 × 100) is called as full value of commuted pension.

As per section 10(10A)(i), any commuted pension is exempt in the hands of a Government employee. In case of non-Government employee exemption in respect of commuted pension will be as follows:

  • If the employee receives gratuity, one third of full value of commuted pension will be exempt from tax under section 10(10A)(ii)(a).
  • If the employee does not receive gratuity, one half of full value of commuted pension will be exempt from tax under section10(10A)(ii)(b).

Following important points should be kept in mind :

  • For exemption in respect of pension in case of gallantry award winner and family members of armed forces refer to section 10(18) and10(19).
  • Family pension received by the family members of the employee after the death of the employee, is charged to tax in the hands of recipient under the head “Income from other sources”. In such a case, deduction of lower of 1/3rd of the amount of pension or Rs. 15,000 is available from suchincome.
  • Relief under section 89 is available in respect of amount of commuted pensionwhich is not exempt fromtax.

Illustration (Government employee)

Mr. Kapoor is a Government employee. On 31-12-2012 he retired from his service. For the month of January 2013, he received pension of Rs. 8,400 per month. On 1-2-2013, he commuted 50% of pension for Rs. 84,000 and continued to receive balance of 50% of pension of Rs. 4,200. What will be the tax treatment of pension in the hands of Mr. Kapoor if he received gratuity of Rs. 1,84,000 at the time of retirement and if he has not received any gratuity at the time of retirement?

Explanation

As per section 10(10A) (i), any commuted pension, i.e., accumulated pension in lieu of monthly pension is exempt in the hands of a Government employee. There is no exemption in respect of uncommuted pension. In this case, for the month of January, Mr. Kapoor had received pension (uncommuted) of Rs. 8,400 and for the month of February and March he would be receiving Rs. 4,200 per month as uncommuted pension. This amount will be fully taxed.

Commuted pension received by a Government employee is exempt from tax. This rule will remain same even if the employee is receiving gratuity. Thus, nothing will be taxed in respect of commuted pension of Rs. 84,000.

Illustration (Non- Government employee)

Mr. Kapoor is a non-Government employee. On 31-12-2012 he retired from his service. For the month of January, 2013, he received pension of Rs. 8,400 per month. On 1-2- 2013, he commuted 50% of pension for Rs. 84,000 and continued to receive balance 50% of pension of Rs. 4,200. What will be the tax treatment of pension in the hands of Mr. Kapoor if he received gratuity of Rs. 1,84,000 at the time of retirement and if he has not received any gratuity at the time of retirement?

Explanation

For the month of January, Mr. Kapoor had received pension (uncommuted) of Rs. 8,400 and for the month of February and March he would be receiving Rs. 4,200 per month as uncommuted pension. This amount (i.e., uncommuted pension) will be fully taxed.

As per section 10(10A)(ii), exemption in respect of commuted pension in case of a non- Government employee will be as follows :

  • If the employee receives gratuity, one third of full value of commuted pension will be exempt from tax under section 10(10A)(ii)(a).
  • If the employee does not receive gratuity, one half of full value of commuted pension will be exempt from tax under section10(10A)(ii)(b).

If Mr. Kapoor has received gratuity, then out of Rs. 84,000 received on account of commuted pension, Rs. 56,000 [1/3rd of Rs. 1,68,000 (Rs.84,000/50*100)] will be exempt from tax. If Mr. Kapoor has not received gratuity, then out of Rs. 84,000 received on account of commuted pension, Rs. 84,000 [1/2 of Rs. 1,68,000 (Rs.84,000/50*100)] will be exempt from tax.

Compensation received at the time of voluntary retirement or separation

Any compensation received at the time of voluntary retirement or separation is exempt from tax, if the following conditions are satisfied:

  • Compensation is received by an employee of an undertaking specified in section 10(10C).
  • Compensation is received in accordance with the scheme of voluntary retirement/separation, which is framed in accordance with prescribed guidelines. (for guidelines see Rule2BA).
  • Maximum amount of exemption is Rs.5,00,000.
  • Where exemption is allowed to an employee under section 10(10C) for any assessment year, no exemption under this section shall be allowed to him for any other assessmentyear.
  • Relief under section 89 is admissible in respect of suchamount.
  • With effect from assessment year 2010-11, section 10(10C) has been amended to provide that where any relief has been allowed to an assessee under section 89 for any assessment year in respect of any amount received or receivable on his voluntary retirement or termination of service or voluntary separation, no exemption under section 10(10C) shall be allowed to him in relation to such, or any other assessment year.

Illustration : Mr. Krunal is working in Essem Ltd. from January, 2000 at a monthly salary of Rs. 84,000. His official date of retirement is January, 2020. In June, 2012, the company declared a voluntary retirement scheme. The scheme of voluntary retirement is framed in accordance with prescribed guidelines given in Rule 2BA. Mr. Krunal opted for the scheme and received Rs. 8,40,000 as compensation on account of voluntary retirement. In this case, Rs. 5,00,000 will be exempt in the hands of Mr. Krunal and balance Rs. 3,40,000 will be charged totax.

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