Gratuity of an employee not covered by the Payment of Gratuity Act

Gratuity and the provision that applies

Gratuity is a lump sum an employer pays an employee for long service, on retirement, on becoming incapacitated before retirement, on termination of employment, or to the legal heirs on death. It is part of salary (it is taxed under the head Salaries), and the exemption depends on who the employee is:

• Government and similar employees: the death-cum-retirement gratuity is wholly exempt (section 19(1), Table: Sl. No. 3), but only where it is received under the Central Government's revised pension rules or the Central Civil Services (Pension) Rules, 2021, or under a similar scheme for those in the Union's civil services (or holding defence-related or civil posts under the Union), the all-India services, a State's civil services (or civil posts under a State), or a local authority's employees (section 19(2)(g));
• employees covered by the Payment of Gratuity Act, 1972: the amount received, restricted to the amount worked out under section 4(2)-(3) of that Act (Sl. No. 5; formerly section 10(10)(ii));
• any other employee (not covered by that Act): Sl. No. 6, formerly section 10(10)(iii). The question names section 10(10)(ii); for an employee not covered by the Payment of Gratuity Act, the provision that applies is this one.

The exemption: the least of three amounts (section 19(1), Table: Sl. No. 6)

The deduction from salary is the least of:

1. the gratuity actually received;
2. the limit notified by the Central Government, having regard to the limit for its own employees: ₹20,00,000; and
3. half a month's salary for each completed year of service = ½ × A × B, where A is the average salary for the ten months immediately before the month of retirement (or other event) and B is the number of completed years of service.

The gratuity received less this deduction is taxable as salary.

Meaning of salary and average salary (section 19(2)(b))

For this purpose salary means basic salary and dearness allowance where the terms of employment make it part of retirement benefits; all other allowances and perquisites are left out. Average salary is the total of such salary for the ten months before the month of retirement, divided by ten, so an increment in those months raises it. Commission fixed as a percentage of the turnover the employee achieves is neither an allowance nor a perquisite, and is generally treated as part of salary for this purpose, so it also enters the ten-month average.

Completed years of service

Only complete years count: any part of a year is ignored (so 24 years and 10 months counts as 24). This is the main difference from an employee covered by the Payment of Gratuity Act, for whom a part of a year above six months counts as a full year at fifteen days' wages for each year (section 4(2) of that Act). There, for a monthly-rated employee, fifteen days' wages are the monthly wages last drawn divided by 26 and multiplied by 15; for a piece-rated employee, daily wages are the average of the total wages of the three months before termination, leaving out overtime; and an employee of a seasonal establishment not employed throughout the year gets seven days' wages for each season.

Points to note

1. Limit is for life. If gratuity has been received from more than one employer in the same year, or exempted in an earlier year, the total deduction cannot exceed the notified limit less the gratuity already allowed (section 19(2)(a)).
2. Gratuity received while in service is fully taxable; the deduction applies only on retirement, incapacity or termination.
3. Gratuity on death paid to the legal heirs is not salary of the heirs, since they were not employees of the payer; Sl. No. 6 itself speaks of gratuity received by an employee on retirement, incapacity or termination.
4. Relief. Section 157(1) (formerly section 89) applies only if the total income is assessed at a rate higher than it would otherwise have been because of one of the receipts it lists: a sum in the nature of arrear or advance salary, salary for more than twelve months in one tax year, profits in lieu of salary under section 18(1), or arrears of family pension. Where the taxable gratuity falls within one of these, the Assessing Officer, on an application made by the employee, grants such relief as is prescribed. No relief is granted on income for which a deduction under section 19(1), Table: Sl. No. 12 has been claimed for that or any other tax year (section 157(2)).

Illustration (our own)

Ms. Meera retires on 15 March 2027 after 28 years and 8 months of service with a private firm not covered by the Payment of Gratuity Act and receives ₹15,00,000 as gratuity. Her basic salary is ₹80,000 a month, and dearness allowance (part of retirement benefits) is 25% of basic; there is no increment in the last ten months. Average salary = ₹80,000 + ₹20,000 = ₹1,00,000. The deduction is the least of (1) ₹15,00,000, (2) ₹20,00,000 and (3) ½ × ₹1,00,000 × 28 = ₹14,00,000, that is ₹14,00,000. Taxable gratuity = ₹15,00,000 − ₹14,00,000 = ₹1,00,000.