Archive / Investment Adviser (Level 2) / Retirement Products

nism-series-xb-section-10-10-iii-gratuity-not-covered-employees[ INVESTMENT ADVISER (LEVEL 2) ]

Under Section 10(10)(iii) of the Income Tax Act, what is the statutory formula to calculate tax-exempt gratuity for employees NOT COVERED under the Payment of Gratuity Act?

[ A ]Gratuity = (15 / 26) * Last drawn salary * Service years (Covered employee formula).

[ B ]Gratuity = Total annual salary * 10.

[ C ]Non-covered employees receive zero gratuity under Indian law.

[ D ]Gratuity = Half-month's average salary (15 / 30) for each completed year of service, based on the average salary of the last ten (10) months preceding retirement (subject to the statutory ₹20 Lakhs ceiling).[ CORRECT ]

Takeaway

The correct answer is D: for employees not covered under the Payment of Gratuity Act, tax-exempt gratuity under Section 10(10)(iii) is computed as half a month's average salary (15/30) for each completed year of service, based on the average of the last 10 months' salary, capped at ₹20 lakhs.

Derivation

The Act distinguishes two formulas. Covered employees (under the Payment of Gratuity Act, 1972) use 15/26 of the last drawn salary per year of service -- a more generous fraction based on a 26-day working month. Non-covered employees instead use 15/30 (half a month) of the average salary drawn over the 10 months immediately preceding retirement, reflecting a smoother, averaged base rather than a single last-drawn figure. Both formulas remain subject to the overall statutory exemption ceiling of ₹20 lakhs under Section 10(10)(iii). The exam regularly swaps these two formulas to test whether candidates know which applies to which category of employee.

Why the others fail

A — Gratuity = (15 / 26) * Last drawn salary * Service years (Covered employee formula).

This is the formula for employees COVERED under the Payment of Gratuity Act (15/26 on last drawn salary), not the non-covered formula being asked about.

B — Gratuity = Total annual salary * 10.

Fabricated formula with no statutory basis; gratuity is never simply ten times annual salary under any recognized provision.

C — Non-covered employees receive zero gratuity under Indian law.

False; Section 10(10)(iii) explicitly provides a statutory gratuity exemption formula for employees outside the Gratuity Act's coverage.