Gratuity Taxation: Exemptions and Limits Under Section 10(10)

Gratuity is a monetary benefit provided by employers to employees as a token of appreciation for their long-term service. Under the Income Tax Act, 1961, gratuity payments are partially or fully exempt from taxation, depending on the type of employment and the applicable conditions under Section 10(10).

This blog explains the taxation rules, exemptions, and limits on gratuity, along with examples and FAQs to help salaried individuals understand its tax implications.

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What is Gratuity?

Gratuity is a lump-sum payment made by an employer to an employee at the time of retirement, resignation, or upon completing a specified period of continuous service (usually five years). The Payment of Gratuity Act, 1972, governs gratuity for employees working in establishments with 10 or more employees.

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Taxation of Gratuity: Overview

The tax treatment of gratuity under Section 10(10) depends on the category of the employee:

1. Government Employees:
   Gratuity received by government employees (Central, State, or local authorities) is fully exempt from tax under Section 10(10)(i).
2. Non-Government Employees Covered Under the Payment of Gratuity Act, 1972:
   Gratuity received by these employees is exempt to the extent specified under Section 10(10)(ii).
3. Non-Government Employees Not Covered Under the Act:
   Gratuity exemption for these employees is governed by the conditions mentioned in Section 10(10)(iii).

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Exemption Limits Under Section 10(10)

1. Government Employees

• Full exemption on the gratuity amount received.
• No upper limit applies.

2. Non-Government Employees Covered Under the Payment of Gratuity Act

The exemption is the least of the following:

• ₹20,00,000 (maximum limit as per the latest notification).
• Actual gratuity received.
• 15 days’ salary for each completed year of service (calculated based on the last drawn salary).

Formula for Calculation:
Exempt Gratuity = 15/26 × Last Drawn Salary × Completed Years of Service

• 15/26 represents 15 days out of 26 working days in a month.
• Salary includes basic salary and dearness allowance (if applicable).

3. Non-Government Employees Not Covered Under the Act

The exemption is the least of the following:

• ₹20,00,000 (maximum limit).
• Actual gratuity received.
• Half a month’s average salary for each completed year of service.

Formula for Calculation:
Exempt Gratuity = ½ × Average Salary × Completed Years of Service

• Average salary is based on the last 10 months’ salary.

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Taxability of Gratuity Beyond Exempt Limits

If the gratuity received exceeds the exempt limit, the excess amount is taxable under the head Income from Salary. The taxable portion is added to the gross salary and taxed as per the applicable slab rates.

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Examples of Gratuity Taxation

Example 1: Government Employee

Mr. Sharma, a Central Government employee, retires and receives a gratuity of ₹25,00,000.

• Gratuity Received: ₹25,00,000
• Exempt Amount: ₹25,00,000 (fully exempt for government employees).
• Taxable Amount: ₹0

Example 2: Non-Government Employee Covered Under the Act

Ms. Priya, employed in a private company, receives a gratuity of ₹15,00,000 after 25 years of service. Her last drawn salary (basic + DA) was ₹60,000 per month.

• 15 days’ salary for each year of service:
  ₹60,000 × 15/26 × 25 = ₹8,65,385
• Exempt Amount: ₹8,65,385 (least of ₹20,00,000, ₹15,00,000, or ₹8,65,385).
• Taxable Amount: ₹15,00,000 – ₹8,65,385 = ₹6,34,615

Example 3: Non-Government Employee Not Covered Under the Act

Mr. Verma receives gratuity of ₹12,00,000 after 30 years of service. His average salary for the last 10 months was ₹50,000.

• Half month’s average salary for each year of service:
  ₹50,000 × ½ × 30 = ₹7,50,000
• Exempt Amount: ₹7,50,000 (least of ₹20,00,000, ₹12,00,000, or ₹7,50,000).
• Taxable Amount: ₹12,00,000 – ₹7,50,000 = ₹4,50,000

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How to Claim Gratuity Exemption?

1. Verify Form 16: Ensure that the exempt portion of gratuity is accurately reflected.
2. Provide Supporting Documents: Submit gratuity calculation details to your employer, if required.
3. File in ITR: Enter the exempt gratuity amount under “Exempt Income” in your income tax return.

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Important Points to Remember

1. Maximum Exemption Limit: The ₹20,00,000 exemption limit is applicable for lifetime gratuity received from one or more employers.
2. Multiple Employers: If gratuity is received from multiple employers, ensure that the aggregate exemption does not exceed ₹20,00,000.
3. Calculation of Service Period: Completed years of service are rounded off to the nearest year if more than 6 months.

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Frequently Asked Questions (FAQs)

1. Is gratuity taxable for government employees?

No, gratuity received by government employees is fully exempt from tax under Section 10(10)(i).

2. What is the maximum exemption limit for private sector employees?

The maximum exemption limit for non-government employees is ₹20,00,000.

3. How is gratuity taxed for employees not covered under the Gratuity Act?

For such employees, the exemption is calculated as half a month’s average salary for each completed year of service, subject to a maximum of ₹20,00,000.

4. Can I claim gratuity exemption more than once?

Yes, but the aggregate gratuity exemption during a lifetime cannot exceed ₹20,00,000.

5. Is gratuity received by heirs taxable?

Gratuity received by legal heirs after the death of an employee is fully exempt from tax.

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Conclusion

Gratuity is an essential retirement benefit, and understanding its taxation under Section 10(10) helps employees plan their finances better. By knowing the exemption rules and limits, both government and private sector employees can minimize their tax liabilities effectively. Always consult a tax advisor for personalized guidance and accurate computation.