Taxation of Gratuity: Permanent or Resettable?

Understanding the Complexities of Gratuity Taxation

Gratuity is a crucial retirement benefit for salaried employees, but its tax treatment often creates confusion, particularly for those who switch jobs multiple times during their career. One of the most debated questions among taxpayers is whether the Rs 20 lakh tax-exempt gratuity limit under Section 10(10) of the Income Tax Act applies separately for every employer or whether it is a lifetime cumulative limit.

The Basics of Gratuity

Gratuity is a financial benefit provided by an employer to an employee, separate from the regular monthly salary. It is governed by the Payment of Gratuity Act, 1972, and is generally paid when an employee retires, resigns, attains superannuation, or faces death or disability due to an accident or illness. Superannuation refers to the stage when an employee reaches the official retirement age. However, gratuity benefits are typically not applicable to interns or temporary employees.

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To be eligible for gratuity, an employee must complete at least 5 years of continuous service with the employer. However, workers who joined a company on or after the new labour codes were implemented will be eligible to receive gratuity after completing one year of continuous service with their employer.

How Gratuity Works

Under the Income Tax Act, gratuity received up to Rs 20 lakh is exempt from tax, subject to specified conditions. For salaried employees, the payout is calculated using a prescribed formula under the law, although employers may choose to pay an amount higher than the statutory limit at their discretion.

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The gratuity calculation formula is as follows:

Gratuity = (Last Drawn Salary × 15 × Completed Years) ÷ 26

Where,

• Last Drawn Salary = Basic + Dearness Allowance (DA)
• 15 is the number of days' salary paid for each year of service.
• 26 is the number of working days in a month (excluding Sundays).

Cumulative Gratuity Exemption Limit

The gratuity exemption limit does not apply separately for each employer. Rather, the exemption ceiling under Section 10(10) is cumulative across the employee's entire career. This is one of the most important yet commonly misunderstood principles relating to gratuity taxation.

According to CBDT Circular No. 573 dated 21 August 1990, where gratuity exemption has already been claimed from a previous employer, the exemption available in subsequent employment gets reduced to that extent. In other words, the exemption limit is a lifetime cap and not a fresh deduction available every time an employee changes employment.

Tracking Remaining Lifetime Limit

To navigate gratuity taxation smoothly, professionals must retain tax breakup statements from all past employers to track their remaining lifetime limit. This tracking is especially important now, as modern rules allow shorter contracts to qualify for gratuity, making multiple payouts common. Fortunately, this tax protection remains accessible under both the old and the simplified new tax regimes.