Question 2 OR (b)

Taxable leave encashment and gratuity on retirement (as set, 1961 Act, AY 2017-18)

7 marks

Time to write
About 14 minutes

From an older CBCS paper

Question

Question 2 OR (b) · 7 marks

X retired on 1st October 2016, having completed 26 years and 9 months of service, and received the following retirement benefits:

  1. Encashment of leave salary of Rs. 4,69,200 for 306 days of unavailed leave (He was entitled to leave of 35 days for every completed year of service, with no entitlement for a part of a year)

  2. Gratuity under Payment of Gratuity Act 1972, amounting to Rs. 9,42,000. His remuneration before retirement included:

  1. Basic salary of Rs. 40,000 p.m.

  2. Dearness allowance of 25% of salary (60% part of retirement benefits)

  3. Bonus of Rs. 5,000 p.m.

  4. Commission of Rs. 3,000 p.m.

Compute the amount of retirement benefits that is taxable, i.e. leave salary and gratuity.

Paper note: The as-set version: set and answered under the Income-tax Act, 1961 for assessment year 2017-18 (previous year 2016-17), with the dates as printed. The question does not say whether X was a government or a non-government employee (which decides the exemption for the leave encashment); the gratuity is stated to be under the Payment of Gratuity Act, 1972. The leave encashment of Rs. 4,69,200 for 306 days is as printed. This note only records what the question leaves out.

Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

14 minfor 7 marks

Read from the question

  • ComputeHead by head: each income under its head, exempt items marked exempt, then the deductions and the tax.

Write it in this order

  1. Read the data; note exactly what is asked 1 min
  2. 1 Average salary and leave at credit 1½ marks 2 min
  3. 2 Leave encashment exempt and taxable 2 marks 3 min
  4. 3 Gratuity exempt and taxable 3 marks 5 min
  5. 4 Total taxable ½ mark 2 min
  6. Check: arithmetic, units (₹, %), final answer underlined 1 min

Try it first. About 14 minutes for 7 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

Assumptions

  1. X is a non-government employee (his gratuity is paid under the Payment of Gratuity Act, 1972, which points to a private employer); the other case is given at the end.
  2. His pay was the same in each of the ten months before retirement, and the commission is a fixed monthly amount, not a percentage of turnover.
  3. He took leave only out of his entitlement of 35 days for each completed year, so the leave he availed is his total entitlement less the 306 days encashed.

(i) Leave encashment (section 10(10AA)(ii))

Average monthly salary for the ten months before retirement: basic ₹40,000 + the part of dearness allowance that counts for retirement benefits, 60% of ₹10,000 = ₹6,000; total ₹46,000. Bonus and the fixed commission are not salary for this purpose (section 10(10), Explanation, read with rule 2(h) of Part A of the Fourth Schedule: salary includes dearness allowance only where the terms of employment so provide and excludes other allowances and perquisites).

Leave at his credit on the basis of 30 days for each year of actual service (section 10(10AA), Explanation): completed years 26; entitlement at 30 days = 780 days; leave availed = 26 × 35 − 306 = 604 days; leave at credit = 780 − 604 = 176 days.

Exempt: the least ofRs.
(a) Amount received4,69,200
(b) Ten months' average salary (₹46,000 × 10)4,60,000
(c) Cash equivalent of 176 days' leave at credit (₹46,000 × 176 / 30)2,69,867
(d) Limit notified by the Central Government (CBDT Notification No. 123/2002 of 31 May 2002 (S.O. 588(E)): employees retiring after 1 April 1998)3,00,000
Exempt2,69,867

Taxable leave encashment = ₹4,69,200 − ₹2,69,867 = ₹1,99,333.

(ii) Gratuity (section 10(10)(ii): covered by the Payment of Gratuity Act, 1972)

Service of 26 years 9 months counts as 27 years, a part year above six months being a full year; salary is the last monthly basic pay and dearness allowance, ₹40,000 + ₹10,000 = ₹50,000 (Payment of Gratuity Act, 1972, section 4(2) and its Explanation; Payment of Gratuity Act, 1972, section 2(s): wages include dearness allowance).

Exempt: the least ofRs.
(a) Gratuity received9,42,000
(b) 15 days' salary for each year of service, on 26 working days a month: ₹50,000 × 15/26 × 277,78,846
(c) Ceiling under that Act for this year (Payment of Gratuity Act, 1972, section 4(3): ₹10,00,000 from 24 May 2010 to 28 March 2018, its footnotes)10,00,000
Exempt7,78,846

Taxable gratuity = ₹9,42,000 − ₹7,78,846 = ₹1,63,154.

Taxable retirement benefits

ParticularsRs.
Leave encashment taxable1,99,333
Gratuity taxable1,63,154
Taxable retirement benefits3,62,487

Both are taxed under the head Salaries (section 17(1)(iii) and (va)) for previous year 2016-17.

If the facts assumed are otherwise

If X was a Central or State Government employee, the whole leave encashment is exempt (section 10(10AA)(i)) and so is the whole gratuity, as one received under the Government's pension or service rules (section 10(10)(i)): nothing is taxable.

Where the 7 marks sit

#ComponentMarks
1Average salary and leave at credit1.5
2Leave encashment exempt and taxable2
3Gratuity exempt and taxable3
4Total taxable0.5
Total7
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