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India exit checklist

Tax on your exit payments

Most of a well-structured settlement is tax-free — but only if the exemptions are applied properly. Here is which part of yours is exempt, and which is not.

Quick Answer

How much tax will I pay on my full and final settlement?

The two largest components carry the two largest exemptions — but ₹20 lakh on gratuity and ₹25 lakh on leave encashment are ceilings, not automatic exemptions. Each is a least-of test, and the ceiling is only its last limb. On ordinary salaries a service- or salary-based limb binds well below it: three years' service on ₹40,000 of Basic + DA caps the gratuity exemption at about ₹69,000, not ₹20 lakh.

Everything else — unpaid salary, notice pay in lieu, and bonus — is ordinary salary income and fully taxable. Reimbursement of genuine business expenses is not income at all. Critically, both ceilings are lifetime figures across every employer you ever have, not fresh allowances at each job.

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Gratuity, leave encashment, unpaid salary, bonus

Tax on your exit payments

Which parts are exempt, which are taxable, and what's left

Which describes your employer?

Ten or more employees — the usual case.

These decide your exemption, so they are not optional. The ₹20 lakh and ₹25 lakh figures are ceilings, not automatic exemptions — for most people a service-based formula caps the exemption well below them. Without your service and salary we would have to assume the ceiling applies, which would overstate what is tax-free.

Counted at no more than 30 days per completed year, whatever your employer's policy allowed.

Have you used any of these exemptions before?+

Both ceilings are lifetime limits across every employer you have ever had — not fresh limits for each job. If you claimed exemption on gratuity or leave encashment at a previous exit, enter it here so the headroom is right.

Your marginal tax rate

The rate your top slice of income is taxed at. We deliberately do not compute slabs — the right answer depends on your regime, rebate, surcharge and cess.

Key takeaways

  • →Every exemption here is a LEAST-OF test. ₹20 lakh on gratuity and ₹25 lakh on encashment are the last limb, not the answer.
  • →For most people a service- or salary-based limb binds far below the ceiling. Three years at ₹40,000 Basic + DA caps the gratuity exemption near ₹69,000.
  • →The encashment test cuts a large leave balance back to 30 days per completed year, and values it on average Basic + DA — not on whatever your employer encashed.
  • →Both ceilings are LIFETIME figures across all employers — not per job. Almost nobody tracks this.
  • →The ₹25 lakh encashment ceiling replaced ₹3 lakh in 2023. Older articles are badly out of date.
  • →Retrenchment compensation and a qualifying VRS each carry their own ₹5 lakh exemption. Ordinary ex-gratia carries none.
  • →Those ₹5 lakh figures are ceilings too — for short service the pay-based limb caps the exemption far lower.
  • →Unpaid salary, notice pay in lieu and bonus are fully taxable. Expense reimbursement is not income.
  • →GST is not payable on notice pay recovery — CBIC Circular 178/10/2022-GST settles it.

How each component is taxed

Tax treatment of Indian exit payment components
ComponentTreatmentAuthority
GratuityExempt at the lowestof: amount received; 15/26 of last drawn Basic + DA per completed year (half a month's average salary per year if the employer is outside the gratuity statute); and ₹20 lakh lifetime. Excess taxable as salary.s.10(10); CBDT Notn. 16/2019
Leave encashmentExempt at the lowestof: amount received; 10 months' average salary; unused leave capped at 30 days per completed year and valued on average Basic + DA; and ₹25 lakh lifetime. Excess taxable.s.10(10AA)(ii); CBDT Notn. 31/2023
Unpaid salaryFully taxable as salary.Ordinary salary income
Notice pay in lieuFully taxable. No exit-specific exemption.Ordinary salary income
Bonus / incentiveFully taxable in the year received.Ordinary salary income
Retrenchment compensationExempt at the lowestof: amount received, 15 days' average pay per completed year, and ₹5 lakh. No ceiling where the scheme is Central Government approved.s.10(10B) / 2025 Act s.19; ID Act s.25F(b)
VRS / voluntary separationExempt to ₹5 lakh, once in a lifetime, if the scheme meets Rule 2BA. Breach the Rule 2BA amount cap and the exemption is lost in full.s.10(10C) / 2025 Act s.19 Sl.12; Rule 2BA
Ex-gratia / severanceFully taxable. No exemption for a goodwill payment as such.Profit in lieu of salary
Expense reimbursementNot income at all, where it reimburses actual expenses.Not a perquisite

The lifetime ceiling nobody tracks

This is the single most consequential thing on this page, and it is almost never explained properly. Both exemptions are lifetime limits. If you claimed ₹8 lakh of gratuity exemption when you left a job in 2019, you have ₹12 lakh of headroom left — not a fresh ₹20 lakh.

