SECTION 10(10)1 l GRATUITY

65. Exemption of gratuity - Scope of clause (10) as it stood prior to amendments made by Finance Acts, 1972, 1974 and 1983

POINT No. 1 : What is the maximum amount of gratuity exempt from tax under section 10(10) ? - A gratuity covered by the latter half of section 10(10) will be exempt (i) insofar as it does not exceed one-half month’s salary for each year of completed service (calculated on the basis of the average salary for the three years immediately preceding the year in which the gratuity is paid); and (ii) insofar as it does not exceed Rs. 24,000 or 15 months’ salary so calculated, whichever is less. In essence, all the three limits, viz., half a month’s salary for each year of completed service, Rs. 24,000, and 15 months’ salary will operate as cumulative conditions and the exempt portion of the gratuity will be restricted to any of these three limits, whichever is the least.

POINT No. 2 : Is the gratuity received by an employee over and above the limit exempt from tax under section 10(10) entitled to relief under section 89(1) ? - Under the 1922 Act, the position was that no part of the gratuity received by the employees in the private sector (i.e., employees other than employees of the Central or a State Government, a local authority or a statutory corporation) was exempt but the gratuity was entitled to relief under section 60(2) in accordance with the instructions laid down in Board’s Circular No. 65 of 1951. Under the 1961 Act, a retirement (see Point No. 4) gratuity received by such employees will be exempt to the extent mentioned in the latter half of section 10(10) and the remaining amount of the gratuity [i.e., the full amount of the gratuity received by the employee less the part thereof which is exempt under section 10(10)] will be entitled to relief under section 89(1). Relief on this remaining amount of the gratuity may be given according to the procedure laid down in Board’s Circular No. 65 of 1951.

POINT No. 3 : Is it permissible for a gratuity fund to have a provision authorising a payment of gratuity to an employee after stipulated period of service even while the employee continues to be in service ? - In the case of gratuity funds approved for the purpose of the Income-tax Act, a provision authorising the payment of gratuity to an employee while he continues to remain in service should not be allowed. At the time of approving a gratuity fund, the Commissioners should ensure that the sole purpose of the fund is the provision of a gratuity to the employees (i) on their retirement at or after a specified age; or (ii) on their becoming incapacitated prior to such retirement; or (iii) on termination of their employment after a minimum period of service specified in the rules of the fund; or (iv) on the death of the employee, to his widow, children or dependants. This stipulation has been clearly provided for in the 1961 Act. Board’s Circular No. 70 of 1951 [see under section 37(1)] which dealt with the informal recognition of gratuity funds under the 1922 Act, also envisaged payment of gratuities under similar circumstances only, vide para 1 of the said Circular.

POINT No. 4 : If in terms of gratuity fund, the gratuity is paid to an employee while he continues to be in service, will such gratuity be exempt under section 10(10)? - The latter half of section 10(10) should be regarded as covering the case of only a gratuity payment on the employee’s retirement or on his becoming incapacitated or on termination of his employment or on his death. Any other gratuity such as that paid to an employee while he continues to remain in service (whether or not after he has put in a minimum specified period of service) should not be regarded as covered by the latter half of section 10(10). Such a gratuity may, therefore, be regarded as not exempt though it will be entitled to relief under section 89(1).

POINT Nos. 5 AND 6 : If in accordance with the rules of a gratuity fund, the gratuity is payable to a retiring employee in a number of annual instalments instead of in a lump sum, how is the tax to be assessed in view of section 10(10) ? - As a general rule, the rules of a fund which are approved for the purposes of Income-tax Act should not permit the payment of gratuity in the form of annuities payable over a specified number of years. If this were to be permitted, legal complications may arise. An attempt may be made to describe the annuities as “annuities certain” (as in the case of Bata Shoe Co.’s gratuity fund) in which case an argument may be taken that only the interest element contained in the annual payments will be taxable, the capital part of the annual instalments being exempt as return of capital. Even otherwise, the payment of the amount in question in annuities will result in reduction of tax liability, or, may be, total exemption depending on the amount of the annual payment and the other income of the assessee. As a general rule, therefore, the rules of approved gratuity funds should not permit payments in the form of annuities. The rules should make it clear that the gratuity is payable immediately on the employee’s retirement, incapacity, termination of service or death, as the case may be. This will ensure that the full amount becomes taxable [subject to any exemption available under section 10(10) or any relief available under section 89 in the very year in which the retirement, etc., takes place].

