Gratuity tax exemption in India — Section 10(10), the ₹20 lakh ceiling, and how it actually works

The short answer

Gratuity received under the Payment of Gratuity Act, 1972 is exempt from income tax under Section 10(10)(ii) of the Income Tax Act, up to a ceiling. The exemption is the least of three amounts:

1. The actual gratuity received
2. ₹20,00,000 (the lifetime ceiling, applicable from 29 March 2018 onwards)
3. (15 ÷ 26) × Last-drawn salary × Completed years of service

Whatever exceeds this exemption is taxable as salary in the year of receipt.

Who falls under which sub-section

The Act distinguishes three categories:

• Government employees (Section 10(10)(i)) — fully exempt, no ceiling, no formula. Includes Central Government, State Government, and statutory body employees.
• Private employees covered under the Payment of Gratuity Act (Section 10(10)(ii)) — exemption per the formula above with a ₹20 lakh ceiling. Most private-sector salaried employees fall here.
• Private employees not covered under the Payment of Gratuity Act (Section 10(10)(iii)) — slightly different formula and ceiling logic; see below.

Worked example 1 — Gratuity-Act-covered employee

Rajesh is a software engineer at a 200-employee firm. He resigns after 8 years and 7 months of service. His last-drawn monthly salary (Basic + DA) is ₹85,000. The company pays him ₹4,80,000 as gratuity.

Step 1: Round service. 8 years 7 months → 9 years (any fraction over 6 months rounds up; under 6 months rounds down). Hence 9 years.

Step 2: Compute the formula amount.

Formula = (15/26) × 85,000 × 9 = ₹4,41,346

Step 3: Apply the "least of three" rule.

• Actual gratuity received: ₹4,80,000
• Statutory ceiling: ₹20,00,000
• Formula amount: ₹4,41,346

Exemption = least = ₹4,41,346. Taxable portion = ₹4,80,000 − ₹4,41,346 = ₹38,654, taxed at slab rate in the year of receipt.

Worked example 2 — Long-tenure, ceiling-binding case

Anika has worked 32 years at the same firm and retires with last-drawn Basic+DA of ₹3,00,000 / month. The company pays her ₹35,00,000 as gratuity.

Formula = (15/26) × 3,00,000 × 32 = ₹55,38,461

• Actual: ₹35,00,000
• Ceiling: ₹20,00,000
• Formula: ₹55,38,461

Exemption = ₹20,00,000. Taxable = ₹35,00,000 − ₹20,00,000 = ₹15,00,000. The ₹20 lakh ceiling binds, not the formula.

Worked example 3 — Not-covered-by-Act employee

If your employer is not covered by the Payment of Gratuity Act (very small firms, certain trusts), the formula changes:

Formula = (1/2) × Average salary of last 10 months × Completed years of service

Two key differences vs. the Act-covered formula:

• The denominator is 2 (not 26), and the numerator is 1 (not 15)
• "Salary" = the average of the last 10 months, not the last-drawn salary
• "Completed years" — fractions are ignored (no rounding-up at 6 months)

The ceiling and "least of three" logic are otherwise identical.

What counts as "salary" for the formula

This is where calculators differ:

• For Gratuity-Act-covered employees (Section 10(10)(ii)): salary = Basic + DA + commission (if commission is a fixed % of turnover). HRA, special allowance, transport, food coupons — excluded.
• For not-covered employees (Section 10(10)(iii)): same definition — Basic + DA + percentage-based commission only.

Most legitimate tax-tribunal disputes around gratuity exemption come from including allowances that should have been excluded. Be precise.

The ₹20 lakh ceiling is per-life, not per-employer

This is the most-missed rule. If you received gratuity from a previous employer (say, ₹8 lakh that was fully exempt), and now receive ₹15 lakh from your current employer, the ceiling for the current claim becomes ₹20 lakh − ₹8 lakh = ₹12 lakh. The remaining ₹3 lakh is taxable. Form 26AS does not track this; the responsibility is on the employee to declare prior-claim usage.

Tax timing and TDS

Gratuity is taxed in the financial year of receipt, not the year of accrual. The employer typically deducts TDS on the taxable portion if the total exceeds ₹2.5 lakh (or your basic exemption limit). PeopleOS computes the exemption automatically using the employee's prior-claim declaration on file and shows the calculation on the FnF settlement statement.

Common mistakes to avoid

• Forgetting that fractions over 6 months count as a full year (Act-covered only)
• Using gross salary instead of Basic + DA in the formula
• Ignoring the per-lifetime ₹20 lakh aggregation across employers
• Treating ex-gratia gratuity (above the formula entitlement) as automatically exempt — it's not. Only the statutory entitlement falls under Section 10(10); voluntary excess is fully taxable as salary.
• Missing the death-in-service rule: if gratuity is paid to nominees on death, the entire amount up to the ceiling is exempt, irrespective of the formula.

How PeopleOS handles it

The FnF (Full and Final Settlement) module in PeopleOS computes gratuity automatically based on the joining date, last-drawn Basic + DA, and the employee's prior-claim history (captured at onboarding via the tax declaration form). Every gratuity entry on the FnF statement carries a calculation trace showing the formula amount, the ceiling, the prior-claim aggregation, and the resulting exempt + taxable split. TDS is computed on the taxable portion only, and the employee receives a self-service breakdown via the ESS portal.

If you need to compute gratuity quickly without running an FnF, our free gratuity calculator uses the Section 10(10) formula directly.