Write your remaining headroom down somewhere you will find it. Nobody sends you a statement of exemption used, no employer tracks it across jobs, and the obligation to get it right sits with you. The calculator above reports what you have left after this settlement — note it for your next exit.

For most people this never bites, because a career total below ₹20 lakh of gratuity is common. It bites hardest on senior employees with long service at two or more employers, which is precisely the group most likely to assume the exemption resets.

“Severance” is three different payments

Employers routinely write ex-gratia on the payslip whatever the exit actually was. The label does not decide the tax; the substance does, and the three possibilities are taxed very differently.

Retrenchment compensation

Exempt at the lowestof what you received, 15 days' average pay for each completed year of continuous service, and ₹5,00,000. The middle limb is the one people miss: at ₹50,000 a month and three years' service it caps the exemption at ₹75,000, not ₹5 lakh. A part-year over six months counts as a full year. Where the scheme is approved by the Central Government the ceiling does not apply at all.

One genuinely unsettled point. Turning monthly average pay into a daily rate needs a divisor, and the Industrial Disputes Act does not supply one. Read fifteen days as half a month and you divide by 30; treat a monthly-rated worker as paid for 26 working days — the base the Payment of Gratuity Act uses expressly — and you divide by 26, which is about 15% more exemption. On the example above that is ₹86,538 rather than ₹75,000. The calculator computes both and defaults to the 30-day figure, since understating an exemption is the recoverable mistake. Check which base your employer used and raise it if the difference favours you.

Voluntary retirement or separation

Exempt at the lower of what you received and ₹5,00,000 — once in a lifetime. The trap is Rule 2BA: the scheme must not pay more than the higher of three months' salary per completed year, or salary for the months you had left to superannuation. Exceed it and the scheme stops qualifying, so the exemption is lost entirely rather than trimmed back to the cap.

Ordinary ex-gratia

A goodwill or negotiated payment carries no exemption and is fully taxable as profit in lieu of salary. This is the correct answer for most private-sector settlements, and no amount of relabelling changes it.

Check what your letter says, not what the payslip says. If you were retrenched, or left under a formal scheme, tell the calculator above — it applies the right test. If your Form 16 treats an exempt component as fully taxable, that is worth raising with payroll in writing before you file.

One more interaction worth knowing: you cannot claim the VRS exemption and relief under section 89 (Form 10E) or section 157 (Form 39) on the same amount. Retrenchment compensation, by contrast, does qualify for that relief — so if yours is large, it is worth checking both routes.

GST on notice pay recovery: settled, and in your favour

For several years after GST came in, some employers charged GST on notice pay recovered from departing employees, on the theory that the employer was “tolerating an act” — a taxable supply under Schedule II.

CBIC Circular No. 178/10/2022-GST, dated 3 August 2022, clarified that this is wrong. Forfeiture of salary or recovery of notice pay for early departure is a deterrent against breach, not consideration for tolerating an act, and therefore not a taxable supply. GST is not leviable on notice pay recovery.

If your settlement statement shows GST added to a notice recovery, that circular is what to cite. Ask payroll in writing which authority they are relying on — in most cases the line simply comes off.

Two worked settlements

The first is the case where the headline ceilings really do decide the answer. It takes a long career and a large salary to get there, and the assumptions are set out in full precisely because they are doing the work. The second is the far more common case, where a limb you may never have heard of binds instead.

