The small, tax-free token of farewell called gratuity that your employer gives you after you have served him well may get bigger. The government has proposed raising the current limit of gratuity from Rs3.5 lakh to Rs10 lakh.
If the proposal goes through, it would mean that the companies will have to pay you more when saying goodbye. Earlier, even if your gratuity exceeded the Rs3.5 lakh limit, you would get only that much.
Also See How To Calculate Gratuity (Graphic)
What is gratuity?
After having served your employer for five years or more you become entitled to a payment called “gratuity”. This is a lump sum tax-free benefit that you are entitled to when you leave for another job or retire. Both government and non-government employees are entitled to gratuity. However non-government employees come under the Payment of Gratuity Act (1972), which makes it mandatory for all employers with more than 10 employees on their payrolls to give gratuity to employees who are retiring or quitting, if they have put in five years of service with the employer.
Typically, employers manage gratuity by creating a fund and outsourcing the management to an insurer or an actuarial company. Some employers show this gratuity payment as your cost to company (CTC). So, when you see your CTC break-up closely, you will see a gratuity cost deduction. Says Amit Gopal, vice-president, India Life, an investment and legal consulting firm in retirement planning: “An employer shows gratuity as his cost for hiring you and, therefore, some employers mention it on the total CTC break-up. Companies usually deduct 4.81% of your basic plus dearness allowance towards gratuity payment. This 4.81% is computed as (15/26)/12. Effectively, it is half a month’s salary on a base of a year’s salary.”
How much do you get?
You get half of your last month’s salary for every year that you have worked. Here salary constitutes your basic salary plus dearness allowance, called “wages” in the Act. Take the monthly salary drawn by you last (basic plus dearness allowance) on resignation or retirement and divide it by 26, assuming there are four Sundays in a month. This is your daily salary. Multiply this amount by 15 days and further with the number of years you have put into service. For example, if your last drawn monthly salary is Rs1 lakh when you are leaving the job after 10 years of service, your gratuity will work out to Rs5.76 lakh. However, as per the present rules, your employer’s maximum liability towards gratuity payment is Rs3.5 lakh. Even in cases where the amount exceeds the threshold, the employer pays only Rs3.5 lakh. Says Pankaj Mathpal, a Mumbai-based financial planner: “Earlier, employers were only giving Rs3.5 lakh as gratuity. Now they will have to pay as much as Rs10 lakh.”
Currently, up to Rs3.5 lakh is tax-free in your hands. Says Kulin Patel, head (employee benefits practice), Towers Watson India, a consultancy: “Currently, the proposal is to change the Payment of Gratuity Act. If the proposal comes through, the maximum limit of gratuity will increase to Rs10 lakh. Subsequently, the Income-tax Act will also have to change to make the new limit of Rs10 lakh tax-free.”
Says Gopal: ”The section 10 (10) of the Income-tax Act says that gratuity under the provisions and limits of the Payment of Gratuity Act, 1972 is tax exempt. So, by that logic, even the higher limit of Rs10 lakh will be tax exempt as long as it is given according to the guidelines mentioned in the Payment of Gratuity Act.”
What if you quit or retire before five years?
If gratuity payments are a part of your CTC and are deducted each month, what happens if you quit before five years? Says Mathpal: “Most companies don’t give you this deduction when you quit as this comes under the cost to the company.” But that doesn’t sound right—you are paying for something that you will not get in the end. “Ideally, you should be reimbursed the deducted amount. But they aren’t because benefits like gratuity or pension come with a vesting period,” says Gopal.
What should you do?
Negotiate to get gratuity out of your CTC when you join a new job. Or try and renegotiate at year end to get it removed from your CTC. Says Ranjeet S. Mudholkar, director, Financial Planning Standards Board India: “Gratuity forms a part of the CTC as it is indeed a cost to the company and this liability needs to be accounted for. However, what is unfair is when CTC is mistaken to be the salary. There should be proper disclosure and distinction between CTC and salary. At the time of getting the offer letter, a lot of people mistake CTC to be the salary.”