In a move thats likely to benefit the salaried, the labour ministry is mulling a proposal to virtually treble the ceiling on tax-free gratuity to Rs 10 lakh from Rs 3.5 lakh now.

The ministry has sought comments from workers and employers, and a decision would be taken after considering the views of both sides. If the proposal is cleared, the ministry would urge the finance ministry to hike the tax-free gratuity limit to Rs 10 lakh, government sources said.

Though the ceiling on gratuity is Rs 3.5 lakh, nothing prevents employers from doling out more. However, income-tax authorities demand tax if a private or PSU employer exceeds this ceiling. If an employee is entitled to a lesser amount and his/her employer decides to give Rs 3.5 lakh, tax has to be paid on the difference. In the case of government employees, however, no tax is levied even if the ceiling is exceeded.

While varying interpretations bring in an element of anomaly, the Gratuity Act, 1972, provides that for every completed year of service the employer shall pay gratuity to an employee at the rate of 15 days wages, based on the basic salary last drawn.

The Act also provides that the amount of gratuity payable shall not exceed Rs 3.5 lakh. There is, however, no restriction on an employee negotiating a better gratuity term with the employer. Some companies, in fact, grant a months salary for every completed year after 14 years of service.

The move to hike the gratuity ceiling would, therefore, clear the confusion over the tax-free limit, besides allowing employees to benefit from higher gratuity. Many employers refuse gratuity over Rs 3.5 lakh even if the actual amount worked out by the formula mentioned in the Act is higher.

Any amount in excess of 15 days last-drawn salary for every year of service or Rs 3.5 lakh is added to the employees salary and taxed in the year he receives it. Effectively, this means a cap of Rs 3.5 lakh on tax-free gratuity.

Raising the ceiling on tax-free gratuity benefits non-government employees with high salaries. Gratuity was not rising in line with inflation. Keeping in mind high inflation, this can be a good step, said Gautam Kakkar, business leader at Mercers retirement practice in India.

The higher limit should also help employers retain talent, as high gratuity would deter employees from switching jobs quickly. The modification will encourage employees to stay longer in an organisation, and accumulate hefty gratuity, said Arun Mahapatra, managing partner (in charge of India) at Heidrick and Struggles. This change could become a good retention tool. Employers would welcome the move because it gives a big incentive to workers to stay on, he added.

The move will help the retirement plans of employees by hiking the tax-free lump sum component. This is particularly important now as the employees provident fund organisation (EPFO) recently scrapped the freedom provided to subscribers to withdraw one-third of their pension corpus at the time of retirement.