Tax treatment of Gratuity [Section 10(10)]

Gratuity is a payment made by the employer to an employee in appreciation of the past services rendered by the employee. Gratuity can either be received by:

(a)      the employee himself at the time of his retirement; or

(b)      the legal heir on the event of the death of the employee.

Gratuity received by an employee on his retirement is taxable under the head “Salary” whereas gratuity received by the legal heir of the deceased employee shall be taxable under the head “Income from other sources”. However, in both the above cases, according to section 10(10) gratuity is exempt upto a certain limit. Therefore, in case gratuity is received by employee, salary would include only that part of the gratuity which is not exempt under section 10(10).

A. Death-cum-retirement gratuity received by Government servants [Section 10(10)(i)]

Section 10(10)(i) grants exemption to gratuity received by Government employee (i.e., Central Government or State Government or local authority).

B. Gratuity Received by a Non-Government Employee covered by Payment of Gratuity Act, 1972 [Section 10(10)(ii)]

Minimum of the following 3 limits: 
(1)      Actual gratuity received, or 
(2)      15 days salary for every completed year, or part thereof exceeding six months 7 days salary for each season in case of employee in seasonal establishment; or 
(3)    ₹. 10,00,000

Meaning of Salary: 
(i)         Basic salary plus dearness allowance. 
(ii)        Last drawn salary. Average salary for preceding 3 months in case of piece rates employees 
(iii)       No. of days in a month to be taken as 26

C. Any other Employee

Minimum of the following 3 limits: 
(1)      Actual gratuity received 
(2)      Half months average salary of each completed year of service.
(3)      ₹. 10,00,000

Meaning of Salary: 
(i)         Basic Salary plus D.A. to the extent the terms of employment so provide Commission, if fixed percentage of turnover. 
(ii)        Average salary of last 10 months preceding the month in which event occurs. 
(iii)       Only completed year of service is to be taken.

Where an employee had received gratuity in any earlier year(s) and had claimed exemptions under section 10(10) in respect of the gratuity received earlier also, he will still be entitled to this exemption but the limit which at present is ₹. 10,00,000 shall be reduced by the amount of exemption(s) availed in the earlier year(s). There will be no change in the other two limits.The words “completed service” occurring in section 10(10) should be interpreted to mean an employee’s total service under different employers including the employer other than the one from whose service he retired, for the purpose of calculation of period of years of his completed service, provided he was not paid gratuity by the former employer. CIT v P.M. Mehra (1993) 201 ITR 930 (Bom).Any gratuity paid to an employee, while he continues to remain in service with the same employer is taxable under the head “Salaries” because gratuity is exempt only on retirement or on his becoming incapacitated or on termination of his employment or death of the employee. In this case, however the assessee can claim relief under section 89.The CBDT vide its instruction in F. No. 194/0/73-IT, dated 19.6.1973 has clarified that the expression “termination of employment” would cover an employee who has resigned from the service.