Employment LawTaxTax Exemption on Gratuity Post Amendment

April 8, 20220


Gratuity is a kind of retirement benefit given to an employee amongst pension, provident fund etc. Simply put, gratuity is a reward given to long serving employees on their retirement as a lump sum amount.

Gratuity is governed by the Payment of Gratuity Act, 1972 (hereinafter referred to as “the Act”) which lays down rules and regulation for applicability, payment, and conditions to be satisfied for the payment of gratuity. Additionally, Income Tax Act, 1961 (hereinafter referred to as “the IT Act”) also governs the subject from tax perspective.

The Supreme Court in Delhi Cloth and General Mills Co. Ltd. v. Their Workmen [(1968) 36 FJR 247] has held that “the objective of providing a gratuity scheme is to provide a retiring benefit to the workmen who have rendered long and unblemished service to the employer and thereby contributed to the prosperity of the employer.”    

Vide a notification dated 29th March, 2018, the Ministry of Labour and Employment enacted the Payment of Gratuity (Amendment) Act, 2018 (hereinafter “the Amendment”) that doubled the tax exemption limit to Rs. 20,00,000 (Twenty Lakhs), which was Rs. 10,00,000 (Ten Lakhs) earlier.


As per Section 1(3) of the Act, the Act shall apply to –

“(a) every factory, mine, oilfield, plantation, port and railway company;

(b) every shop or establishment within the meaning of any law for the time being in force in relation to shops and establishments in a State, in which ten or more persons are employed, or were employed, on any day of the preceding twelve months;

(c) such other establishments or class of establishments, in which ten or more employees are employed, or were employed, or, any day of the preceding twelve months, as the Central Government may, by notification, specify in this behalf.”

Thus, from a bare reading, it can be concluded that the Act is wide enough to bring within its scope the entire organised sector of commerce and industry. It is important to note that in reference to clause (b) of Section 1(3) of the Act, the word ’law’, was interpreted to be any law and not only the Central or the State law particularly.

Eligible Employees

The following conditions are required to be met in order to be eligible for payment of gratuity under the Act:

  1. The employee must be engaged in any establishment factory, mine, oil-field, plantation, port, railway company or shop whether to do skill, unskilled, manual, supervisory, technical, or clerical work, but it does not include such person who holds a post under the Central or State Government and is governed by any other Act or rules providing for payment of gratuity.
  2. The employee shall have at least 5 years of continuous service on the termination of his/her employment with the previous employer. However, this condition is not required where the termination of the employee is due to death or disablement.

In catena of judgements, it has been held that where the specified period of continuous service has not been rendered, gratuity shall not be paid under the Act.

For instance, in Sushil Kumar Maloo v. Gujarat Raffia Industries Ltd [2015 II LLJ 317 (Guj)], the Gujrat High Court held that “on a fair reading of Section 4 of the Act what is required to be considered is that on eventuality service for not less than 5 years or not and nothing further than that.”

The Supreme Court in Allahabad Bank and Ors. v. All India Allahabad Bank Retired Emps. Assn. and Ors. [2010 (1) AWC 931 (SC)] has held that:

“Gratuity payable to an employee on the termination of his employment after rendering continuous service for not less than 5 years and on superannuation or retirement or resignation etc. being a statutory right cannot be taken away except in accordance with the provisions of the Payment of Gratuity Act, 1972 (Act) whereunder an exemption from such payment may be granted only by the appropriate Government under Section 5 of the Act which itself is a conditional power. No exemption could be granted by any Government unless it is established that the employees are in receipt of gratuity or pension benefits which are more favourable than the benefits conferred under the Act.”

When does the Gratuity become Due?

As per the Section 4(1) of the Act, gratuity is payable on the occurrence of any of the following event:

  • On superannuation;
  • On retirement or resignation;
  • On death or disablement due to accident or disease.


According to Section 4 of the Act, gratuity is calculated using the following formula:

Gratuity = Last drawn salary × 15/26 × number of years of service

In the foregoing, it is important to note the following:

  • The ratio 15/26 represents 15 days out of 26 working days in a month
  • Last drawn salary = basic salary + dearness allowance
  • Years of service are rounded off to the nearest full year. For example, if the employee has a total service of 10 years, 10 months and 25 days, it will be deemed as 11 years for calculating gratuity.

Maximum amount payable

The maximum amount that could be paid as gratuity has been increased from time to time like from Rs. 3,50,000 (Rupees Three Lakhs Fifty Thousand Only) to Rs. 10,00,000 (Rupees Ten Lakhs Only) in 2010. Thereafter, the Amendment increased it further to Rs. 20,00,000 (Rupees Twenty Lakhs Only).


In case of gratuity received under the Act, the following tax treatment is provided under the IT Act, 1961.

 Section 10(10)(ii) of the IT Act states that “any gratuity received under the Payment of Gratuity Act, 1972 (39 of 1972), to the extent it does not exceed an amount calculated in accordance with the provisions of sub-Sections (2) and (3) of Section 4 of that Act”.

Therefore, according to the abovementioned Section gratuity would be exempted up to the least of:

  • Last salary (Basic + DA) × number of years of employment × 15/26
  • 20 lakhs
  • Gratuity Actually received

In case of gratuity received which is not governed under the Act:

Section 10 (10) (iii) of the IT Act states that:

“any other gratuity received by an employee on his retirement or on his becoming incapacitated prior to such retirement or on termination of his employment, or any gratuity received by his widow, children or dependants on his death, to the extent it does not, in either case, exceed one-half month’s salary for each year of completed service, calculated on the basis of the average salary for the ten months immediately preceding the month in which any such event occurs, subject to such limit as the Central Government may, by notification in the Official Gazette, specify in this behalf having regard to the limit applicable in this behalf to the employees of that Government.”

As per the aforementioned provision, the least of the following is exempted from tax:

  • Last 10 month’s average salary (Basic + DA) × number of years of employment × 1/2;
  • Rs. 10 lakhs;
  • Gratuity actually received

It is pertinent to note that the increased exemption of Rs. 20,00,000 (Twenty Lakhs) would not be available to employees that are not covered under the Act. However, the tax on gratuity is fully exempted for the Government employees.


The Act, like Minimum Wages Act, 1948, Maternity Benefit Act, 1961 or number of similar Acts has always made a significant contribution in uplifting the economic strength of the employees and vulnerable sections.

Measures like increasing the threshold of tax exemption on gratuity from Rs. 10,00,000 (Rupees Ten Lakhs Only) to Rs. 20,00,000 (Rupees Twenty Lakhs Only) has been perceived as a welcoming change introduced by the Government.

However, the applicability of the Act depends on a number of factors like minimum number of employees in the organisation, status of the concerned person in the organisation etc. In the backdrop of the aforementioned, the employees should be careful while exercising the benefits provided under this Act.

-Team AMLEGALS assisted by Mr. Aditya Baheti (Intern)

For any queries or feedback, please feel free to get in touch with chaitali.sadayet@amlegals.com or mridusha.guha@amlegals.com.

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