Gratuity ceiling doubled to Rs. 20 lakh: What does it mean for you?

October 2017
| India

By Kulin Patel, Head – Retirement (South Asia), Willis Towers Watson

As per the recommendations of the seventh Pay Commission, the Central Government increased the gratuity ceiling applicable to central government employees to INR 20 lakhs (INR 2 Million) in 2016. Earlier this week, the Cabinet approved a bill which proposes a similar amendment for non-Central Government employees. The bill is likely to be tabled in the next session of Parliament and will look to increase in the gratuity ceiling to the Payment of Gratuity Act (PG Act) itself. The current limit is INR 10 Lakhs (INR 1 Million) which has been in place since 2010. The higher limit will also apply to the tax free amount payable to an employee.

The date from which the new provisions will apply has not yet been finalised, but this date is likely to lie in late 2017 / early 2018. As in previous such updates, the increased limit would apply to gratuity already accrued to date as well as accrual in respect of future service.

Impact on employers / sponsors

Companies in India make provisions in their financial statements for the Gratuity obligation as per the relevant accounting standards (AS15 Revised or INDAS19, as applicable). However, not all companies’ financials will be affected by the change. An internal study by Willis Towers Watson in 2016 showed that about 40% companies already provide the benefit with no ceiling to their employees and would therefore not be affected by such a change, except being able to pay a higher tax-free benefit. About 55% of them provided gratuity purely in line with the PG Act and would be impacted. 

The remainder have chosen to provide a benefit calculated on a different basis altogether, and have the PG Act benefit effectively acting as a minimum. Any benefit paid out in excess of the PG Act would be taxable as income in the hands of the employee on receipt of the payment.

If an employer / sponsor may be impacted, they should consider the following:

  • If the gratuity arrangement currently applies a ceiling which is less than INR 20 Lakhs (all PG Act plans would also fall here), quickly assess the impact of the ceiling change on your accounts.
  • The extent of the impact will depend on how many people, and the extent to which employees are likely to be projected to go above the current 10Lakh limit by the time they leave or retire from the organization. If a company has no one likely to even reach 10lakh, then the new change will not impact them.
  • Ensure the company and the company’s gratuity Trust projects anticipated increase in cashflow requirements for higher projected payouts. This includes anticipated increase in contributions to a Trust (if applicable).
  • Even if your gratuity arrangements apply an overall cap of INR 20 Lakhs or higher, you may still wish to share the ‘good news’ with your employees as a higher amount of their gratuity benefit will attract tax relief.

Impact on active / ‘in service’ employees

Most employees who are part of their employers’ gratuity arrangement are set to gain from the amendment with the advantages coming in various forms:

  • The increase in limit applies to the overall gratuity payouts an individual receives over the working lifetime, which can now be higher.
  • If you have already received the full INR 10 Lakhs from our previous employers, you can accrue another INR 10 Lakhs as a tax-free gratuity benefit.
  • If your gratuity benefit has already breached INR 10 Lakh with current employer (see formula in footnote), you can now continue to accrue additional benefits up to a total limit of INR 20 Lakh tax-free.

The following table demonstrates the additional benefits an individual will receive via the amendment. For simplicity, the illustrations assume that all arrangements allow accrual as per PG Act.

Previous Gratuity Payments Received Current PG Act Proposed Amendment
Mr A Nil Current Benefit = INR 8L Can accrue an additional INR 2L (tax-free) Current Benefit = INR 8L Can accrue an additional INR 12L (tax-free)
Current Benefit = INR 4L Can accrue an additional INR 1L (tax-free) and another INR 5L subject to marginal tax rate Current Benefit = INR 4L Can accrue an additional INR 11L (tax-free) and another INR 5L subject to marginal tax rate
Current Benefit = INR 10L Cannot accrue further benefits Will receive INR 5L (tax-free) and marginal tax rate will apply on the other 5L Current Benefit = INR 10L Can accrue an additional INR 10L of which 5L (tax-free) and marginal tax rate will apply on the other 5L

This article should not be relied upon as formal tax or legal advice.
*First published in Money Control