Gratuity Rules: The gratuity rules have undergone changes. Additionally, there are indications that employees’ gratuity might rise. Nevertheless, a concern is that employees could also face tax obligations. Let’s explore the reasons behind potential tax payments.In simple terms, gratuity was previously calculated using only Basic + DA, but with the new regulations, it will now include Basic + DA + additional allowances. This indicates that as your salary base grows, your gratuity will also grow.
However, the issue is that tax exemption still applies based on the old calculation of Basic + DA. Therefore, while you will receive a larger gratuity, you might also incur tax liabilities.For instance, if you receive gratuity of Rs 10 lakh based on the old calculation and Rs 15 lakh based on the new calculation, the Rs 10 lakh gratuity will be entirely tax-free, whereas the Rs 15 lakh gratuity will have Rs 5 lakh subject to tax.Seek expert advice on these regulations.
As per O.P. Yadav, former Principal Commissioner of Income Tax, under the previous Payment of Gratuity Act, 1972, gratuity was determined solely by basic pay and dearness allowance (DA). This narrow definition allowed employers to structure salaries in a way that kept basic pay low while providing more in allowances like house rent allowance (HRA), bonuses, and special allowances. As a result, the salary base for gratuity calculations remained limited, effectively minimizing the employer’s liability.
The new Labor Code alters this scenario. Although the gratuity calculation remains at 15 days’ salary for each completed year of service, the definition of salary has been broadened significantly. It now encompasses basic pay, DA, and retaining allowance, along with a specific 50% rule. If allowances surpass 50% of the total salary, the excess must be added back to the salary, thereby increasing the base for gratuity calculations. This means your gratuity will rise.Gratuity PaymentsThis change is expected to significantly increase gratuity payments, especially for employees whose salary is largely allocated to allowances.
Sectors such as IT, financial services, and corporate roles, where flexible compensation designs are common, are likely to see the greatest impact. With long-term work, even a small increase in the salary base can significantly increase retirement benefits.However, tax rules have not yet been updated to reflect this change. While the old rules allowed a gratuity exemption of up to Rs 20 lakh, income-tax rules still calculate the exemption based only on basic pay and DA. This creates a tax-related conflict between labor law and tax law. Yadav said there’s a mismatch between how gratuity is calculated under the Social Security Code and how it’s taxed under current income-tax rules. This could result in employees receiving higher gratuity on paper, but incurring a sudden higher tax burden.