Income Tax Exemption on Gratuity

Gratuity is a benefit given by the employer to employees. A recently approved amendment by the Centre has increased the maximum limit of gratuity. Now it is tax exempt up to Rs 20 lakh from the previous ceiling of Rs 10 lakh, which comes under Section 10(10) of the Income Tax Act. The CBDT Notification No. S.O. 1213(E), dated 8 March 2019, clarified that the exemption limit of Rs 20 lakh would be applicable to employees in the event of retirement or death or resignation or disablement on or after 29 March 2018.

Let us understand the impact of this amendment in comparison with the previous provisions.

Understanding the Basics of Gratuity

Gratuity is a monetary benefit given by the employer, but not paid as part of the regular monthly salary. The provisions of gratuity are governed by the Payment of Gratuity Act, 1972, and it is given on the occurrence of any of the following events.

• On superannuation (means an employee who attains the age of retirement is said to be in superannuation)
• On retirement or resignation
• On death or disablement due to accident or disease (the time limit of 5 years shall not apply in the case of death or disablement of the employee) It is mandatory for the employee to have completed a minimum of five years in service to be able to receive gratuity. It is not available for interns or temporary employees.

Eligibility to Get Gratuity

The employer will pay gratuity when the employee satisfies the following conditions:

• The employee should be drawing wages as a full-time employee of an organisation. An apprentice is not eligible to receive gratuity. 
• The employee should be in continuous service for a minimum of 5 years.
• The employee can also get gratuity upon resignation, superannuation, disablement due to accident or disease, or death. The condition of 5 years is not applicable in the case of disablement or death. 

Employees Covered Under the Payment of Gratuity Act

Every individual – working in a factory, mine, oil field, port, railways, plantation, shops & establishments, or educational institution having 10 or more employees on any day in the preceding 12 months – is entitled to gratuity. 

Once the Act becomes applicable to an employer, even if the number of employees goes below 10, gratuity is still applicable.

Calculation of the amount of gratuity exempted from tax

The least of the following is exempt from tax:

• Last salary (basic + DA)* number of years of employment* 15/26;
• Rs. 20 lakhs (which has been hiked from Rs. 10 Lakh as per the amendment);
• Gratuity actually received

Let us understand this through an illustration: The last salary drawn by Rohan is Rs.1 Lakh per month (basic + DA). He is entitled to receive a gratuity of Rs. 11 Lakhs. He has been in employment for the last 19 years and 7 months.

Points to note:

• 15 days salary based on the salary last drawn for every completed year of service or part thereof i.e. 15/26.
• Number of years in service is rounded off to the nearest full year.

Employees Not Covered Under the Payment of Gratuity Act

There is no law that restricts an employer from paying gratuity to his employees, even if the organization is not covered under the Payment of Gratuity Act. The amount of gratuity payable to the employee can be calculated based on half month’s salary for each completed year.

Calculation of amount of gratuity exempted from tax 

The least of the following are exempt from tax:

• Last 10 month’s average salary (basic + DA)* number of years of employment* 1/2;
• Rs. 20 lakhs (the exemption is enhanced from Rs. 10 lakhs to Rs.20 Lakhs even for employees not covered under the Payment of Gratuity Act w.e.f. 29.3.2018)
• Gratuity actually received

Gratuity exemption for such employees would be computed as follows: 

Raghav has been in employment for 25 years and 2 months. The average salary for the last 10 months is Rs. 90,000. The actual gratuity received by him is Rs. 11 Lakhs.

Points to note:

• An average salary of previous 10 months is considered
• Number of years in service is rounded off to the nearest full year

Government Employees

Gratuity paid by the government to government employees is fully exempt from tax.

Impact of the Amendment

The impact of the amendment is evident from the example. A hike in the ceiling limit of maximum exemption helps reduce the taxable gratuity amount. This amendment is going to benefit those earning higher salaries in the short run. However, if you have a long time left before your retirement, this amendment will benefit most employees.

Exemptions on Gratuity

The income tax exemptions on gratuity can be categorised as follows: 

Exemptions on gratuity received by government sector employees

The gratuity given to employees working in a government sector upon their termination, retirement or superannuation are fully exempted from paying tax. It is applicable to employees of the central government, state government, defense sector, members of civil services and other local authorities. 

Exemptions on gratuity received by private sector employees

The income tax exemption on gratuity given to employees working in the private sector depends on whether they are covered under the Payment of Gratuity Act or not. 

When private sector employees are covered under the Act

The income tax exemption on gratuity received is the least of the following three:

• Gratuity amount of Rs 20 lakhs 
• Last 15 days salary (consider no.of days in a month to be 26) x number of years of employment 
• Actual gratuity received

When private sector employees are not covered under the Act

The income tax exemption on gratuity received is the least of the following three:

• Actual gratuity received
• Gratuity of Rs 20 lakhs
• Last 10 months average salary x number of years of employment x 1/2

For calculating gratuity use our calculator:

• Gratuity Calculator