Learn how gratuity is taxed in India and explore key exemptions under Section 10(10) to maximise your tax savings.
Gratuity serves as a financial token of appreciation from employers to employees for their dedicated service over the years. You are eligible for gratuity after completing 5 years of service with a company. Understanding the tax implications of gratuity is crucial for effective financial planning. Know the nuances of gratuity, its eligibility criteria, calculation methods, and the tax exemptions available under Indian law.
Gratuity is a lump sum payment made by an employer to an employee as a gesture of gratitude for the services rendered. Governed by the Payment of Gratuity Act, 1972, it is applicable to establishments with ten or more employees. The primary objective is to provide a financial cushion to employees post-retirement or upon leaving the organisation after a significant period.
To qualify for gratuity, an employee must meet the following conditions:
Continuous Service: The employee should have completed at least five years of continuous service with the same employer. Exceptions are made in cases of death or disablement, where the five-year rule is waived.
- Termination of Employment: Gratuity becomes payable upon retirement, resignation, superannuation, or termination due to death or disablement.
The calculation of gratuity depends on whether the organisation is covered under the Payment of Gratuity Act.
There are two methods of gratuity calculation:
1. For Employees Covered Under the Gratuity Act
Formula:
Gratuity = (Last drawn salary × 15 × Number of years of service) ÷ 26
Last drawn salary includes Basic Pay + Dearness Allowance (DA).
If an employee completes more than 6 months in the final service year, it is rounded up.
Example:
If Amit worked for 20 years with a last drawn salary of ₹25,000
Gratuity = (25,000 × 15 × 20) ÷ 26 = ₹2,88,462
2. For Employees Not Covered Under the Gratuity Act
Formula:
Gratuity = (Last drawn salary × 15 × Number of years of service) ÷ 30
Here, the month is considered as 30 days instead of 26.
Service period is rounded down unless it exceeds 6 months.
Example:
If Ravi worked for 5 years with a last drawn salary of ₹31,000
Gratuity = (31,000 × 15 × 5) ÷ 30 = ₹77,500
Note: In both cases, if an employee has served more than six months in a year, it is rounded up to the next year for calculation purposes.
The government has set an upper limit on the gratuity amount that an employee can receive.
For government employees: No maximum limit. The full amount is tax-free.
For private-sector employees: The gratuity limit is ₹20 Lakhs. Even if an employer pays more, only ₹20 Lakhs is tax-exempt.
Example:
If an employee receives ₹25 Lakhs in gratuity, the taxable portion will be:
₹25 Lakhs - ₹20 Lakhs (exempt) = ₹5 Lakhs (taxable amount)
The Income Tax Act, 1961, provides exemptions on gratuity under Section 10(10). The extent of exemption varies based on the type of employment:
1. Government Employees
Gratuity received by employees of the Central or State Government, local authorities, and defence services is fully exempt from income tax.
2. Non-Government Employees Covered Under the Payment of Gratuity Act
For these employees, the least of the following three amounts is exempt:
Actual gratuity received.
₹20,00,000 (statutory limit)
Calculation as per the formula: (Last Drawn Salary × 15 × Number of Years of Service) / 26
3. Non-Government Employees Not Covered Under the Act
For such employees, the least of the following is exempt:
Actual gratuity received
₹20,00,000 (statutory limit)
Calculation as per the formula: (Average Salary of Last 10 Months × ½ × Number of Years of Service)
Note: The average salary includes basic pay, dearness allowance, and commission based on a fixed percentage of turnover.
Gratuity provides financial security and tax advantages. Key benefits include:
Boosts employee morale and loyalty by rewarding long-term service.
Provides retirement security with a lump sum payout.
Tax benefits as gratuity are exempt up to a certain limit.
Legal protection under the Payment of Gratuity Act, 1972.
The maximum tax exemption limit for gratuity is ₹20 Lakhs. Any amount exceeding this is taxable under the head "Income from Salary".
If an employee receives gratuity from multiple employers in the same financial year, the total exemption cannot exceed ₹20 Lakhs.
In case of death or disablement, the gratuity received by the nominee or legal heir is fully exempt from tax.
Employees must nominate a family member by filling Form F after completing one year of service.
Employers can withhold gratuity if an employee is dismissed for:
Misconduct
Criminal offence involving moral turpitude
Violence or disorderly conduct
Employers must pay gratuity within 30 days of it becoming due, or else they are liable to pay interest on the delayed amount.
Gratuity is more than just a financial benefit; it's a recognition of an employee's loyalty and dedication. Understanding the tax implications ensures that employees can make informed decisions and maximise their post-retirement benefits. It's advisable to consult with a tax professional or financial advisor to navigate the complexities and make the most of the available exemptions.
Frequently Asked Questions
Is gratuity taxable or not in India?
Government employees get a gratuity that is exempted from tax. Private sector employees may qualify for tax exemptions. But this depends on whether they are covered under the Payment of Gratuity Act. If you are covered, you can get tax exemption on gratuity of up to ₹20 Lakhs.
How is tax on gratuity in India calculated?
The taxable gratuity amount is added under the head ‘Income from Salary’. It is taxed as per the tax slab you fall under. The least of the below amounts is exempt from taxation:
Actual gratuity received
Last 10 month's average salary*years of employment* half a month’s salary i
₹20 Lakhs
Can an employee get excess gratuity?
Yes, if their employer decides to do so. But the excess gratuity amount will fall under the taxable income.
How does the new amendment in the Payment of Gratuity Act benefit employees?
The amendment raised the upper cap for gratuity eligible for tax exemption ₹20 Lakhs. It earlier stood at ₹10 Lakhs. This means you now enjoy a higher tax benefit.
Is the gratuity amount a part of the CTC?
Yes. Gratuity is commonly included as a component of the Cost to Company (CTC) package in India.
Who can enjoy the benefit of gratuity?
Employees who have served a company for five or more years can get gratuity. Additionally, employees receive gratuity in the event of retirement, disability, or death. In case of death, the nominee receives the amount.
Is there another way other than manual calculations to determine the gratuity amount?
You can use an online gratuity calculator. It will show you the taxable gratuity amount and the total gratuity amount.
What kind of deduction is applicable to gratuity?
The gratuity may be deducted if the employment is terminated. This could be for damaging the employer's property or wilful negligence. The cost of the damage may be deducted from the gratuity amount.
Is the gratuity limit increased to ₹30 Lakhs?
No. The amendment set the upper tax-exempt cap for gratuity at ₹20 Lakhs under the Payment of Gratuity Act.
How can I claim tax exemption on gratuity while filing ITR?
If you are a salaried individual, you can use ITR-1 or ITR-2 and report the gratuity amount in the 'Salaries' Head. Enter the exempted amount under the ‘Income exempt under section 10’.
Is TDS deducted on gratuity amounts?
Yes, the employer will deduct TDS on gratuity. But this is only if the amount that exceeds the exempted amount mentioned under Section 10(10) of the Income Tax Act.
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