Categories B.COMECO-11: ELEMENTS OF INCOME TAXIGNOUIGNOU ASSIGNMENTS

TAXABILITY OF GRATUITY AND ENCASHMENT OF EARNED LEAVES

Question 2. Explain the provisions of Income tax Act in connection with taxability of gratuity And Encashment of earned leave by an employee retiring form an organization.

Solution:

Gratuity

Gratuity means “a gift or present, often in return for favours or services.” Gratuity is paid over and above the normal salary. It is paid in recognition of long and meritorious services, rendered by the employee. The Payment of Gratuity Act, 1972 has legally recognized the concept. Even where the Act is not applicable, invariably all employers provide for payment of gratuity to their employees through the terms of employment.

The tax treatment of gratuity is as follows:

Gratuity paid is taxable as salary. However, Section 10 (10) provides for certain exemptions. Such exempted portion of gratuity is not to be treated as income.

  1. Any death-cum-retirement gratuity received by all categories of central government employees, State government employees or employees of a local authority is fully exempt from income tax.
  2. Non-government employees covered by the Payment of Gratuity Act, 1972: Any death cum retirement gratuity is exempt from tax to the extent of least of the following:
    • Maximum Limit of Rs. 10,00,000/-
    • Gratuity actually received
    • 15 days’ salary based on last drawn salary for each completed year of service or part thereof in excess of 6 months

Note: Salary for this purpose means basic salary and dearness allowance. No. Of days in a month for this purpose, shall be taken as 26.

  1. Non-government employees not covered by the Payment of Gratuity Act, 1972: Any death cum retirement gratuity is exempt from tax to the extent of least of the following:
    • Maximum Limit of Rs.10,00,000/-
    • Gratuity actually received
    • Half month’s salary (based on last 10 months’ average salary immediately preceding the month of retirement or death) for each completed year of service

Note: Salary for this purpose means basic salary and dearness allowance, if provided in the terms of employment for retirement benefits, forming part of salary and commission which is expressed as a fixed percentage of turnover

For calculating completed years of service any fractional portion (even if it amounts to 11 months and 29 days) is to be ignored. This is different from the basis adopted under the Payment of Gratuity Act.

While calculation exemption in respect of Gratuity, following points shall be noted:

  1. Gratuity received during the period of service is fully taxable.
  2. Where gratuity is received from 2 or more employers in the same year then aggregate amount of gratuity exempt from tax cannot exceed Rs.10,00,000/-.
  3. Where gratuity is received in any earlier year from former employer and again received from another employer in a later year, the limit of Rs.10,00,000/- will be reduced by the amount of gratuity exempt earlier.
  4. The exemption in respect of gratuities would be available even if the gratuity is received by the widow, children or dependents of a deceased employee.
Encashment of Earned Leave

An employee can encash his earned leave while in service and also at the time of retirement. Section 10(10AA) provides exemption in respect of amount received by way of encashment of unutilised earned leave by an employee at the time of his retirement whether on superannuation or otherwise. The provisions of this clause are mentioned below:

  1. employees: Leave salary received at the time of retirement is fully exempt from tax.
  2. Non-government employees: Leave salary received at the time of retirement is exempt from tax to the extent of least of the following :
    • Maximum Limit of Rs. 3,00,000/-
    • Leave salary actually received
    • 10 months’ salary (on the basis of average salary of last 10 months )
    • Cash equivalent of leave (based on last 10 months’ average salary immediately preceding the date of retirement) to the credit of the employee at the time of retirement or death. Earned leave entitlement cannot exceed 30 days for every year of actual service rendered for the employer from whose service he has retired.

Following points must be Noted while calculating exemption for encashment of earned leave:

  1. Leave salary received during the period of service is fully taxable.
  2. Where leave salary is received from two or more employers in the same year, then the aggregate amount of leave salary exempt from tax cannot exceed Rs. 3,00,000/-.
  3. Where leave salary is received in any earlier year from a former employer and again received from another employer in a later year, the limit of Rs. 3,00,000/- will be reduced by the amount of leave salary exempt earlier.
  4. Salary for this purpose means basic salary and dearness allowance, if provided in the terms of employment for retirement benefits and commission which is expressed as a fixed percentage of turnover.
  5. ‘Average salary’ will be determined on the basis of the salary drawn during the period of ten months immediately preceding the date of his retirement whether on superannuation or otherwise.

 

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Having on his soul, the passion to be the Virtuoso of the enumerated aspects of commerce, Dipesh Aggarwal is indulged in the constant process of absorbing the maximum from the infinite knowledge pool available. Mentoring the youth has proved to be his successful manoeuvre in contemplating, analysing and executing his understanding of varying and crucial aspects.

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