How Is Gratuity And Interest On Delayed Payment Taxed?

Gratuity is a lump sum amount that is payable to the employee by the employer to express gratitude to the loyal employees. For many employees, this works as a motivation factor to stay with one employer for at least five years while building up the retirement corpus through this amount. Although it started as a token of appreciation, it was made a legal obligation under the Payment of Gratuity Act, 1972, for establishments employing 10 or more employees. The Act has been subsumed by the Code on Social Security, 2020, which is now part of the labour codes; however, the core provisions remain largely the same.

One important change introduced in the new labour codes is that the gratuity is now payable to fixed-term employees (FTEs) only after one year. For a permanent employee, the eligibility period remains five years.

An employee must complete a minimum of five years of continuous service to be eligible for receiving gratuity. However, in case of death or disability, it is paid before completing this mandatory service period.

While it is paid as a lump sum, intending to provide employees with a financial cushion at the time of leaving the organisation, unlike lump sum provident fund payment, gratuity is not 100 per cent tax-free.

Is Gratuity Taxable?

The taxability of gratuity depends on whether the individual is a government sector or a private sector employee.

CA Ashish Niraj, Partner, A S N & Company, Chartered Accountants, says, “Gratuity is taxable if it is withdrawn during the service. If it is payable on retirement, death, resignation, etc., then, for private sector employees its exempt for up to Rs 20 Lakh. For government sector employees, gratuity is fully exempt on retirement, resignation, death, etc.”

For government employees, the gratuity received upon retirement is fully tax-exempt from income tax.

For private sector employees, the taxability depends on the amount received and whether the organisation is covered under the Act. In 2025, the government amended the law and increased the exempted gratuity limit from Rs 10 lakh to Rs 20 lakh, under section 10 (10) of the Income-tax Act.

How Is Gratuity Taxed?

For private sector employees, the gratuity is calculated differently, based on an organisation’s coverage under the Act.

Covered By The Act:

If a company is covered under the Act (the organisation has 10 or more employees), the tax-exemption will be the least amount of the following:

• Actual gratuity received

• Rs 20 lakh statutory limit

• Calculated amount based on this formula: Gratuity = (Last Drawn Salary × 15 days × Years of service) ÷ 26 days

Not Covered By The Act:

For smaller organisations that are not covered under the Act, the exemption limit is the least of the following:

• Actual gratuity received

• Rs 20 lakh statutory limit

• Calculated amount based on this formula: Gratuity = (Last Drawn Salary × 15 days × Years of service) ÷ 30 days

But, in the event of the death of an employee, the gratuity is paid to the nominee or legal heir. For them, gratuity is not a part of salary; therefore, it is considered under the income from other sources for the nominee or legal heirs.  

Notably, as per Section 7(3) of the Act, the employer is liable to pay gratuity within 30 days. It states: “The employer shall arrange to pay the amount of gratuity within thirty days from the date it becomes payable to the person to whom the gratuity is payable.”

But what if an employer does not pay it on time?

Delay In Gratuity Payment

According to Section 7(3A) of the Act, “If the amount of gratuity payable under sub-section (3) is not paid by the employer within the period specified in sub-section (3), the employer shall pay, from the date on which the gratuity becomes payable to the date on which it is paid, simple interest at such rate, not exceeding the rate notified by the Central Government from time to time for repayment of long-term deposits, as that Government may, by notification specify.”

Niraj explains, “If gratuity is not paid within 30 days of it becoming due, then the employer is liable to pay interest at the prevailing rate (currently 10 per cent) per annum.”

Is Interest On Delayed Payment Of Gratuity Taxable?

Unlike the principal gratuity amount, there is no tax exemption available on interest amount. It is taxed for the employees under the ‘Income from other sources'. It is added to their total income for that year and taxed as per their tax slab rate.