Oct 2110 min read

Gratuity Exemption: A Detailed Overview

Updated: Oct 27

Section 80RRB of the Income Tax Act was introduced to ensure that an individual doing exceptional work gets their reward. Royalty on the patent is an instance of a reward that should be encouraged so that individuals keep doing good work. Under this section, these individuals can claim deductions in their income tax against the payments received as royalty. The goal of the section is to boost patenting and innovation in India. In this comprehensive guide, we will explain the concept of patenting and the process of claiming a deduction with Section 80RRB.

Understanding the Essentials of Gratuity

An employer-provided gratuity is a financial bonus that is not deducted from the employee's regular monthly pay. The Payment of Gratuity Act, 1972 governs the provisions of gratuity, which is given in the event of any of the following:

On superannuation (a term used to describe an employee who reaches retirement age).
Regarding retirement or leaving
A minimum of five years of service must have been completed by the employee in order for them to be eligible for a gratuity. In the event of an accident or disease that results in death or disablement, the five-year time restriction will not apply. Temporary workers and interns are not eligible to use it.

Eligibility to Get Gratuity

The following are the requirements to be eligible for a gratuity:

Employee-employer Relationship: The person must be an employee having a contract of employment with the company in order to be eligible for a gratuity. Both fixed-term and permanent staff are included in this.
Completion of the Service: The worker needs to have worked for the company for at least five years without a break. This service time is computed starting on the day of hire and ending on the date of resignation, retirement, or termination.
Tailored or Superannuated Income: A gratuity is normally given to an employee at their retirement, resignation, or voluntary separation following five years of employment. Gratuity may be awarded even before the worker has completed five years of service in the event of the worker's passing or disablement as a result of an illness or accident.
Termination Owing to Incapacity or Death: The gratuity amount is due regardless of the minimum service requirement if an employee's employment is terminated due to death or disability prior to completing five years of service.
Minimum Number of Workers: Any day during the previous 12 months when an establishment employs ten or more people is subject to the Payment of Gratuity Act, 1972.

Coverage of the Payment of Gratuity Act

Employees Covered by the Act

A gratuity is due to every person who worked in a factory, mine, oil field, port, railway, plantation, store or enterprise, or educational institution with ten or more employees on any given day during the previous year. Gratuity is still applicable after the Act becomes enforceable against an employer, regardless of how few workers there are.

Determination of the amount of gratuity that is tax-exempt

The following are tax-exempt, in order of least amount:

Prior compensation (DA + base pay) years of service 15/26;
Rs. 20 lakhs, which, according to the modification, was raised from Rs. 10 lakhs;
The real gratuity received

Let's use an example to better grasp this.

In the past, A was paid Rs. 1 lakh per month (basic + DA). A gratuity of 11 lakh rupees is due to him. For the past 19 years and 7 months, he has worked.

Particulars	Before Amendment	As Amended
Last drawn salary (Basic and DA)	Rs. 1 lakh	Rs. 1 lakh
Number of years of employment	20 (rounded off)	20 (rounded off)
Gratuity	1,00,0002015/26 = Rs. 11,53,846	1,00,0002015/26 = Rs. 11,53,846
Maximum permissible exemption	Rs. 10 lakhs	Rs. 20 lakhs (as amended)
Gratuity received	Rs. 11 lakh	Rs. 11 lakh
Amount of exemption (least of the above three)	Rs. 10 lakh	Rs. 11 lakh
Taxable gratuity	1 lakh	–

Important things to remember:

A 15-day wage based on the most recent salary received for each full year of service, or portion thereof, i.e., 15/26.
The years of service are rounded to the closest whole year.

Employees Not Covered by the Act

Employers are free to give gratuities to their staff members even if their company isn't covered by the Payment of Gratuity Act. A half month's salary can be used to determine how much gratuity is owed to the employee for each full year of service.

Estimation of gratuity amount free from tax

The following are exempt from tax, in the least amount:

The average wage for the last ten months (basic plus DA) the number of years worked 1/2;
Rs. 20 lakhs, which has increased from Rs. 10 lakh in accordance with the modification
The real gratuity received

For these workers, the exempt gratuity would be calculated as follows:

B joined the company twenty-five years and two months ago. For the past ten months, the average salary has been Rs. 90,000. He really received a gratuity of Rs. 11 lakhs.

Particulars	Amount (Rs.)
Average of last ten month’s salary	Rs. 90,000
Number of years of employment	25 (rounded off)
Gratuity	90,000251/2 = Rs. 11,25,000
Maximum exemption allowed	Rs. 20 lakhs
Gratuity received	Rs. 11 Lakhs
Amount of exemption (least of the above three)	Rs. 11 Lakhs
Taxable Gratuity	Nil

Important things to remember:

An average pay for the preceding ten months is taken into account.
The years of service are rounded to the closest whole year.

