Gratuity

Gratuity is the employer's thank-you for long service, made compulsory by law. Under the Payment of Gratuity Act, 1972 it must be paid when employment ends — on retirement, resignation or otherwise — provided the employee has at least five years of continuous service.

Two things set it apart from the other employer benefits in Chapter 6. The employee contributes nothing. And it is paid in a lump sum, not as a pension: there is no corpus to commute and no annuity to buy.

For a retirement plan it is a one-time inflow at the start of retirement, and most of its value lies in how much of it escapes tax.

Eligibility. Termination of employment after not less than five years' continuous service. The five-year condition does not apply where termination is due to death or disablement. Section 4(3) of the Act deals with the limit on gratuity payable.

Tax — Government employees. All retirement and gratuity benefits received are exempt under section 10(10).

Tax — non-Government employees. Exempt up to the least of:

The exemption is not available for gratuity paid while the employee is still in service.

A separate ceiling. Chapter 6 notes that the Rs 20 lakh tax figure should be distinguished from the gratuity ceiling for Central Government employees, enhanced to Rs 25 lakh with effect from 1 January 2024 under Central Government service rules.

Exempt gratuity (non-Government) = least of
   (a) 0.5 × average monthly salary × completed years of service
   (b) Rs 20,00,000
   (c) actual gratuity received

Taxable gratuity = actual gratuity received − exempt gratuity

Farida retires from a private company after 24 completed years. Her average monthly salary is Rs 1,20,000 and the company pays Rs 17,00,000 in gratuity. (The salary and payment are illustrative; the test is the workbook's.)

(a) 0.5 × 1,20,000 × 24 = Rs 14,40,000
(b) Statutory cap        = Rs 20,00,000
(c) Actual received      = Rs 17,00,000

Exempt  = least of the three = Rs 14,40,000
Taxable = 17,00,000 − 14,40,000 = Rs 2,60,000

Change one fact. Had she been a Government employee, the full Rs 17,00,000 would be exempt under section 10(10) — no least-of test.

Change another. Had the company paid the same sum while she was still in service, none of it would be exempt.

And if she had left after 4 years 11 months? No gratuity would be payable under the Act — unless the termination was due to death or disablement, where the five-year condition does not apply.

Chapter 6, section 6.1 (Mandatory Retirement Benefit Schemes), covers gratuity with the Employees' Provident Fund, the Employees' Pension Scheme, EDLI and superannuation. The first Chapter 6 sample question asks how gratuity is paid — in a lump sum. Expect that question, the five-year condition and its death-or-disablement exception, and a least-of-three exemption calculation.

• Gratuity is a lump sum. It is not commuted, not annuitised and not credited to the EPF each year — the sample question's three wrong answers.
• Half a month's salary per completed year, not a full month's.
• Rs 20 lakh is the tax exemption cap; Rs 25 lakh is the Central Government gratuity ceiling from 1 January 2024. They are different figures for different purposes.
• Government employees are fully exempt under section 10(10); the least-of test is for non-Government employees.
• No exemption while still in service.
• The five-year rule does not apply on death or disablement.
• Stale statutory reference. This passage cites section 10(10) of the 1961 Act without the Income-tax Act, 2025 cross-reference the rest of the workbook provides. The exam figure remains section 10(10) as printed.