Understanding Gratuity Exemption Limit for Government Employees in India

Gratuity is a statutory benefit provided to employees as a token of gratitude for their long-term service when they retire, resign, or in case of their death or termination. For government employees in India—covering Central and State Government employees, defense personnel, and employees in local authorities—the gratuity received is fully exempt from income tax under Section 10(10)(i) of the Income Tax Act. This means the entire amount of gratuity paid upon retirement or death is tax-free.

Increased Exemption Limit to ₹25 Lakh (2024)

Effective January 1, 2024, the maximum gratuity payable to eligible Central Government employees has been raised from ₹20 lakh to ₹25 lakh. This increase followed the rise of the Dearness Allowance (DA) to 50% of Basic Pay, based on the recommendations of the 7th Central Pay Commission. The Department of Pension & Pensioners Welfare issued an official memorandum confirming this enhancement.

Key Points:

• Full Tax Exemption for Government Employees: Unlike private sector employees, government employees receive 100%exemption on gratuity receipt, irrespective of the amount, up to the maximum payable limit.
• Maximum Gratuity Payment Limit: The cap for gratuity payment is now ₹25 lakh. This applies to retirement gratuity as well as death gratuity for Central Government employees.
• State Government Differences: While the ₹25 lakh limit applies to Central Government employees, state government employees’ limits may vary depending on the respective state rules.
• Private Sector vs. Government Sector: Private sector employees have a maximum exemption limit of ₹20 lakh on gratuity under Section 10(10)(ii) or (iii), and the exemption calculations differ based on whether they are covered under the Payment of Gratuity Act, 1972 or not.

Calculation and Tax Treatment for Private Sector Employees

For private sector employees covered under the Payment of Gratuity Act, the exemption is the minimum of:

• Actual gratuity received,
• 15 days’ salary for each year of service, calculated as (Last drawn salary (Basic + DA) × years of service × 15/26),
• ₹20 lakh (exemption limit).

Any amount exceeding the exemption limit is taxable.

Summary

This summary captures the recent policy update that government employees in India can receive gratuity tax-free up to ₹25 lakh in 2024, reflecting the government’s commitment to aligning retirement benefits with inflation and cost of living increases. The clarity on exemption limits helps both employees and employers understand their rights and obligations concerning gratuity payments and taxation.

When an employee is removed from a company due to recession (i.e., retrenchment or termination for economic reasons), the taxability of retirement benefits like ex-gratia depends on the nature and terms of the payment:

• Ex-gratia payments on termination due to retrenchment or recession are generally taxable as salary income under Section 17(3) of the Income Tax Act unless they qualify for specific exemptions. In most cases, ex-gratia payments given upon termination are treated as “profits in lieu of salary” and are taxable.
• However, if the ex-gratia payment is voluntary and without any legal obligation or contract to pay it, such a payment is often considered a capital receipt and may not be taxable as salary. This depends on whether the payment is made as genuine ex-gratia (i.e., a gift or favor) rather than compensation tied to employment termination.