Income tax on gratuity for private employees — exemption limit under Section 10(10)
Gratuity is a retirement benefit paid by an employer to an employee in recognition of services rendered during employment. For private-sector employees, gratuity received on retirement, resignation, termination, or in certain cases of death or incapacity may qualify for tax exemption under Section 10(10) of the Income-tax Act, 1961, subject to specified conditions and limits.
The tax treatment depends primarily on whether the employee is covered by the Payment of Gratuity Act, 1972 or is not covered by it. The Income Tax Department currently specifies an exemption ceiling of ₹20 lakh for the relevant non-government employee categories.
What is Gratuity?
Gratuity is a lump-sum amount generally paid by an employer when an employee leaves employment after completing the prescribed period of service.
It may become payable on:
Retirement
Resignation
Termination
Superannuation
Death of the employee
Incapacity due to accident or illness
The exact eligibility for gratuity is governed by the applicable employment law, including the Payment of Gratuity Act, 1972 where applicable.
Section 10(10) – Gratuity Exemption
Section 10(10) provides tax exemption for qualifying gratuity receipts. The applicable exemption depends upon the employee’s category.
For private employees, there are two important situations:
Employee covered by the Payment of Gratuity Act, 1972
Employee not covered by the Payment of Gratuity Act, 1972
1. Private Employee Covered by the Payment of Gratuity Act
For an employee covered by the Payment of Gratuity Act, the exemption under Section 10(10)(ii) is the least of the following three amounts:
Gratuity actually received
₹20,00,000
Amount calculated according to the prescribed gratuity formula
The Income Tax Department confirms the ₹20 lakh ceiling for this category.
Formula
For employees covered by the Payment of Gratuity Act:
15/26 × Last Drawn Salary × Completed Years of Service
For this purpose, salary generally consists of last drawn basic salary plus dearness allowance, subject to the specific statutory rules. Bonus, commission, HRA, overtime and other allowances are generally excluded from the salary calculation.
A part of a year exceeding six months is generally treated as a completed year for this calculation.
Example
Suppose Mr. A is a private employee covered under the Payment of Gratuity Act and has:
Last drawn salary for gratuity purposes: ₹80,000 per month
Service: 15 years and 8 months
Gratuity received: ₹10,00,000
Completed years for calculation = 16 years.
Gratuity as per formula:
₹80,000 × 15/26 × 16
= ₹7,38,462 approximately
The exemption would be the least of:
Actual gratuity: ₹10,00,000
Statutory ceiling: ₹20,00,000
Formula amount: approximately ₹7,38,462
Therefore, the exempt amount would be approximately ₹7,38,462, subject to the applicable facts.
2. Private Employee Not Covered by the Payment of Gratuity Act
For a private employee who is not covered by the Payment of Gratuity Act, Section 10(10)(iii) applies.
The exemption is the least of:
Gratuity actually received
₹20,00,000
½ × Average Salary × Completed Years of Service
The average salary is generally calculated based on the average salary of the 10 months immediately preceding the month of retirement.
Example
Suppose:
Average salary for the relevant 10-month period: ₹60,000
Completed years of service: 12 years
Gratuity received: ₹8,00,000
Formula:
½ × ₹60,000 × 12
= ₹3,60,000
The exemption would therefore be the least of:
₹8,00,000 actual gratuity
₹20,00,000 statutory ceiling
₹3,60,000 calculated amount
Therefore, ₹3,60,000 would be exempt, subject to the applicable conditions.
Gratuity Taxability – Quick Comparison
Particulars Covered by Gratuity Act Not Covered by Gratuity Act
Relevant provision Section 10(10)(ii) Section 10(10)(iii)
Maximum statutory limit ₹20 lakh ₹20 lakh
Calculation basis 15/26 × Last Salary × Completed Years ½ × Average Salary × Completed Years
Salary basis Last drawn salary Average salary of preceding 10 months
Actual gratuity Considered Considered
Exemption Least of prescribed amounts Least of prescribed amounts
Is the ₹20 Lakh Gratuity Limit Applicable to All Private Employees?
The ₹20 lakh limit is important, but it does not mean that every private employee receiving up to ₹20 lakh of gratuity automatically gets a ₹20 lakh exemption.
The exemption is subject to the applicable formula and the amount actually received.
For example, if the formula-based exemption is ₹8 lakh and the employee receives ₹15 lakh, the exemption may be limited to ₹8 lakh.
Therefore, the correct approach is to calculate all applicable limits and take the lowest amount.
What Happens if Gratuity Exceeds the Exemption Limit?
The portion of gratuity that does not qualify for exemption under Section 10(10) is generally taxable as salary income.
Example
Suppose:
Gratuity received: ₹25 lakh
Eligible exemption: ₹20 lakh
Then:
Exempt gratuity: ₹20 lakh
Taxable gratuity: ₹5 lakh
The taxable portion is included in the employee’s taxable salary income and taxed according to the applicable tax provisions.
Gratuity Received on Death
Gratuity received by the widow, children, or dependants of a deceased employee can also qualify for exemption under Section 10(10), subject to the applicable provisions and limits.
The calculation and exemption conditions depend on whether the employee was covered by the Payment of Gratuity Act.
What About Government Employees?
Government employees are treated differently.
Gratuity received by eligible government employees covered under Section 10(10)(i) is generally fully exempt, unlike the prescribed limits applicable to private/non-government employees.
This article is primarily focused on private-sector employees.
Gratuity and Income Tax Return Filing
When filing an Income Tax Return, gratuity should be correctly classified between:
Exempt gratuity under Section 10(10)
Taxable gratuity, if any
The Income Tax Department’s current ITR validation rules specifically provide that the Section 10(10) exemption cannot exceed the gratuity income reported under salary and, for the relevant non-government categories, cannot exceed ₹20 lakh.
Employees should therefore reconcile:
Form 16
Gratuity calculation provided by employer
Salary records
Actual gratuity received
ITR reporting
Important Points to Remember
The ₹20 lakh limit is a maximum statutory ceiling, not an automatic exemption.
The actual exemption depends on the applicable formula.
Employees covered by the Payment of Gratuity Act use a different calculation from employees who are not covered.
For employees covered by the Act, 15/26 of last drawn salary is generally used.
For employees not covered by the Act, half-month’s average salary based on the preceding 10 months is generally used.
The portion exceeding the eligible exemption can be taxable.
Previous gratuity exemptions and gratuity received from multiple employers can affect the available exemption in certain circumstances.
Conclusion
Gratuity can provide a significant tax benefit to private-sector employees at the time of retirement or separation. However, the ₹20 lakh exemption limit under Section 10(10) should not be interpreted as an automatic tax-free limit.
The actual exemption is determined by comparing the gratuity received, the statutory ceiling, and the applicable formula based on the employee’s coverage under the Payment of Gratuity Act.
Navneet Kumar is a Senior Taxation professional in TAXAJ's Accounts & Taxation team. With over six years of industry experience, Navneet supports clients on tax compliance, filings and advisory. TAXAJ is a multi-disciplinary consulting firm spanning finance, taxation, legal, secretarial, FEMA and IPR, with offices in Delhi, Bihar, Bangalore and Goa.
View all posts by Navneet Kumar →