POINT No. 7: In order to claim exemption under section 10(10) is it necessary that the amount of gratuity should be calculated exactly on the basis laid down in that section, i.e., on the basis of one-half month’s salary for each year of completed service calculated on the basis of the average salary for the three years immediately preceding the year in which gratuity is paid? - Exemption under section 10(10) should not be denied only on the ground that the gratuity paid by the employer has been calculated on the basis of three weeks’ salary or one month’s salary for each year of the completed service. The exemption available under section 10(10) will, of course, be limited in the manner described in paragraph 2 above.

Letter : F. No. 1(79)/62-TPL, dated 13-12-1962.

66. Expressions “salary”1 and “year” as used in clause (10) as it stood prior to its substitution by Finance Act, 1974 - Interpretation of

CLARIFICATION 1

1. Reference is invited to the Board’s Circular No. 4-P(LVIII-22), dated 6-8-1964 [Clarification 2] on the above subject. Several representations have been received by the Board seeking clarification about the meaning of the term “salary” as used in section 10(10).

2. As was explained in that circular, salary would include only the periodical payments made to the employee by the employer as compensation for his services. Any payment made by the employer to the employee by way of allowances or perquisites, etc., is not to be taken into consideration as salary for the purposes of section 10(10). If, however, dearness allowance is merged with salary, it no longer remains dearness allowance but becomes salary and is then includible in the term “salaries” for the purposes of section 10(10).

Circular : No. 46 [F. No. 194/70-IT(A-I)], dated 14-9-1970.

CLARIFICATION 2

1. Clause (10) of section 10, inter alia, provides that the gratuity received by an employee from a private employer shall not be included in his total income to the extent the amount of such gratuity does not exceed one-half month’s salary for each year of completed service or 15 months’ salary or Rs. 24,000, whichever is the least. Under this clause, a month’s salary is to be calculated on basis of the average salary of the employee for three years immediately preceding the year in which the gratuity is paid.

This circular explains the import of the expressions “salary” and “year” used in the aforesaid clause.

2. The Income-tax Act does not contain a general definition of the word “salary”. The definition contained in section 17 is only for the purposes of sections 15, 16 and 17. Similarly, certain other provisions of the Income-tax Act, and the Rules [e.g., rule 2(h) of Part A of the Fourth Schedule to the Act and clause (2) of the Explanation to rule 3(b) of the Rules], contain a special definition of “salary” for specified purposes. These definitions are not relevant for the interpretation of the expression “salary” occurring in section 10(10). The said expression is also not defined in the General Clauses Act, 1897. Hence, the expression has to be given its ordinary natural meaning as understood in the English language. In this view of the matter, “salary” as contemplated by section 10(10) would include only the periodical payments made to the employee by the employer as compensation for his services. Any payments made by the employer to the employees by way of allowances, or perquisites or any payment in the nature of gratuity or bonus should not, therefore, be taken into consideration as “salary” for the purpose of the aforesaid provision.

3. The word “year” is not defined in the Income-tax Act and, therefore, its meaning has to be construed in accordance with its definition in section 3(66) of the General Clauses Act, 1897. According to the said definition, unless there is anything repugnant in the subject or context, “years” means a year reckoned according to the British calendar, i.e., the calendar year commencing from January 1 and ending on December 31. The word “year”, wherever it occurs in clause (10) of section 10 (except where it is used therein for the first time in the expression “year of completed service”), should therefore, be construed to mean each calendar year and not every period of twelve months reckoned from the date of the employee’s joining service with the employer. Thus, the expression “three years” in that clause refers to three calendar years immediately preceding the calendar year in which the gratuity is paid to the employee. However, the word “year” used in the clause for the first time in the expression “each year of completed service” is not used as simpliciter but in relation to the service rendered by the employee. In this context, the expression “each year of completed service” is to be construed to mean a period or periods of twelve months’ service rendered by the employee, reckoned from the date on which he joined service with his employer.

