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Gratuity is a benefit given by the employer to the employee. A recently approved amendment by the Centre has increased the maximum limit of gratuity, to be exempted from tax to Rs. 20 Lakhs from the existing ceiling of Rs. 10 Lakhs. This will be applicable to the private sector and public sector employees. Calculations for exemption of gratuity under the Income Tax Act is covered under section 10(10).
Through this article, we intend to help you understand the impact of this amendment in comparison with the previous provisions.

  1. Understanding the Basics of Gratuity
  2. Employees Covered Under the Payment of Gratuity Act
  3. Employees Not Covered Under the Payment of Gratuity Act
  4. Government Employees
  5. Impact of the Amendment

Income Tax Gratuity

1. Understanding the Basics of Gratuity

Gratuity is a monetary benefit given by the employer to his employee on the occurrence of any of the following events:

a. On superannuation (means an employee who attains the age of retirement is said to be in superannuation)

b. On retirement or resignation

c. 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 minimum of five years in service to be able to receive gratuity. It is not applicable to interns or temporary employees. Gratuity is not paid as part of your regular monthly salary; it is only payable on the occurrence of any of the above events. The provisions of gratuity are governed by the Payment of Gratuity Act, 1972.

2. Employees Covered Under the Payment of Gratuity Act

Every person 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 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 impact 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.

Sr. No. Particulars Previously As Amended
1 Last drawn salary (Basic + DA) 1 lakh 1 lakh
Number of years of employment 20 (will be rounded off) 20 (will be rounded off)
Gratuity 1,00,000*20*15/26 = 11,53,846 1,00,000*20*15/26 = 11,53,846
2 Maximum exemption allowed 10 lakhs 20 lakhs (as amended)
3 Gratuity actually received 11 lakh 11 lakh
Amount of exemption (least of the above) 10 lakh 11 lakh
Taxable gratuity 1 lakh


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.

3. 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. 10 lakhs (the hike to Rs 20 lakhs is not applicable for employees not covered under the Payment of Gratuity Act)
    • 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.

Sr. No. Particulars Amount (Rs.)
1 Average of last 10 month’s salary 90,000
Number of years of employment 25 (will be rounded off)
Gratuity 90,000*25*1/2 = 11,25,000
2 Maximum exemption allowed 10 lakhs
3 Gratuity actually received 11 Lakhs
Amount of exemption (least of the three) 10 Lakhs
Taxable Gratuity 1 Lakh

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

4. Government Employees

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

5. 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.

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