Published 21 October 2026
When employment ends, the last salary slip can carry more than a year’s pay: gratuity, encashment of accumulated leave, perhaps a voluntary retirement package or retrenchment compensation. Each is salary, and each has its own formula for the part that escapes tax. The formulas share a feature that catches people out. The limits are lifetime ceilings, shared across every employer and every year. The Income-tax Act, 2025 has also moved these reliefs. They are no longer exemptions in section 10 but deductions from salary in section 19, and in one case an entry in Schedule III. This guide sets out each receipt, its limit and its address in both Acts. Pension and its commutation are covered separately, in Pension, Commuted Pension and Family Pension.
Which Act governs which year
- Receipts in financial year 2025-26 (assessment year 2026-27) and earlier. Section 10 of the Income-tax Act, 1961 governs, in clauses (10) gratuity, (10AA) leave encashment, (10B) retrenchment compensation and (10C) voluntary retirement.
- Receipts in tax year 2026-27 onwards. The Income-tax Act, 2025 governs. The reliefs are deductions in the Table in section 19(1), read with section 19(2). Gratuity paid to the family on an employee’s death is excluded by Schedule III, serial number 38, given effect by section 11.
- The year of receipt decides which Act applies. Notifications fixing the monetary limits under the 1961 Act continue under the 2025 Act, “so far as it is not inconsistent”, by section 536(2)(j).
| Receipt | 1961 Act | 2025 Act |
|---|---|---|
| Gratuity, Government employees | s.10(10)(i) | s.19(1), serial numbers 3 and 4 |
| Gratuity under the Payment of Gratuity Act, 1972 | s.10(10)(ii) | s.19(1), serial number 5 |
| Any other gratuity | s.10(10)(iii) | s.19(1), serial number 6; s.19(2)(a), (b) |
| Gratuity to widow, children or dependants on death | s.10(10)(iii) | Schedule III, serial number 38 |
| Leave encashment, Government employees | s.10(10AA)(i) | s.19(1), serial number 13 |
| Leave encashment, other employees | s.10(10AA)(ii) | s.19(1), serial number 14; s.19(2)(b), (f) |
| Retrenchment compensation | s.10(10B) | s.19(1), serial numbers 10 and 11; s.19(2)©, (d) |
| Voluntary retirement or separation | s.10(10C), rule 2BA of the 1962 Rules | s.19(1), serial number 12; s.19(2)(e), (h); rule 20 of the 2026 Rules |
| Commuted pension | s.10(10A) | s.19(1), serial numbers 7 to 9 |
Both regimes keep these reliefs
The new regime under section 115BAC of the 1961 Act does not exclude any of these clauses. Its list in section 115BAC(2)(i) names section 10(5), (13A), (14), (17) and (32), and leaves out (10), (10AA), (10B) and (10C). Section 202(2)(a)(iv) of the 2025 Act excludes only serial number 1 of the section 19 Table, which is professional tax. The gratuity, leave encashment, retrenchment and voluntary retirement entries remain available to an employee in either regime.
Gratuity
Government employees. Death-cum-retirement gratuity under the Central Government’s pension rules or similar schemes, and retiring gratuity of the defence services, are wholly free of tax. The 2025 Act names the Central Civil Services (Pension) Rules, 2021 in section 19(2)(g).
Employees covered by the Payment of Gratuity Act, 1972. The relief is the gratuity received, limited to the amount calculated under section 4(2) and (3) of that Act. Section 4(2) gives fifteen days’ wages at the rate last drawn for every completed year of service, or part of a year above six months. Section 4(3) caps the total. The Income Tax Department’s published answer on this point gives the ceiling as Rs 20,00,000, under S.O. 1420(E) of 29 March 2018. Serial number 5 of the 2025 Act Table refers to gratuity received under the Payment of Gratuity Act, 1972. This guide does not address the effect of the Code on Social Security, 2020 on that reference.
