Proposed increase in tax-free gratuity limit to Rs 20 lakh – Who will get benefit ?
The government has proposed to hike the tax free gratuity payment limit from the current Rs 10 lakh to Rs 20 lakh – on 12 September 2017, the Cabinet cleared The Payment of Gratuity (Amendment) Bill, 2017. However, before you rejoice, do you know if this will actually benefit you monetarily? It will immediate beneficiaries of this move will be very senior level employees and the bulk of the working class at current salary levels are unlikely to gain from this move immediately. Yes, if you have just joined the workforce this move would be beneficial in the long run.
What the rules say
Gratuity payable to you depends on two factors:
i) last drawn basic monthly salary and,
ii) number of years in service.
The tax-exempt gratuity limit had already been raised to Rs 20 lakh for most government employees as per the 7th Pay Commission recommendations effective from 1 January, 2016 and were notified by the government in July 2017. Therefore, the current increase in limit impacts people working in the private sector and those who are not covered under the Central Civil Services (Pension) Rules, 1972.
As per the current rules, one is eligible to claim gratuity benefit only if an employee has rendered five years of continuous service in one organisation.
Further, the maximum tax-exempted gratuity amount is applicable to a person’s entire working period or career. What this means is that during your entire working life, the tax-exempted gratuity amount you can claim cannot exceed Rs 10 lakh currently in total from one or more employers.
The employers can pay more than what the gratuity formula says if they feel so. The Payment of Gratuity Act, 1972 does not prevent them from doing so. The Act only prescribes the minimum limit which is exempted from tax.
There is nothing in the Act that prevents an employer to offer better terms and conditions to his employee if he feels so. “It means he can pay more than what the gratuity formula says and/or reduce the time period to be eligible to receive the gratuity benefit,” she explains.
The table below tells you how much your gratuity will be at the end of different employment tenures at different levels of last drawn basic salary. The boxes with figures in bold and highlighted in green are those where the gratuity amount is equal to or crosses the current tax-exempt limit of Rs 10 lakh. Only those whose gratuity amount falls in this section will immediately benefit by proposed increase to Rs 20 lakh.
*The above table is applicable for people covered under the Gratuity Act, 1972.
* Assumption: There is no dearness allowance and commission on sales in a person’s salary. It is also assumed that a person works continuously with one employer for the time intervals chosen for service tenure, i.e., 5 years, 10 years, 15 years and so on.
From the table above you can see that a person with a last drawn basic salary of Rs 45,000 a month would have to have worked
continuously for 40 years to get a gratuity of more than Rs 10 lakh at the time of retirement. With the tax-exempt gratuity limit being Rs 10 lakh as per current rules, he would have to pay tax on Rs 38,461. Once the tax-exempt limit is raised to Rs 20 lakh even this Rs 38,461 will become tax exempt.
Similarly, someone with a higher last drawn basic salary of Rs 50,000 per month would cross the Rs 10 lakh gratuity limit after working for 35 years. It should be noted that even people with a last drawn monthly basic salary of Rs 80,000 would get a gratuity of more than Rs 10 lakh only after working for 25 years.
So, how much basic salary does one have to earn to really gain from the proposed increase in tax-exempt limit of gratuity?
This move will be immediately beneficial to employees with large salaries and senior employees. However, in the long run, most employees will benefit from this. Here is how.
The above table is based on an assumption that a person has joined an organization at the age of 25 years with a basic salary of Rs 20,000 per month. By assuming an average annual salary increase of 7%, he will reach the limit of Rs 10 lakh gratuity by the time he is around 47 years of age. The gratuity limit of Rs 20 lakh will be reached in the age bracket of 50 to 55.
No short cuts If you are tempted to hike the basic salary component of your CTC in order to increase the gratuity amount, there is a catch. If you increase your basic salary to up the gratuity amount (because gratuity is linked to your basic salary) then your basic taxable income rises in tandem. So, your tax outgo will increase as well.
For instance, if your basic monthly salary is Rs 45,000, you will fall in the 20% tax bracket. This is without adding other components of the salary such as house rent allowance (HRA), special allowance etc., and without claiming deductions available under sections 80C to 80U of the Income-tax Act, 1961.
Higher basic salary also affects the Employees’ Provident Fund (EPF) contribution made by you and the employer. EPF contribution of 12% is deducted from your basic salary. While you will be able to claim this deduction under section 80C to reduce your tax outgo, this will also decrease your take home salary. Many employers also choose to have keep the basic salaries low as this will help them to reduce their contribution to EPF.
It appears that the proposed increase in tax-exempt gratuity limit will immediately benefit mostly those with high salaries as not many people would be earning a basic salary of over Rs 70,000 a month at present. However, if there are years to go for your retirement or you just started working, this increase will benefit most employees.