Gratuity Tax Exemption — the Least-of-Three-Amounts Rule
Gratuity tax exemption under Section 10(10) is the LEAST of the actual gratuity received, ₹20,00,000, or the amount computed under the statutory formula (15/26 × last drawn wages × completed years) — government employees are fully exempt regardless of amount.
The four Labour Codes came into force on 21 November 2025. Central rules are still being finalised and state rules vary — some states have notified final rules, others remain in draft. Verify the position for your state before relying on these figures.
Fixed-term gratuity vests after 1 year under the Code on Social Security, not 5.
HRA, conveyance, special allowance, overtime, etc. — needed to compute the Codes' expanded wage base.
Non-covered establishments use 15/30, not 15/26.
Years of service
7y 1m
Qualifying years
7
Final year had ≤6 months, not rounded up
Required service
5 years
Formula: Statutory wages × 15/26 × qualifying years
Calculated gratuity (uncapped)
₹2,01,923
Ceiling limit
₹20,00,000
Payable amount₹2,01,923
Tax treatment (Section 10(10))
Tax-exempt amount: ₹2,01,923
Taxable amount: ₹0
TDS applicable: No
Why this amount — the wage base matters
On the OLD basic-only base (₹50,000/month), this gratuity would have been ₹2,01,923.
This employee's excluded allowances were already within the 50% cap, so the wage base is unchanged from basic-only — no add-back applies here.
The three-way test
For private-sector employees covered under the Payment of Gratuity Act, exemption from income tax under Section 10(10) is the LEAST of three figures: (a) the actual gratuity amount received, (b) the statutory ceiling of ₹20,00,000, and (c) the amount that would be computed under the statutory 15/26 formula. Whichever of these three is smallest is exempt; anything received above that figure is taxable as salary income in the year of receipt.
Government employees (Central and State) receive full exemption on gratuity regardless of amount — the ₹20,00,000 ceiling and the least-of-three test apply specifically to non-government employees.
Where the wage base change affects the tax calculation too
Since the statutory formula amount (test 'c' above) is now computed on the Labour Codes' expanded wage base rather than basic pay alone, an employee whose excluded allowances previously exceeded the 50% cap may find their formula-computed amount is higher than it would have been under the old basic-only calculation — which can, in some cases, push more of an actual lump-sum payout into the exempt category rather than the taxable one, since the formula ceiling (test 'c') rises alongside the other two tests.
What happens to the taxable portion
Any amount above the exempt limit is added to the employee's salary income for the relevant financial year and taxed at their applicable slab rate. Depending on the employer's payroll process, TDS may be deducted on the taxable portion at the time of payment — check with the employer's payroll/finance team on whether TDS was actually withheld before filing the return.
Frequently asked questions
Related pages
Why this matters
Gratuity disputes come down to two numbers — years of service and the wage base — and getting either wrong for one exiting employee is a liability. PracticeFlow keeps the calculation consistent across every client.
Related tools
Managing full-and-final settlements for 60 clients? PracticeFlow tracks exit dates, gratuity eligibility and settlement deadlines for every employee, across every client, in one place.
See PracticeFlow for CA FirmsEstimate for planning purposes, not legal or tax advice — always confirm with a CA/CS before finalising a settlement.