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.
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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 \u20b920 lakh for the relevant non-government employee categories.
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What is Gratuity?
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Gratuity is a lump-sum amount generally paid by an employer when an employee leaves employment after completing the prescribed period of service.
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It may become payable on:
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Retirement
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Resignation
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Termination
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Superannuation
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Death of the employee
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Incapacity due to accident or illness
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The exact eligibility for gratuity is governed by the applicable employment law, including the Payment of Gratuity Act, 1972 where applicable.
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Section 10(10) \u2013 Gratuity Exemption
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Section 10(10) provides tax exemption for qualifying gratuity receipts. The applicable exemption depends upon the employee’s category.
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For private employees, there are two important situations:
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Employee covered by the Payment of Gratuity Act, 1972
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Employee not covered by the Payment of Gratuity Act, 1972
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1. Private Employee Covered by the Payment of Gratuity Act
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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:
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Gratuity actually received
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\u20b920,00,000
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Amount calculated according to the prescribed gratuity formula
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The Income Tax Department confirms the \u20b920 lakh ceiling for this category.
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Formula
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For employees covered by the Payment of Gratuity Act:
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15\/26 \u00d7 Last Drawn Salary \u00d7 Completed Years of Service
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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.
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A part of a year exceeding six months is generally treated as a completed year for this calculation.
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Example
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Suppose Mr. A is a private employee covered under the Payment of Gratuity Act and has:
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Last drawn salary for gratuity purposes: \u20b980,000 per month
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Service: 15 years and 8 months
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Gratuity received: \u20b910,00,000
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Completed years for calculation = 16 years.
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Gratuity as per formula:
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\u20b980,000 \u00d7 15\/26 \u00d7 16
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= \u20b97,38,462 approximately
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The exemption would be the least of:
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Actual gratuity: \u20b910,00,000
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Statutory ceiling: \u20b920,00,000
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Formula amount: approximately \u20b97,38,462
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Therefore, the exempt amount would be approximately \u20b97,38,462, subject to the applicable facts.
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2. Private Employee Not Covered by the Payment of Gratuity Act
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For a private employee who is not covered by the Payment of Gratuity Act, Section 10(10)(iii) applies.
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The exemption is the least of:
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Gratuity actually received
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\u20b920,00,000
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\u00bd \u00d7 Average Salary \u00d7 Completed Years of Service
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The average salary is generally calculated based on the average salary of the 10 months immediately preceding the month of retirement.
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Example
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Suppose:
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Average salary for the relevant 10-month period: \u20b960,000
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Completed years of service: 12 years
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Gratuity received: \u20b98,00,000
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Formula:
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\u00bd \u00d7 \u20b960,000 \u00d7 12
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= \u20b93,60,000
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The exemption would therefore be the least of:
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\u20b98,00,000 actual gratuity
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\u20b920,00,000 statutory ceiling
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\u20b93,60,000 calculated amount
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Therefore, \u20b93,60,000 would be exempt, subject to the applicable conditions.
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Gratuity Taxability \u2013 Quick Comparison
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Particulars\tCovered by Gratuity Act\tNot Covered by Gratuity Act
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Relevant provision\tSection 10(10)(ii)\tSection 10(10)(iii)
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Maximum statutory limit\t\u20b920 lakh\t\u20b920 lakh
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Calculation basis\t15\/26 \u00d7 Last Salary \u00d7 Completed Years\t\u00bd \u00d7 Average Salary \u00d7 Completed Years
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Salary basis\tLast drawn salary\tAverage salary of preceding 10 months
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Actual gratuity\tConsidered\tConsidered
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Exemption\tLeast of prescribed amounts\tLeast of prescribed amounts
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Is the \u20b920 Lakh Gratuity Limit Applicable to All Private Employees?
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The \u20b920 lakh limit is important, but it does not mean that every private employee receiving up to \u20b920 lakh of gratuity automatically gets a \u20b920 lakh exemption.
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The exemption is subject to the applicable formula and the amount actually received.
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For example, if the formula-based exemption is \u20b98 lakh and the employee receives \u20b915 lakh, the exemption may be limited to \u20b98 lakh.
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Therefore, the correct approach is to calculate all applicable limits and take the lowest amount.
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What Happens if Gratuity Exceeds the Exemption Limit?
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The portion of gratuity that does not qualify for exemption under Section 10(10) is generally taxable as salary income.
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Example
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Suppose:
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Gratuity received: \u20b925 lakh
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Eligible exemption: \u20b920 lakh
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Then:
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Exempt gratuity: \u20b920 lakh
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Taxable gratuity: \u20b95 lakh
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The taxable portion is included in the employee’s taxable salary income and taxed according to the applicable tax provisions.
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Gratuity Received on Death
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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.
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The calculation and exemption conditions depend on whether the employee was covered by the Payment of Gratuity Act.
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What About Government Employees?
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Government employees are treated differently.
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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.
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This article is primarily focused on private-sector employees.
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Gratuity and Income Tax Return Filing
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When filing an Income Tax Return, gratuity should be correctly classified between:
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Exempt gratuity under Section 10(10)
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Taxable gratuity, if any
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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 \u20b920 lakh.
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Employees should therefore reconcile:
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Form 16
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Gratuity calculation provided by employer
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Salary records
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Actual gratuity received
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ITR reporting
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Important Points to Remember
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The \u20b920 lakh limit is a maximum statutory ceiling, not an automatic exemption.
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The actual exemption depends on the applicable formula.
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Employees covered by the Payment of Gratuity Act use a different calculation from employees who are not covered.
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For employees covered by the Act, 15\/26 of last drawn salary is generally used.
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For employees not covered by the Act, half-month’s average salary based on the preceding 10 months is generally used.
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The portion exceeding the eligible exemption can be taxable.
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Previous gratuity exemptions and gratuity received from multiple employers can affect the available exemption in certain circumstances.
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Conclusion
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Gratuity can provide a significant tax benefit to private-sector employees at the time of retirement or separation. However, the \u20b920 lakh exemption limit under Section 10(10) should not be interpreted as an automatic tax-free limit.
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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.<\/p>\n","protected":false},"excerpt":{"rendered":"
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