1. Rakesh — long service, high salary, and the ceilings bind

Rakesh leaves after 22 completed years. His last drawn Basic + DA is ₹2,60,000 a month, and that is also his average over the last ten months. He holds 300 days of unused earned leave. His employer is covered by the gratuity statute. He has never claimed either exemption before, and his marginal rate is 30%. His settlement is gratuity ₹25,00,000, leave encashment ₹30,00,000, unpaid salary and bonus ₹4,00,000, and expense reimbursement ₹50,000.

Gratuity — s.10(10)(ii), least of three

  • Received: ₹25,00,000
  • Formula: (₹2,60,000 ÷ 26) × 15 × 22 years = ₹33,00,000
  • Lifetime ceiling: ₹20,00,000 ← lowest, so this binds
  • Exempt ₹20,00,000; ₹5,00,000 taxable

Leave encashment — s.10(10AA)(ii), least of four

  • Received: ₹30,00,000
  • Ten months' average salary: 10 × ₹2,60,000 = ₹26,00,000
  • Eligible leave: 300 days held, inside the 30-per-completed-year limit of 660, valued at ₹2,60,000 ÷ 30 = ₹8,667 a day = ₹26,00,000
  • Lifetime ceiling: ₹25,00,000 ← lowest, so this binds
  • Exempt ₹25,00,000; ₹5,00,000 taxable
  • Salary and bonus: ₹4,00,000 taxable
  • Reimbursement: not income
  • Total taxable: ₹14,00,000 → tax at 30% ≈ ₹4,20,000

He received ₹59,50,000 and keeps about ₹55,30,000. ₹45,50,000 of it escaped tax — ₹20,00,000 of gratuity, ₹25,00,000 of encashment and the ₹50,000 reimbursement, which was never income in the first place. Notice how narrowly the ceilings won: the other limbs came in at ₹26,00,000 and ₹33,00,000. Drop his salary or his service a little and a different limb decides it. His lifetime headroom on both ceilings is now fully used, a fact worth recording if he ever changes jobs again.

2. Priya — the ceilings are nowhere near it

Priya leaves after 6 completed years. Her last drawn Basic + DA is ₹60,000 a month, the same as her ten-month average, but her gross is ₹1,20,000 and her employer's policy encashes leave on gross. She holds 200 days of unused earned leave. She receives gratuity of ₹3,00,000 — more than the statutory formula, as a contractual top-up — and leave encashment of ₹8,00,000 (200 × ₹1,20,000 ÷ 30).

Gratuity — least of three

  • Received: ₹3,00,000
  • Formula: (₹60,000 ÷ 26) × 15 × 6 = ₹2,07,692 ← binds
  • Ceiling: ₹20,00,000
  • Exempt ₹2,07,692; ₹92,308 taxable

Leave encashment — least of four

  • Received: ₹8,00,000
  • Ten months' average salary: ₹6,00,000
  • Eligible leave: her 200 days are cut back to 180 (30 × 6 completed years) and valued on average Basic + DA at ₹60,000 ÷ 30 = ₹2,000 a day = ₹3,60,000 ← binds
  • Ceiling: ₹25,00,000
  • Exempt ₹3,60,000; ₹4,40,000 taxable

She was paid ₹8,00,000 of encashment and only ₹3,60,000 of it is exempt — despite being ₹21 lakh clear of the ₹25 lakh ceiling. Two things did it: the 30-day-per-completed-year cut-back, and the fact that the exemption is valued on average Basic + DAeven though her employer generously encashed on gross. Anyone who reads “tax-free up to ₹25 lakh” and stops there will get a surprise at filing.

Related tools

Section 89 relief (Form 10E)Reduce tax when arrears bunch into one year.Gratuity calculatorWork out the gratuity figure first.Leave encashment calculatorAnd the encashment figure.India exit checklistEverything you're owed when you leave.

