What is gratuity? How is it calculated for income tax benefit?

Updated: March 24, 2018 12:37:34 PM

Private sector employees will be able to receive tax-free gratuity of up to Rs 20 lakh now as against Rs 10 lakh earlier. However, how is gratuity calculated for the purpose of income tax exemption?

gratuity, tax free gratuity limit doubled, Rs 20 lakh, Parliament, Payment of Gratuity (Amendment) Bill, Rajya Sabha, Lok Sabha, maternity leaveThe government will also be able to increase the gratuity ceiling from time to time without amending the law.

The Payment of Gratuity (Amendment) Bill, 2017 was passed in the Lok Sabha a week earlier and yesterday the Bill got passed by the Rajya Sabha through a voice vote. This Bill seeks to amend the Payment of Gratuity Act, 1972. It raised issues in respect of two aspects: (i) Considering inflation and wage increase, enhancement of the amount of gratuity available to employees even for private and public sector. (ii) Determination of the period for maternity leave which would be eligible for qualifying as continuous service.

The good news is the Bill has cleared the way to increase the tax-free limit of gratuity payable to an employee from the existing ceiling of Rs 10 lakh to Rs 20 lakh. Additionally, the government has been empowered to increase the gratuity ceiling from time to time without amending the law. Further, in respect of maternity leave, the Bill has removed the limit of 12 weeks and simultaneously empowers the government to notify the maximum maternity leave.

Now, let us understand the impact of this amendment in respect of calculation of the exempt gratuity amount. Here is all what you need to know about gratuity for the purpose of income tax.

What is Gratuity?

Gratuity is paid by an employer in appreciation of past services of an employee. However, the employee should render services for at least five years in the organisation to become eligible to receive gratuity. It is paid at the time of retirement to the employee himself or to his legal heir in the event of death of the employee.

How is it calculated for the purpose of Income Tax exemption?

As per Section 10(10), the gratuity amount receivable by government employees and employees of local authority is wholly exempt. However, it is not the case with non-government employees. So, in order to calculate the amount of exempt gratuity in their case, we shall understand the provisions stated in the Income Tax Act in this regard.

As per the provisions under the Income Tax Act, the lower of below three amounts shall be exempt as gratuity in case of employees covered under the Gratuity Act:

(i) Actual Gratuity received

(ii) Last Drawn Salary x 15/26 × Completed years of service , where salary shall be Basic + Dearness Allowance and for the calculation of completed years of service part of month above 6 months shall be accounted for.

(iii) Maximum amount specified, i.e., Rs. 20,00,000 (As per the Gratuity Amendment Bill. However, the Presidential assent and publication in the Official Gazette is still pending)

Now, after understanding the provisions, let’s rationalise them!

The calculation with the help of e xamples has been enumerated in the table given below:


Example 1

Example 2

1.Completed year of service

30 Years

25 Years

2. Annual Income

10,00,000 (83,333 per month)

15,00,000 (1,25,000 per month)

3. Actual Gratuity Received

15,00,000  (Assumed)

18,00,000  (Assumed)

4. Calculation

i) 15,00,000

ii) 83,333*15/26*30 = 14,42,302

iii) 20,00,000

(Whichever is lower shall be selected)

i) 18,00,000

ii) 125000*15/26*25 = 18,02,885

iii) 20,00,000

(Whichever is lower shall be selected)

5. Exempted Gratuity




After the implementation of the 7th Pay Commission recommendations, the expected change required for private sector employees in respect of gratuity ceiling in the Payment of Gratuity Act, 1972 has been done, which is surely a welcome move. The Gratuity Amendment Bill, which got passed by the Rajya Sabha, will come into force on such date as the Central government may notify in the official gazette after the assent of the President.

(By CA Abhishek Soni, Founder, tax2win.in)

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Switch to Hindi Edition