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Higher tax-free gratuity to benefit senior employees more

Priya Nair / 08 Mar 17 | 03:04 PM

Salaried employees in the private sector may soon be able to enjoy up to Rs 20 lakh tax-free gratuity. The Labour Ministry has proposed an amendment to Payment of Gratuity Act following a meeting with the central trade unions. The amendment is likely to be passed by the government by April. This proposal will bring private sector employees on par with government and public sector undertakings'. Increasing the tax-free gratuity to Rs 20 lakh was one of the recommendations of the 7th Pay Commission, which been approved.

Gratuity is one of the mandatory benefits enjoyed by salaried employees, the other one being the Employees Provident Fund (EPF). All employers who have more than 10 employees have to mandatorily pay gratuity. As per the Payment of Gratuity Act gratuity is to be paid after five years of service on separation or retirement with a limit of Rs 10 lakh. Though some companies do offer gratuity without the waiting period of five years.

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Broadly, there are two sets of employees. Those who have a limit of Rs 10 lakh, in strict accordance with Payment of Gratuity Act and those who have gratuity without any limits.

"Many companies do not limit the gratuity to Rs 10 lakh and provide gratuity without limit. Some companies also follow a hybrid plan, giving increased benefit with increasing year of service. For example, many pay one month of salary each year of service instead of 15 days after an employee completes say 15 years," says Chitra Jayasimha, Senior Actuary & Practice Leader, Retirement & Investment, Aon Hewitt.

The first set of employees, (those with the limit) would benefit from increased gratuity as and when they reach the cap. The second of employees (who are already on no limit) will benefit from tax exemption up to Rs 20 lakh, which is currently at Rs 10 lakh, she adds.

The gratuity amount depends on the tenure of service and the last drawn salary. The formula is as follows: Last drawn salary (basic salary plus dearness allowance) x 15/26 x number of completed years of service.

For an employee with a basic of Rs 2 lakh and a past service of 15 years , in the current scenario will get a gratuity of Rs 10 lakh ( 15/26*15*200000 capped to Rs 10 lakh). In the new scenario, his gratuity benefit as of today would be Rs 17.30 lakh.

"The current limit of Rs 10 lakh already covers a large chunk of employees in the organised private sector. The increase in the limit to Rs 20 lakh will apply to only very senior level employees whose basic is very high. Those employees staying with their employers for a long time will see benefits. From the accounting perspective this will impact the employer because the expenses will increase. Employers will have to provide for gratuity assuming a limit of Rs 20 lakh now instead of Rs 10 lakh. The gratuity is projected assuming that the employee will continue with the company and will touch the limit of Rs 10 lakh or Rs 20 lakh at some point of time,'' says Anil Lobo, India Business Leader-Retirement, Mercer.

If your gratuity payment exceeds the limit, current Rs 10 lakh and proposed Rs 20 lakh, then any amount above that limit is taxed as per your income tax slab. For example, if the gratuity payout is Rs 25 lakh, tax is calculated on Rs 5 lakh (Rs 25 lakh-Rs 20 lakh).

According to Sudip Mukhopadhyay, Principal Consultant, Phronesis in the short term the change in the statutory level helps only senior management people in private sector and mid to senior government officials. "Rather than an ad-hoc increase in statutory level of gratuity, the government should look at an inflation adjusted increase every five years. The government should also focus on increasing retirement funding for people in the SME and unorganised sectors,'' he says.

One debate is whether gratuity should be part of the cost to company (CTC). Some companies show it as part of CTC, while some pay gratuity over and above that threshold. There is no rule in this regard, say experts.

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