Frequently asked questions

Is gratuity taxable in India?+
Partly, and ₹20 lakh is a ceiling rather than an automatic exemption. For a non-government employee covered by the gratuity statute, section 10(10)(ii) exempts the LEAST of three amounts: the gratuity actually received; fifteen days' salary (15/26 of the last drawn Basic + DA) for each completed year of service, a part over six months counting as a full year; and ₹20,00,000, the limit notified by CBDT in Notification No. 16/2019 dated 8 March 2019. Where the employer is not covered, the middle limb becomes half a month's average salary for each completed year, with fractions of a year ignored. On ordinary salaries and service the middle limb binds well below ₹20 lakh — someone with three years and ₹40,000 of Basic + DA is capped at about ₹69,000, not ₹20 lakh. The ₹20 lakh is also a lifetime figure across your entire career, so gratuity exempted at an earlier exit reduces what is left. Anything above whichever limb binds is taxable as salary. Government employees are wholly exempt under section 10(10)(i).
Is leave encashment taxable on resignation?+
Partly. Section 10(10AA)(ii) exempts encashment received on retirement or resignation by a non-government employee at the LEAST of four amounts: the encashment actually received; ten months' average salary (Basic + DA over the last ten months); the cash value of unused leave counted at no more than 30 days for each completed year of service; and ₹25,00,000. CBDT Notification No. 31/2023 dated 24 May 2023 raised that last figure from ₹3 lakh with effect from 1 April 2023 — a substantial change a lot of older guidance has not caught up with — but it is only the fourth limb, and on ordinary salaries one of the first three binds long before it. The 30-day-per-year limb is the one that surprises people: a large accumulated balance is cut back to 30 days per completed year and then valued on average Basic + DA, not on whatever component your employer actually encashed. Like the gratuity ceiling, ₹25 lakh is a lifetime aggregate across all employers. Government employees are wholly exempt under section 10(10AA)(i), and encashment taken while still in service is fully taxable as salary.
Is notice pay taxable?+
Notice pay you receive in lieu of notice is ordinary salary income and is fully taxable — there is no exit-specific exemption for it. Where your employer instead recovers notice pay from you for notice you did not serve, the treatment of that recovery is contested: one view taxes you on the salary contracted, the other on the salary actually received. Check which basis your Form 16 reflects and raise it with a tax adviser if it differs from what reached your account.
Is GST charged on notice pay recovery?+
No. CBIC Circular No. 178/10/2022-GST dated 3 August 2022 clarified that forfeiture of salary or recovery of notice pay when an employee leaves early is a deterrent against breach rather than consideration for tolerating an act, and so is not a taxable supply. If an employer has added GST to a notice recovery, that circular is the authority to point them to — and worth raising in writing before you pay it.
How much of my full and final settlement is tax-free?+
It depends on the mix, and on your own salary and service — not just on the headline ceilings. Gratuity and leave encashment carry the largest exemptions, but each is a least-of test in which ₹20 lakh and ₹25 lakh are merely the last limb; for most people a service- or salary-based limb decides the answer instead, and it is usually well below the ceiling. Unpaid salary, notice pay in lieu and bonus are ordinary salary and fully taxable. Reimbursement of genuine business expenses is not income at all. Retrenchment compensation and a qualifying VRS carry their own least-of tests. The calculator above runs each test on your own figures and tells you which limb actually bound — that is the number to check against your Form 16.
Is retrenchment compensation taxable?+
Not entirely. Compensation paid to a workman on retrenchment is exempt under section 10(10B) of the 1961 Act — section 19 of the Income-tax Act 2025 — at the lowest of three figures: what you actually received, 15 days' average pay for each completed year of continuous service (a part over six months counting as a full year, per section 25F(b) of the Industrial Disputes Act 1947), and ₹5,00,000. The ₹5 lakh figure is only the last of the three, and for short service the pay-based limb binds well below it: three years at ₹50,000 a month gives an exemption of ₹75,000, not ₹5 lakh. The ceiling is also an aggregate across every retrenchment in your career, not a fresh allowance each time. Where the compensation is paid under a scheme approved by the Central Government the ceiling falls away and the whole amount is exempt. One point is genuinely unsettled: converting monthly average pay to a daily rate needs a divisor the Industrial Disputes Act does not specify. Dividing by 30 treats fifteen days as half a month; dividing by 26 treats a monthly-rated worker as paid for 26 working days, the base the Payment of Gratuity Act uses expressly, and yields about 15% more exemption. The calculator computes both and defaults to the more conservative 30-day figure.
How is VRS or voluntary separation compensation taxed?+
Compensation on voluntary retirement is exempt at the lower of the amount received and ₹5,00,000, under section 10(10C) of the 1961 Act — section 19, Sl. No. 12 of the Income-tax Act 2025. Two conditions matter more than the arithmetic. First, it is available once in a lifetime: having claimed it at one exit, you cannot claim it again. Second, the scheme must satisfy Rule 2BA of the Income-tax Rules 1962 (Rule 20 of the 2026 Rules), which caps the payment at the higher of three months' salary for each completed year of service or salary for the months left to superannuation. If the payment exceeds that cap the scheme does not qualify and the exemption is lost entirely rather than reduced — so a generous-looking package can leave you worse off than one inside the cap. You also cannot claim section 89 / section 157 relief on the same amount as well as this exemption; it is one or the other.
What is the difference between ex-gratia, retrenchment compensation and VRS?+
Tax treatment, and it is worth lakhs. Ordinary ex-gratia — a goodwill or negotiated payment — carries no exemption and is fully taxable as salary. Retrenchment compensation carries the section 10(10B) exemption described above. A qualifying voluntary retirement carries the section 10(10C) exemption. Employers frequently label all three 'ex-gratia' on the payslip regardless of what actually happened, and payroll's label does not decide the tax treatment — the substance does. If your exit was a retrenchment, or under a formal voluntary retirement scheme, say so in the calculator above and check the result against what your Form 16 shows.
Can I reduce the tax on a large settlement?+
If part of your settlement is arrears relating to an earlier year, section 89(1) relief can reduce the tax caused by receiving it all in one year — you must file Form 10E before your return to claim it. Beyond that, the main lever is making sure both statutory exemptions are correctly applied and that your employer has not treated an exempt component as taxable. Check the Form 16 against your own figures rather than assuming payroll got it right.

