Legal Reference
Schedule II (gratuity exemption), Payment of Gratuity Act 1972, Section 17(3) (profit in lieu of salary), ITA 2025 | Rs 20L lifetime limit | 5-year qualifying service | 15 days per year formula
1. Gratuity: A Retirement Benefit
Gratuity is a lump sum payment by an employer to an employee as a token of appreciation for services rendered. It is payable on retirement, superannuation, resignation after 5 years, death, or disablement. Tax treatment depends on whether the employee is a government employee and whether the employer is covered under the Payment of Gratuity Act, 1972.
2. Three Categories of Employees
| Category | Exemption |
|---|
| Government employees | Fully exempt — entire gratuity amount |
| Non-government (covered under PGA 1972) | Lowest of: actual gratuity; 15 days salary per completed year; Rs 20 lakh |
| Non-government (NOT covered under PGA 1972) | Lowest of: actual gratuity; half-month average salary per year; Rs 20 lakh |
3. Formula: 15 Days Salary Per Year (PGA Covered)
For companies covered under the Payment of Gratuity Act:
Exempt gratuity = Last drawn salary × 15/26 × Completed years of service
- "Last drawn salary" = Basic + DA only (not HRA or allowances)
- 15/26: 15 working days out of 26 working days in a month
- Years rounded to nearest half year if excess > 6 months
- Maximum: Rs 20,00,000
4. Example Computation
Illustrative only. Ramesh works for 28 years and 8 months. Last drawn salary (Basic + DA) = Rs 1,00,000/month. Gratuity received = Rs 18 lakh.
- Completed years: 28 years 8 months → 29 years (rounds up as >6 months)
- Formula: Rs 1,00,000 × 15/26 × 29 = Rs 16,73,077
- Actual gratuity: Rs 18,00,000
- Limit: Rs 20,00,000
- Exempt = lowest = Rs 16,73,077
- Taxable gratuity = Rs 18,00,000 - Rs 16,73,077 = Rs 1,26,923
5. Lifetime Rs 20 Lakh Limit
The Rs 20 lakh exemption is a lifetime limit — across all employers combined. If you receive Rs 10 lakh gratuity from first employer, you can claim Rs 10 lakh more from subsequent employers. Track the cumulative exemption claimed across your career. Excess beyond the lifetime limit is fully taxable.
6. Gratuity on Death or Disability
Gratuity paid on death or disablement of an employee is fully exempt without the 5-year qualifying service requirement and without the Rs 20L cap. The payment to legal heirs on death is entirely tax-free.
7. Why TaxClue
Gratuity computation — PGA coverage, formula application, and lifetime limit tracking — requires precision. TaxClue ensures correct gratuity reporting in ITR. Contact us under ITA 2025.
Disclaimer
This article is for general informational and educational purposes only. It does not constitute legal, financial, or professional tax advice. Readers are advised to consult a qualified Chartered Accountant or tax professional before making any decisions. TaxClue Consultech Pvt Ltd accepts no liability. All case studies and examples in this article are illustrative only and do not represent actual persons or transactions.
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❓ Frequently Asked Questions
How much gratuity is tax-free?
Gratuity exemption under ITA 2025: government employees — fully exempt. Non-government employees covered under Payment of Gratuity Act: exempt up to the lowest of actual gratuity, 15/26 × last salary × completed years, or Rs 20 lakh. Non-government not covered under PGA: lowest of actual, half-month average salary × years, or Rs 20 lakh. The Rs 20 lakh is a lifetime limit across all employers.
How is gratuity computed under the Payment of Gratuity Act?
Formula: Last drawn basic+DA × 15/26 × Completed years of service. The 15/26 factor represents 15 working days out of 26 working days in a month. Years are rounded to nearest half-year (if service beyond last anniversary is more than 6 months, it counts as a full year). Example: 28 years 8 months → 29 years. Last salary Rs 80,000: Rs 80,000 × 15/26 × 29 = Rs 13.38 lakh. This is the maximum exempt under the formula — actual gratuity may differ.
What is the lifetime Rs 20 lakh gratuity limit?
The Rs 20 lakh gratuity exemption is a lifetime limit across all employers. If you received Rs 8 lakh gratuity from your first employer (and claimed full exemption), you can claim only Rs 12 lakh more from future employers under the lifetime cap. The total exempt gratuity across your entire career cannot exceed Rs 20 lakh. Keep records of gratuity received and exemption claimed from each employer.
Is gratuity on death or disability taxable?
No. Gratuity paid on death or permanent disablement of an employee is fully exempt without any limit — the Rs 20 lakh cap does not apply, and the 5-year qualifying service requirement is also waived. The entire gratuity paid to the legal heirs or to the disabled employee in such cases is tax-free under Schedule II of ITA 2025.
What salary figure is used for the gratuity formula?
For the Section II exemption formula, last drawn salary = basic salary + dearness allowance only. HRA, special allowance, medical allowance, and other allowances are excluded. The formula uses the last drawn salary at the time of retirement/separation — not an average. For companies not covered under the Payment of Gratuity Act, the formula uses half-month average salary (last 10 months average) instead of last drawn.
