Gratuity is one of the retirement / separation dues paid to the employees. An employee becomes eligible for gratuity after rendering minimum service of 5 years in an organization (subject to certain exceptions)

The exemption for gratuity from tax is covered under Sec 10(10) of income tax Act 1961.

Any Gratuity received during service is fully taxable.

For the Gratuity received at the time of retirement / separation the exemption u/s 10(10) is available and for that employees has been classified into 2 categories:

  1. Govt Employees
  2. Non- Govt Employees (including PSU employees)

The whole amount of Gratuity received by Govt employees is fully exempt u/s 10(10)(i)

For Non-Govt employees / other employees the exemption amount depends on whether employee is covered under Payment of Gratuity Act 1972 or not.

If the employee is covered by payment of Gratuity Act 1972- Exemption is available u/s 10(10)(ii) being least of the following:

a. Amount of Gratuity received

b. Rs 20 Lacs

c. 15 days salary (based on last drawn salary) for every completed year of service or part in excess of 6 months (No of days in a month to be taken as 26)

If the employee is NOT covered by payment of Gratuity Act 1972- Exemption is available u/s 10(10)(iii) being least of the following:

a. Amount of Gratuity received

b. Rs 20 Lacs

c. Half month salary (based on last 10 months salary) for every completed year of service.

Note:

1st proviso to sec 10(10)- Where Gratuity is received from 2 or more employer in the same year then the aggregate amount of gratuity exempt from tax would not exceed Rs 20 lacs

2nd proviso to sec 10(10)- Where gratuity is received in any earlier year from former employer and again received from same/ another employer in a later year the limit of Rs 20 lacs will be reduced by the amount of gratuity exempt earlier.

The above provision can be illustrated with the help of following flow diagram:

Taxability of Enhanced Gratuity received after retirement

It may be noted that the above limit of Rs 20 lacs has undergone changes from time to time

Notification No Maximum Exempt amount of Gratuity Effective for those employees retired/ separated on or after
S.O. 287 dated the 20th January, 1999 Rs 3.5 Lacs 24th Sep 1997
S.O. 141(E), dated the 11th June, 2010 Rs 10 lacs 24th May 2010
S.O. 1213(E).dated the 8th March 2019 Rs 20 lacs 29th March 2018

So in nutshell if a person is retiring between 24.09.1997 to 23.05.2010, he is entitled for a maximum exemption of Rs 3.50 lacs u/s 10(10).

Similarly if a person is retiring between 24.05.2010 to 28.03.2018, he is entitled for a maximum exemption of Rs 10 lacs u/s 10(10).

And if a person is retiring on or after 29.03.2018 then he is entitled for a maximum exemption of Rs 20 lacs u/s 10(10). 

Taxability of Enhanced Compensation

Many a time enhanced compensation of gratuity is paid due to various reasons. In such cases certain amount is paid on the date of retirement / separation and balance amount is paid on subsequent date.

Since the maximum amount of exemption under gratuity keeps on changing from time to time (eg for period 24.05.10 to 28.03.18 the maximum amount of exemption was Rs 10 lacs and for period 29.03.18 onwards maximum exemption is Rs 20 lacs) so main confusion arises when the original amount of gratuity and enhanced amount is gratuity is paid on different dates on which different exemption amount is applicable u/s 10(10).

For example – Mr X retired on 31.01.2018 and received a compensation of Rs 10 lacs on account of gratuity on that date. Hence at the time of retirement he was entitled for maximum exemption of Rs 10 lacs u/s 10(10) and taxable amount on account of gratuity was Nil.

Mr X got enhanced compensation of gratuity of Rs 6 lacs on 28.02.2019. Now question arises whether this additional Rs 6 lacs is fully taxable or fully exempt under the provisions of Income Tax Act 1961.

Notification No S.O. 1213(E).dated the 8th March 2019 clearly spells out that exemption of Rs 20 lacs will be applicable for those retiring / separated on or after 29.03.2018. In the given case since the Mr X has retired on 31.01.2018 (i.e prior to 29.03.2018) so he will not be allowed enhanced exemption of Rs 20 lacs and whole Rs 6 lacs received on 28.02.2019 will be fully taxable.

In the given case one can’t even take benefit of second proviso to section 10(10) which provides that in case subsequent gratuity received the total exemption would be limited to Rs 20 lacs since here the subsequent gratuity amount is not on account of retirement/ separation.

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