Gratuity Exemption

For employees covered by the Payment of Gratuity Act, the formula is (15/26) × last drawn basic + DA × completed years of service, with any service beyond 6 months counted as a full year. The exemption under Section 10(10) is the lowest of three: this calculated amount, actual gratuity received, or Rs 20 lakh. Whatever's above that lowest figure is taxable as salary. Example: 15 years of service, last basic+DA Rs 60,000. Calculated gratuity = (15/26) × 60,000 × 15 = Rs 5,19,231. If employer pays Rs 6 lakh, Rs 5,19,231 is exempt and Rs 80,769 is taxable in your hands.

of Gratuity Act? If your employer has 10 or more employees and is in a covered industry, the Payment of Gratuity Act, 1972 applies, and the (15/26) × salary × years formula governs both the legal entitlement and the tax exemption. If the employer is outside the Act (some small or specialised establishments), payment is contractual. The tax exemption formula then changes to (1/2) × average salary of last 10 months × completed years (only fully completed years count, no 6-month rounding). Average salary includes basic, DA forming part of retirement benefits, and commission as a fixed percentage of turnover. Same Rs 20 lakh overall cap applies either way.

Gratuity itself is generally not payable under the Act unless you've completed 5 years of continuous service, except in cases of death or permanent disability where the 5-year rule is waived. If an employer voluntarily pays gratuity before 5 years (some progressive companies do), it's treated as ex-gratia and fully taxable as salary income, since the Section 10(10) exemption is tied to legitimate gratuity payment. Recent rulings have allowed fixed-term employees to receive gratuity from the first year onwards under certain conditions, but the tax treatment of any below-threshold payment usually still falls outside the exemption.

For employees covered under the Payment of Gratuity Act, only basic salary plus dearness allowance (the DA portion that forms part of retirement benefits) goes into the formula. HRA, conveyance, special allowance, bonus, overtime, performance pay and reimbursements are all excluded. For employees not covered under the Act, salary includes basic, DA forming part of retirement benefits, and commission expressed as a fixed percentage of turnover, but again excludes the rest. Many disputes arise here because employers sometimes restructure salary with low basic and high allowances; that strategy reduces the gratuity payable but also disadvantages the employee at separation.

Same formula whether you resign or retire, provided you've completed 5 years of continuous service (or covered exceptions like death/disability). For Act-covered employees: (15/26) × last drawn basic + DA × completed years, rounding any service over 6 months up to a full year. The amount is paid within 30 days of cessation of employment; delays attract simple interest. Example: a 30-year-veteran retiring with basic+DA of Rs 80,000 receives (15/26) × 80,000 × 30 = Rs 13,84,615, fully exempt within the Rs 20 lakh ceiling. Voluntary retirement schemes under Section 10(10C) carry a separate Rs 5 lakh exemption.

Yes, this is a useful change. Following amendments and clarifications under the Code on Social Security, 2020 and earlier industrial law notifications, fixed-term employees are entitled to gratuity on a pro-rata basis even if their contract is shorter than 5 years, provided they complete the contracted term. The tax exemption under Section 10(10) follows the same formula and Rs 20 lakh cap. So a fixed-term contractor who serves out a 3-year contract is now legally entitled to (15/26) × salary × 3, paid at the end of the term. Confirm with your HR; many companies are still updating their internal policies on this.

Gratuity received by legal heirs upon the death of the employee is fully exempt from income tax in their hands under Section 10(10), regardless of the Rs 20 lakh ceiling that applies in normal cases, because the entire amount qualifies as compassionate payment in the nature of capital receipt for the family. The 5-year service condition is also waived for death cases. The amount must be reported under exempt income while filing the deceased's final return or in the heir's return as applicable. Keep the gratuity sanction letter and bank credit advice on file in case the assessing officer raises queries during processing.