Sources for the figures on this page

  • Income-tax exemption ceiling on gratuity for non-government employees

    Income-tax Act 1961, s.10(10); CBDT Notification No. 16/2019 (S.O. 1213(E)) dated 8 March 2019

    View sourceChecked 2026-08-11

  • Income-tax exemption ceiling on leave encashment at retirement/resignation for non-government employees (lifetime, across all employers)

    Income-tax Act 1961, s.10(10AA)(ii); CBDT Notification No. 31/2023 dated 24 May 2023, effective 1 April 2023

    View sourceChecked 2026-08-11

  • Ceiling on the retrenchment-compensation exemption — the third limb of the least-of test, aggregated across every retrenchment in a career

    Income-tax Act 1961, s.10(10B); Income-tax Act 2025, s.19 read with Schedule II. Limit notified by the Central Government for retrenchment on or after 1 January 1997

    View sourceChecked 2026-08-13

  • Ceiling on the exemption for compensation on voluntary retirement or voluntary separation — claimable once in a lifetime

    Income-tax Act 1961, s.10(10C) read with Rule 2BA of the Income-tax Rules 1962; Income-tax Act 2025, s.19 (Sl. No. 12) read with Rule 20 of the Income-tax Rules 2026

    View sourceChecked 2026-08-13

  • Is GST payable on notice pay recovery by an employer?

    CBIC Circular No. 178/10/2022-GST dated 3 August 2022 — forfeiture of salary or recovery of notice pay is a deterrent, not consideration for tolerating an act, and is therefore not a taxable supply

    View sourceChecked 2026-08-11

Deepak Middha, Founder of LayoffNext

Written and reviewed by Deepak Middha, Chartered Accountant (ICAI, India) and founder of LayoffNext.

Legal and tax positions last checked 14 August 2026Editorial standards
Deepak Middha, Founder of LayoffNext
Deepak MiddhaFounder of LayoffNext

Deepak Middha is the founder of LayoffNext and a Chartered Accountant (ICAI, India). A U.S. immigrant with nearly 20 years of experience — and 17 years in hedge fund and private equity administration, including as Vice President of Fund Accounting at NAV Fund Administration Group and Associate Director of Private Equity and Real Estate at SS&C Technologies — he builds free, plain-language layoff tools and guides for employees, H-1B workers, and immigrant families.

Updated August 14, 2026
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