Any other gratuity on retirement, on incapacity before retirement, or on termination. The relief is the least of three amounts:
- the gratuity received;
- the limit notified by the Central Government; and
- half a month’s salary for each completed year of service, on the average salary of the ten months immediately before the month of the event.
The notified limit is Rs 20,00,000, set by Notification No. 16/2019 (S.O. 1213(E)) of 8 March 2019 for events on or after 29 March 2018. Section 19(1), serial number 6, sets out the same three amounts. “Salary” here means basic pay and dearness allowance that forms part of retirement benefits under the terms of employment, and excludes all other allowances and perquisites. This is section 19(2)(b), and under the 1961 Act rule 2(h) of Part A of the Fourth Schedule.
The ceiling is cumulative. Under the provisos to section 10(10)(iii), gratuities from more than one employer in the same year share one limit. That limit is reduced by any gratuity exempted in an earlier year. Section 19(2)(a) of the 2025 Act writes this as “A − B”. A is the notified limit. B is the gratuity “received in any one or more earlier tax years and allowed as an exemption or a deduction”.
On death. Under the 1961 Act, section 10(10)(iii) extends to gratuity “received by his widow, children or dependants on his death”, within the same limits. Under the 2025 Act, Schedule III, serial number 38, excludes from the income of any widow, children or dependants “Any gratuity computed as per the provisions of section 19(1)(Table: Sl. No. 3.C) to (Table: Sl. No. 6.C)”.
Leave encashment on retirement
Leave encashed while still in service is salary in full. It is within section 17(1)(va) of the 1961 Act and section 16(h) of the 2025 Act, with no relief. The relief applies only to leave encashed “at the time of his retirement whether on superannuation or otherwise”.
Government employees. The cash equivalent of earned leave at retirement is wholly free of tax. This is section 10(10AA)(i), and serial number 13 of the 2025 Act Table.
Other employees. The relief is the least of:
- the cash equivalent of the leave salary for the earned leave at credit, counting no more than 30 days for every year of actual service;
- ten months’ average salary, on the ten months immediately before retirement;
- the limit notified by the Central Government; and
- the amount actually received.
The notified limit is Rs 25,00,000, set by Notification No. 31/2023 of 24 May 2023 with effect from 1 April 2023. It replaced the Rs 3,00,000 limit in force since 2002. Serial number 14 of the 2025 Act Table sets out the same four amounts, with the ten-month figure written as “A = 10 × B”.
The ceiling is cumulative here too. The provisos to section 10(10AA)(ii), and section 19(2)(f) of the 2025 Act, apply the same “A − B” rule across employers and years. Someone who encashed leave on leaving an earlier job, and had part of it exempted, has a smaller ceiling at final retirement.
A worked example
A private-sector employee not covered by the Payment of Gratuity Act retires after 25 completed years. His average salary (basic and qualifying DA) for the last ten months is Rs 1,20,000 a month. He has 240 days of earned leave at credit, and no earlier exempt gratuity or leave encashment. The figures are the same in FY 2025-26 and tax year 2026-27.
| Gratuity | Leave encashment | |
|---|---|---|
| Amount received | Rs 18,00,000 | Rs 9,60,000 |
| Formula figure | Half month × 25 years: Rs 15,00,000 | Leave salary for 240 days: Rs 9,60,000; ten months’ average: Rs 12,00,000 |
| Notified limit | Rs 20,00,000 | Rs 25,00,000 |
| Free of tax (least) | Rs 15,00,000 | Rs 9,60,000 |
| Taxable as salary | Rs 3,00,000 | nil |
The taxable gratuity of Rs 3,00,000 relates to past service. Relief from the higher rate may be available under section 89 of the 1961 Act or section 157 of the 2025 Act. See Relief for Salary Arrears: Form 10E.
