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Monday, March 13, 2017

Is it time to discard 'minimum five years of service' gratuity rule?

Recently, the central government decided to increase the gratuity limits for private sector employees as well from Rs 10 lakh to Rs 20 lakh. This is a welcome step and follows the same principle applied to the central government employees whose gratuity limit was increased to Rs 20 lakh in July 2016. To implement these changes, the government will amend both the Payment of Gratuity Act and the Income Tax Act. This is because the gratuity received (i.e. computed as per the Payment of Gratuity Act) is tax free. 

This is a welcome step, but the government needs to liberalise the gratuity rules further. First, the rule about 'minimum five years of service', set a long time ago, needs to be discarded because labour mobility is quite high these days. Since very few employees stick with a company for five years, this needs to be brought down to at least three years. 

There is another reason this reduction is needed: since most companies follow cost-to-the-company (CTC) rules, gratuity is already part of the salary package. That means an employee, who leaves service before completing 5 years, is actually forced to give up a part of his or her salary. There may be some benevolent companies that pay gratuity as a taxable component at the time of final settlement, but most companies keep it to themselves. 

Although the gratuity rules of central government and private sector employees are aligned to this move, state government employees are still left out. There are several state governments that still continue with the Rs 10 lakh restrictions on gratuity . Hope they also increase this limit to Rs 20 lakh at the earliest. 

Third, ad-hoc increases in limits, such as the recent one, create problems for employees who retire just before these hikes kick in. For example, consider an employee who retired in 2016 and got a gratuity of Rs 18 lakh (i.e. Rs 10 lakh tax free and Rs 8 lakh taxable) with another employee who retired in 2017 and got a gratuity of Rs 18 lakh (i.e. entire Rs 18 lakh tax free). To make these things equal to all, the government need to revise these limits annually and this can be based on the inflation data published by the government. 

Finally, this arbitrary ceiling on gratuity (at Rs 20 lakh) is not needed because gratuity is calculated based on a well laid-out formula. As per the Payment of Gratuity Act, employees are eligible to get 15 days salary for each completed years of service. Gratuity is computed using the formula ­ last drawn salary×15/26×number of years of service. Please note that only basic and dearness allowance (DA) is considered as salary here. Since there are only 26 working days a month, the same is used instead of 30 days for calculations. 

Now assume that an employee's gratuity value comes to Rs 23 lakh.Here again, some benevolent companies may pay this gratuity as a taxable component (i.e. Rs 20 lakh as tax free and Rs 3 lakh as taxable), but other companies may keep it to themselves. To avoid such situations, the government should remove ceiling from the Payment of Gratuity Act. And if the government wants to restrict tax benefit on gratuity (i.e. to avoid misuse of this provision), it can retain the restrictions under the Income Tax Act.
Source : The Economic Times

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