Gratuity Exemption

The following categories apply to the income tax exemptions on gratuities:

Public sector employees are exempt from paying gratuities:

Gratuities given to employees in the public sector upon their retirement, termination, or superannuation are fully tax-free. Employees of the federal government, state governments, the defence industry, the civil service, and other municipal authorities are all covered.

Exemptions from income tax on gratuities for employees in the private sector:

The Payment of Gratuity Act governs whether or not a private sector employee's gratuity is exempt from income tax.

When the Act provides protection to employees in the private sector

The lowest of the following three amounts represents the income tax exemption on gratuities received:

Prior compensation (DA + base pay) years of service 15/26;
Rs. 20 lakhs, which, according to the modification, was raised from Rs. 10 lakhs;
The real gratuity received

When workers in the private sector are not protected by the Act

The lowest of the following three amounts represents the income tax exemption on gratuities received:

Average income for the last ten months (basic plus DA) number of years worked 1/2;
Rs. 20 lakhs (up from Rs. 10 lakh as per the amendment);
The real gratuity received

Gratuity Payment in Case of Employee’s Death

Even if an employee has not worked the needed five years of continuous service to be eligible for regular gratuity, compensation is nevertheless due in the sad event of their death. The Payment of Gratuity Act of 1972 establishes guidelines for paying gratuities to employees who pass away or become disabled.

The following are the main details for paying a gratuity in the case that an employee passes away:

Minimum Requirement for Services: In case of the employee's demise, a gratuity becomes refundable provided they have worked for the company for a minimum of one year without interruption.
Appointee or Lawful Heir: Ordinarily, the nominee designated by the departed employee receives the gratuity amount. The deceased's legal heirs receive it if there isn't a nominee.
Calculation of Gratuities: The number of completed years of service up to the date of death is used to determine the gratuity amount that will be paid in the event of an employee's death. Any portion of a year that exceeds six months is counted as one year for calculation purposes.
Formula for Calculation: In this instance, the formula to determine gratuity is (last drawn salary × 15 days × completed years of service) / 26.
Tax Repercussions: Income tax is not applied to the gratuity amount received by the nominee or legal successor, subject to a cap set by the government. Amounts over the exemption limit could be subject to taxes.
Quick Payment: According to the law, employers must pay gratuities to employees within 30 days of the date the employee passes away, or the date the gratuity becomes due.

Illustrations

After working for 25 years and 6 months, Mr. A received a gratuity of Rs. 15,00,000 on July 28, 2020, after he retired. When he retired, he was paid:

The monthly basic salary is Rs. 40,000.
Dearness Allowance: Rs. 15,000 per month, of which 60% is used for retirement payments.
Commission: 1% of turnover (Rs. 1,20,000,000 in turnover during the previous 12 months).
Bonus: Rs. 30,000 annually.

The following is the calculation of his taxable gratuity in different situations:

Case 1: He works in the private sector and is therefore protected by the 1972 Payment of Gratuity Act.

Particulars	Amount
Gratuity received on retirement	Rs. 15,00,000
Less: Exemption under section 10(10)(ii)Least of the following: Statutory limit= Rs. 20,00,000Gratuity received= Rs. 15,00,000As per formula:(salary last drawn x number of years of employment x15/26)(40,000+9000) x 26 x15/26= Rs. 7,35,000	Rs. 7,35,000
Taxable Gratuity	7,65,000

Case 2: He works in the private sector, so the Payment of Gratuity Act of 1972 does not apply to him.

Particulars	Amount
Gratuity received on retirement	Rs. 15,00,000
Less: Exemption under section 10(10)(iii)Least of the following: Statutory limit= Rs. 10,00,000Gratuity received= Rs. 15,00,000As per formula:1/2x(last 10 months salary)/10 x years of employment.1/2x ([(40,000x10)+(15,000x60% x10)+(1% x1,20,00,000 x 10/12)])/10x 25= Rs. 7,37,500	Rs. 7,37,500
Taxable Gratuity	7,65,000

Case 3: He works for the government.

Particulars	Amount
Gratuity received on retirement	Rs. 15,00,000
Less: Exemption under section 10(10)(i) (fully exempt)	Rs. 15,00,000
Taxable Gratuity	Nil

Conclusion

The process of submitting an income tax return can appear complicated if there are numerous exemptions to be claimed. A gratuity received upon retirement or resignation from an organisation is one example of an exemption. Seek professionals to help you submit your ITR with the highest refund and save taxes so you can keep more of your earnings if you received a gratuity and feel uneasy about filing your income taxes. The TaxBuddy gratuity calculator makes it simple and accurate to determine the exact amount.