Voluntary retirement or separation
Section 10(10C) exempts an amount received on voluntary retirement or termination under a scheme of voluntary retirement, or a public sector company’s scheme of voluntary separation, “to the extent such amount does not exceed five lakh rupees”. It applies to employees of the bodies listed, from companies and co-operative societies to universities, IITs and the Central and State Governments. Serial number 12 of the 2025 Act Table allows the least of the compensation received and Rs 5,00,000. Section 19(2)(h) lists the same employers.
Four conditions apply.
- The scheme. It must meet the guidelines in rule 2BA of the 1962 Rules or rule 20 of the 2026 Rules:
- it applies to employees with ten years’ service or aged forty, a condition that does not apply to a public sector company’s voluntary separation scheme;
- it covers all employees except directors;
- it reduces the existing strength, and the vacancy is not filled;
- the employee is not re-employed in a concern under the same management; and
- the amount does not exceed three months’ salary for each completed year of service, or salary at retirement multiplied by the months of service left before superannuation. Rule 20(2)(vi) writes these as “A” and “B”.
- Once in a lifetime. Under the second proviso to section 10(10C) and section 19(2)(e)(ii), once the relief is allowed for one year, none is allowed for any other year.
- No double relief. Relief under section 89 or section 157 on the same amount rules out the voluntary retirement relief, and the other way round. This is the third proviso to section 10(10C), section 19(2)(e)(iii), and section 157(2).
- The amount above Rs 5,00,000 is taxable as profits in lieu of salary.
Retrenchment compensation
Compensation received by a workman at the time of retrenchment is relieved to the least of:
- the compensation received;
- the amount under section 25F(b) of the Industrial Disputes Act, 1947; and
- an amount notified by the Central Government, which may not be less than Rs 50,000.
This is section 10(10B), and serial number 10 of the 2025 Act Table. Under the second proviso, and serial number 11, compensation under a scheme approved by the Central Government is wholly relieved. Closure of the undertaking, and certain transfers of ownership that interrupt service or worsen its terms, are treated as retrenchment.
How these receipts are reported
The employer shows each amount, and the part it has treated as exempt or deductible, in Form 16. Under the 2026 Rules this is Form No. 130. See TDS Certificates: Form 16 and 16A. Tax on the taxable part is deducted as salary, as described in Deducting and Depositing TDS. In the return for AY 2026-27, the exempt part is shown against the relevant clause of section 10 in the salary schedule. A job change in the year, with settlement items from the old employer, is covered in Changing Jobs: Two Employers in One Year.
What to have ready
- The full and final settlement statement, showing gratuity, leave encashment, notice pay, any voluntary retirement or retrenchment payment, and the tax deducted.
- Service details: the date of joining, the date of leaving, completed years of service, and whether the employer is covered by the Payment of Gratuity Act.
- Salary for the last ten months, split into basic pay, dearness allowance that counts for retirement benefits, and other allowances.
- The earned leave balance at the date of leaving, and the leave rules showing days earned each year.
- Any earlier gratuity or leave encashment exempted in previous years, from any employer, to fix the remaining ceiling.
- For voluntary retirement: the scheme document, and confirmation that no earlier voluntary retirement relief and no section 89 or 157 relief was claimed on the amount.
- Form 16 or Form No. 130 from the employer.
In order
- Each receipt is identified: gratuity, leave encashment, voluntary retirement payment, retrenchment compensation or commuted pension.
- The Act is chosen by the year of receipt: section 10 of the 1961 Act up to FY 2025-26, section 19 and Schedule III of the 2025 Act from tax year 2026-27.
- Each formula is applied: the least of the listed amounts, with “salary” as the Acts define it.
- The remaining lifetime ceiling is checked after any earlier exempt gratuity or leave encashment, from any employer.
- The taxable balance is included in salary. Relief under section 89 or 157 is considered for gratuity or compensation, unless a voluntary retirement relief has been claimed on it.
This guide completes the salaried set. Pension, commutation and family pension are covered in Pension, Commuted Pension and Family Pension.