Not for job hoppers

With the government raising the gratuity limit, it makes sense to negotiate for a higher basic salary to ensure a better payout.

The Union cabinet’s decision to raise the tax-free gratuity limit from Rs 3.5 lakh to Rs 10 lakh is likely to become a tool for companies to retain employees.

In 2008, when the government implemented the Sixth Pay Commission for central government employees, it was with effect from 2006. This helped employees reap rich benefits. The decision to increase the limit for private sector employees brings them at par with government employees in terms of gratuity benefits.

However, employees wanting to take advantage of this decision need to be aware of a few things. One, salary negotiations will become critical as it makes sense to ask for a higher basic salary, especially if he is planning to stay with the company for long. Also, job-hoppers stand to lose money which is deducted from their salary under the gratuity head.

“To have a cost-optimum structure, the basic salary should be 40-50 per cent of the pay,” says Vikas Vasal, executive director, KPMG. This ensures that a person strikes a balance between the taxes he has to pay, his take-home salary, and exemptions and deductions available under the Income-Tax Act.

While negotiating for a new job, it is best if you ask for a higher basic pay. This will help you accumulate a good gratuity, or “accrued benefit,” as it is called. “After this announcement, employees should be more concerned with the basic salary than the cost to company, especially the middle class, for whom Rs 10 lakh is a significant sum,” said K Pandia Rajan, managing director, Ma Foi Randstad, citing the example of the US, where the basic salary is 70 per cent of the total.

In India, many employers keep the basic pay low, say tax experts. In such cases, employees should take a re-look at their basic salaries. If the basic salary as a percentage of the overall salary is low, the person should ask the employer to bring it to the 40-50 per cent level. “In small organisations, there is a scope for such negotiations,” said a tax expert. Knowing the method of gratuity calculation will clarify this point. The calculation is based on the current basic salary multiplied by the number of years, and further multiplied by 15/26.

If an employee with a basic monthly salary of Rs 20,000 has resigned after completing five years of service, he will get Rs 57,692 as gratuity. For someone who is retiring after 30 years and has a basic salary of Rs 60,000, the gratuity will be Rs 10,38,461. Of this, the person does not need to pay tax on Rs 10 lakh. The remaining Rs 38,461 will attract tax. The taxpayer needs to add the excess amount to his income to calculate his tax liability.

In future, an employee will be able to save tax on gratuity if he invests the amount in an annuity plan. “The draft of the Direct Tax Code has made a provision for such an investment,” said Vasal. In the Budget speech, the finance minister said the government was likely to implement the Direct Tax Code from April 1, 2011.

Any organisation with more than 10 employees needs to make provision for gratuity payouts according to the Payment of Gratuity Act, 1972. An employer makes this payment at the time of retirement, resignation, and death or disablement due to an accident or a disease.

In the private sector, only manufacturing companies have low employee churn. In other sectors, attrition rates are quite high.

Many feel that employees in the private sector do not give importance to gratuity as they rarely work in a company for long. “Young employees today look at cash-in-hand more than long-term benefits like gratuity,” said a human resource head of a large company.

To be eligible for gratuity, an employee needs to put in a substantial number of years in the job. While the Payment of Gratuity Act, 1972, pegs this at five years, many companies have set higher limits.