Circular : No. 4-P(LVIII-22) [F. No. 1(2)/63/TPL], dated 6-8-1964.

67. Whether the expression “termination of ... employment” used in clause (10) covers “resignation”

The expression “termination of ... employment” used in section 10(10), as amended by the Finance Act, 1972 [section 10(10)(iii) as substituted by the Finance Act, 1974], covers the case of any employee whose service comes to an end due to resignation.

Letter : F. No. 194/6/73-IT(A-I), dated 19-6-1973.

68. Exemption limit increased to Rs. 1,00,000 in terms of third proviso1 in relation to employees who retire, become incapacitated or die, etc., on or after 1-1-1986

In exercise of the powers conferred by the third proviso1 to clause (10) of section 10 of the Income-tax Act, 1961 (43 of 1961), the Central Government, having regard to the maximum amount which is for the time being exempt under sub-clause (i) of the said clause and in supersession of the order issued by the Notification No. GSR 537(E), dated 1st July, 1985, increases the limit of fifty thousand rupees to one lakh rupees for all the three purposes mentioned in the provisions of that clause in relation to the employees who retire or become incapacitated or die on or after 1st January, 1986, or whose employment is terminated on or after the said date.

Notification : No. SO 260, dated 18-9-1987.

69. Specification of exemption limit in relation to employees who retire or become incapacitated prior to such retirement or die, on or after 1-4-1988, or whose employment is terminated on or after 1-4-1988 under sub-clause (iii) of clause (10)

In exercise of the powers conferred by sub-clause (iii) of clause (10) of section 10 of the Income-tax Act, 1961 (43 of 1961), the Central Government, having regard to the maximum amount of any gratuity payable to its employees, hereby specifies one lakh rupees as the limit for all the three purposes mentioned in that sub-clause in relation to the employees, referred to therein, who retire or become incapacitated prior to such retirement or die on or after the 1st day of April, 1988 or whose employment is terminated on or after the said date.

Notification: No. GSR 405, dated 28-4-1988.

70. Exemption limit of Rs.1,00,000 raised to Rs. 2,50,000 in relation to employees who retire or become incapacitated prior to such retirement or die on or after 1-4-1995 or whose employment is terminated on or after 1-4-1995, under sub-clause (iii) of clause (10)

In exercise of the powers conferred by sub-clause (iii) of clause (10) of section 10 of the Income-tax Act, 1961 (43 of 1961), the Central Government, having regard to the maximum amount of any gratuity payable to its employees, hereby specifies two lakhs and fifty thousand rupees as the limit for all the three purposes mentioned in that sub-clause in relation to the employees, referred to therein, who retire or become incapaci-tated prior to such retirement or die on or after the 1st day of April, 1995 or whose employment is terminated on or after the said date.

Notification : No. SO 394, dated 1-2-1996.

71. Exemption limit raised from Rs. 2,50,000 to Rs. 3,50,000 in relation to employees who retire or become incapacitated prior to such retirement or die on or after 24-9-1997 or whose employment is terminated on or after 24-9-1997, under sub-clause (iii) of clause (10) of section 10

In exercise of the powers conferred by sub-clause (iii) of clause (10) of section 10 of the Income-tax Act, 1961 (43 of 1961), the Central Government, having regard to the maximum amount of any gratuity payable to its employees, hereby specifies three lakhs and fifty thousand rupees as the limit for the purposes of the said sub-clause in relation to the employees who retire or become incapacitated prior to such retirement or die on or after the 24th September, 1997 or whose employment is terminated on or after the said date.

Notification : No. 10772 [F. No. 200/77/97-IT(A-I)], dated 20-1-1999.