Usually, you file your income tax returns only once a year, there are many types of ITR and a host of taxes you continue to pay through the year. In India, the taxation structure is divided into:
- Direct taxes: This category includes taxes that are levied on the income earned by individuals and profits generated by corporates. The onus of depositing these taxes lies on the assesses. This means that individuals and corporates need to file for these themselves.
- Indirect taxes: This category comprises taxes that are levied on the sale of goods and services. The onus of paying these taxes lies on the sellers. This means that you may be paying the tax when you purchase a product, but you don’t need to file the returns.
If you are a salaried individual, you may pay advance tax or pay tax while filing your returns. The income tax you pay every year falls under direct taxes. However, there are more taxes that are included in this category.
Taxation on Gratuity, Pension and Retirement Compensation
Through your working life, you continue to pay taxes on the income you earn. However, what about your retirement? When you complete your services and retire from employment, you may receive some benefits like gratuity, pension, and retirement compensation. It is important to understand the taxation on them, so you can maximise your savings and enjoy your golden years peacefully.
What is Gratuity?
When you retire from a company, you may receive a lump sum amount as appreciation for your hard work and loyalty. This payment is known as gratuity. The computation of gratuity, eligibility criteria and other legalities around this payment are governed by the Payment of Gratuity Act, 1972. The maximum amount of gratuity is fixed at ₹20 lakhs. This means that the maximum amount a company can give to any employee as gratuity is ₹20 lakhs . Any amount received above this will be treated as ex-gratia.
How is Gratuity Taxed in India?
If you are a government employee or employed by a local authority, the gratuity that you receive is fully exempted. This means that you do not need to pay any taxes on gratuity.
However, if you are working in the private sector, the gratuity you receive on retirement may be fully exempt from tax only in certain cases.
The Payment of Gratuity Act states that among the following three amounts whichever is less will be exempt from tax:
- Actual lumpsum is given by the company as gratuity
- The amount calculated based on 15 days’ salary for every year of completed service or part thereof, in case it is over 6 months
- Amount of ₹20 lakhs
You can use an income tax calculator to know the exact amount of tax exempt.
What is Pension?
Rather than paying you a lumpsum, your employer may choose to pay a small amount on a monthly basis, after you retire. This amount is known as pension and is paid every month as long as you live.
How is Pension Taxed in India?
The pension you receive every month is exempted from tax if you are:
- A government employee
- Employed by a local authority or a statutory corporation
- A judge in the Supreme Court or High Court
- Employed by the United Nations
- A Gallantry Award winner
The family pension given to the widows and children of military personnel who have sacrificed their lives in the line of duty is also exempt from tax.
If you are employed in the private sector, the tax payable on the pension will depend on whether it is commuted and uncommuted pension. Half your commuted pension is exempted from tax. However, this is only in the case when you have not received any gratuity from the company. In case you have received gratuity, then only one-third of your pension is exempted from tax. The amount of the pension above the exempted limit is subject to tax. Check the relief you can seek under Section 89 of the Income Tax Act. You can also use an income tax calculator to get an estimate of the taxable amount.
What is Retirement Compensation?
Compensation may be given to employees on voluntary retirement from a company or on separation from a local authority or university mentioned in Section 10(10C). Compensation may also be given by cooperative societies. Such compensation, to a maximum of ₹5 lakhs, is exempt from tax.
To claim the exemption, the compensation must adhere to Rule 2BA of the Income Tax Rules. It says that:
- The employee needs to have worked at the organization for at least 10 years or should be more than 40 years of age.
- The scheme has been created to downsize the organisation (letting go employees without replacing them).
- The employee should not be hired by the same management
- The amount given does not exceed the employee’s salary of three months for every year completed in service or the monthly payments on retirement multiplied by the months of service left.
It is important to understand the types of ITR and the taxation for gratuity, pension, and retirement compensation, to file our returns correctly.