Gratuity, Pension Tax Rules and Residential Status in India

Q. 4. Give a Detailed Note on the Following

(i) Gratuity

Gratuity is a monetary benefit paid by an employer to an employee in recognition of past service. It is generally paid at the time of retirement, resignation, death, or termination, provided the employee has completed a specified number of years of service.

The taxability of gratuity under Section 10(10) of the Income Tax Act depends on the type of employee:

A. Government Employees (Central / State / Local Authority)

• Gratuity received by a government employee is fully exempt from tax.

B. Non-Government Employees

For non-government employees, the tax treatment depends on whether the employer is covered under the Payment of Gratuity Act, 1972.

Taxable amount: (Actual gratuity received) – (Exempt amount)

Note: For Category II, ‘salary’ includes Basic Salary and Dearness Allowance (DA) if the terms of employment so provide for retirement benefits. ‘Completed years of service’ ignores any fraction of a year.

(ii) Pension

Pension is a periodic payment received by an employee after retirement for services rendered. The taxability of pension depends on whether it is commuted (lump sum) or uncommuted (periodic).

A. Uncommuted Pension (Periodic Pension)

This is the regular monthly or periodic payment received by the pensioner.

• Government Employees: Fully taxable under the head ‘Salaries’.
• Non-Government Employees: Fully taxable under the head ‘Salaries’.

B. Commuted Pension (Lump Sum Pension)

This is the lump sum amount received by an employee by surrendering a portion or the whole of their future uncommuted pension. The tax treatment depends on the type of employee:

Total commuted pension value: This is calculated by grossing up the amount received to 100%.

Q. 5. What Do You Mean by Residential Status?

Meaning of Residential Status

Residential status is a fundamental concept under the Income Tax Act, 1961. It determines the scope of an individual’s total income that will be subject to tax in India. It is a status derived solely for tax purposes and is not the same as citizenship, domicile, or nationality.

• An individual’s residential status must be determined for each financial year (Previous Year) because it can change from year to year.
• The status determines whether an individual’s global income (income earned both in India and abroad) or only their Indian income will be taxed in India.

Categories of Residential Status for an Individual

For any Previous Year, an individual can fall into one of the following categories:

• Resident (R)
• Resident and Ordinarily Resident (ROR)
• Resident but Not Ordinarily Resident (RNOR)
• Non-Resident (NR)

Provisions to Determine Residential Status of an Individual (Section 6)

The determination involves a two-step process: first, checking for Residency (R or NR), and second, checking for Ordinary Residency (ROR or RNOR).

Step 1: Determining Resident (R) or Non-Resident (NR)

An individual is considered a Resident (R) in a Previous Year if they satisfy at least one of the two basic conditions:

• If an individual satisfies at least one of these conditions, they are a Resident (R).
• If an individual satisfies neither of these conditions, they are a Non-Resident (NR).

Exceptions to Basic Condition 2

The 60-day limit in Basic Condition 2 is extended to 182 days for the following Indian citizens/persons of Indian origin:

• An Indian citizen who leaves India during the Previous Year for the purpose of employment outside India.
• An Indian citizen who leaves India during the Previous Year as a member of the crew of an Indian ship.
• An Indian citizen or a person of Indian origin engaged in a visit to India during the Previous Year.

Step 2: Determining Ordinarily Resident (ROR) or Not Ordinarily Resident (RNOR)

This step applies only to those who qualify as a Resident (R) under Step 1. A Resident is classified as Resident and Ordinarily Resident (ROR) if they satisfy both the additional conditions:

• If a Resident satisfies both additional conditions, they are Resident and Ordinarily Resident (ROR).
• If a Resident satisfies only one or neither of the additional conditions, they are Resident but Not Ordinarily Resident (RNOR).

Would you like me to explain the incidence of tax for each of these residential statuses (ROR, RNOR, and NR)?

Q. 2. Income Tax Is Charged on the Previous Year Income. Do You Agree?

Agreement: Yes. The fundamental rule is that income earned in the Previous Year (P.Y.) is taxed in the next financial year, the Assessment Year (A.Y.).

Exceptions (P.Y. Income Taxed in the P.Y. Itself)

• Income of non-residents from shipping business.
• Income of persons leaving India (with no intention to return).
• Income of bodies / AOP / BOI formed for short duration.
• Income of persons transferring assets to avoid tax.
• Income from discontinued business or profession (at the discretion of the Assessing Officer).

Q. 3. Write a Short Note on the Following

(i) Tax Planning, Tax Avoidance, Tax Evasion

(ii) Role of PAN & Aadhaar Number in Income Tax

• PAN (Permanent Account Number): A unique 10-character alphanumeric ID essential for filing ITR, tracing major financial transactions, and proper deduction of TDS/TCS.
• Aadhaar Number: A 12-digit unique ID that is mandatory to link with PAN (Section 139AA). It is required for filing ITR and facilitates e-verification of tax returns.

Q. 4. Give a Detailed Note on the Following (Repeat)

(i) Gratuity (Section 10(10))

• Government Employees: Fully exempt from tax.
• Non-Government Employees: The amount exempt is the least of the following three:
  1. Actual gratuity received.
  2. Statutory limit (currently ₹20,00,000).
  3. A calculated amount based on salary and years of service (15 days’ wages for covered employees; 1/2 month’s average salary for others).

(ii) Pension (Section 10(10A))

• Uncommuted (Monthly) Pension: Fully taxable under the head ‘Salaries’ for all employees.
• Commuted (Lump Sum) Pension:
  • Government employees: Fully exempt.
  • Non-government employees: Exempt up to:
    • 1/3 of the full commuted value if gratuity is also received.
    • 1/2 of the full commuted value if gratuity is not received.

Q. 5. Residential Status: Provisions and Categories (Repeat)

Meaning of Residential Status

It is a tax concept determined every financial year to ascertain the scope of an individual’s taxable income in India. It is not the same as citizenship.

Categories of Assessees (Individual)

• Resident and Ordinarily Resident (ROR)
• Resident but Not Ordinarily Resident (RNOR)
• Non-Resident (NR)

Provisions to Determine Status (Two Steps)

Step 1: Resident (R) or Non-Resident (NR)

An individual is a Resident (R) if they satisfy at least one of the two basic conditions:

• Stay in India in the P.Y. is 182 days or more; OR
• Stay in India in the P.Y. is 60 days or more AND 365 days or more in the 4 preceding P.Y.s.

Step 2: ROR or RNOR (Applies only to Residents)

A Resident is an ROR if they satisfy both Additional Conditions:

• Resident in India for at least 2 out of 10 preceding P.Y.s; AND
• Stay in India for 730 days or more during the 7 preceding P.Y.s.

If the Resident satisfies only one or neither of the Additional Conditions, they are an RNOR.

Brief Account (Incidence of Tax)

• ROR: Taxable on global income (income from anywhere in the world).
• RNOR: Taxable on Indian income + foreign income if derived from a business controlled or a profession set up in India.
• NR: Taxable only on Indian income.