FAQ

Q1. What is gratuity?

A gratuity is a sum of money given to an employee by their employer as a token of appreciation for their work. It is usually paid when an employee retires, resigns, or passes away.

Q2. Is gratuity mandatory for all employers to provide?

Employers with 10 or more workers are required by the Payment of Gratuity Act of 1972 to offer gratuities to qualified workers. However, unless they pass away or become disabled, workers must complete a minimum of five years of continuous service in order to be eligible for a gratuity.

Q3. What are the eligibility criteria for gratuity?

An employee has to have worked for the company for at least five years in order to be eligible for a gratuity. However, in the event of an employee's demise or handicap, gratuity becomes payable even if they have worked for a minimum of a year.

Q4. Who is not eligible for receiving gratuity?

All workers who have worked for the same company for five years, regardless of whether they are permanent or temporary employees, are eligible to receive gratuities, with the exception of apprentices.

Q5. Is gratuity applicable to contract or temporary employees?

Yes, all workers who have fulfilled the minimum qualifying service period—including contract or temporary workers—are eligible for a gratuity.

Q6. Is the gratuity a government employee receives on retirement taxable?

No, a government employee's gratuity upon retirement is entirely excluded.

Q7. Which class of employers have to pay gratuity to their employees?

Gratuities are expected of employers with more than ten workers. Additionally, in order for an employee to be eligible for a gratuity, they must have worked for the same employer for the whole five years required for minimum service.

Q8. Is gratuity taxable for private employees?

You are exempt from paying taxes if you work in the private sector and your gratuity is less than Rs. 20 lakhs. Nevertheless, you must pay tax if the gratuity exceeds 20 lakhs.

Q9. What is the maximum exemption for gratuity for non-government employees?

The maximum amount that can be claimed as a gratuity exemption, regardless of whether you are covered by the Payment of Gratuities Act, 1972, is Rs. 20,000,000.

Q10. How is gratuity calculated?

The number of years of completed service and the employee's most recent salary are used to determine the gratuity amount. The following method is used to determine gratuity: (last drawn pay × 15 days × years of service completed) / 26.

Q11. Can an employer deny gratuity to eligible employees?

No, it is a statutory benefit, and companies are required by law to provide gratuities to qualified workers in accordance with the Gratuity Act's stipulations.

Q12. Is gratuity taxable?

Government employees are completely exempt from income tax on gratuities they receive. Gratuities for non-government workers are only partially refundable. The government has set a maximum limit on the exempt amount. Any sum over this limit may be subject to taxation.

Q13. Can the employee nominate someone to receive gratuity in case of their death?

It is possible for an employee to designate someone else to receive the gratuity in the event that they pass away. The legal heirs of the dead receive the gratuity in the absence of a nominee.

Q14. Is there a time limit for gratuity payments?

The date the gratuity becomes payable—that is, the date the employee retires, resigns, or passes away—must be met by the employer within 30 days.

Q15. Can an employee claim gratuity if they resign before completing 5 years of service?

No, unless they pass away or become disabled, an employee must work for a minimum of five years without a break in order to be eligible for a gratuity.

Q16. What is the gratuity exemption limit for ay 2023-24?

The Centre recently passed an amendment that raised the maximum gratuity amount. Section 10(10) of the Income Tax Act exempts it from tax up to Rs. 20 lakh, replacing the former cap of Rs. 10 lakh.

Q17. What is Section 10(10) of the Income Tax Act?

Any gratuity that an employee receives while working is subject to full taxation as income under the Income Tax Act of 1961 (also known as "the Act"). However, section 10(10) of the Act provides tax exemption if a gratuity is received in the event of a death, retirement, resignation, or in certain other circumstances.

Q18. What is section 10(10d) of the Income Tax Act?

The amount of gratuity that an employee receives is excluded from income tax under Section 10(10D) of the Income Tax Act, subject to a cap. The government periodically modifies the cap on gratuity exemptions. As of right now, a gratuity's maximum tax exemption is set at Rs. 20 lakhs.

Q19. Is gratuity taxable on resignation?

A tax exemption is granted under section 10(10) of the Act if a gratuity is paid in the event of a death, retirement, resignation, or in certain other circumstances. Any sum that an employee receives as a gratuity is classified as their income under the heading "Salaries."

Q20. What is the gratuity ceiling limit?

Currently, the Act's maximum gratuity sum is Rs. 10 Lakh.

Q21. What is TDS on gratuity?

When paying a gratuity, the employer must deduct tax at source (TDS) at the appropriate income tax rate if the amount exceeds the Income Tax Act's exemption limit.

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