Hello Dinesh,
Gratuity can be received by the employee at the time of his retirement or by his legal heir in the event of the death of the employee. Gratuity received by an employee on his retirement is taxable under the head "Salary" and gratuity received by the legal heir is taxable under the head "Income from Other Sources."
In both of the above situations, gratuity up to a specified limit is exempt under the provisions of sec.10(10) of the Income Tax Act, 1961.
For the purpose of exemption of gratuity under sec.10(10), the employees are divided into three categories:
1) Govt. employees - In the case of government employees, the entire amount of death-cum-retirement gratuity is exempt from tax, and nothing is, therefore, taxable under the head Salaries.
2) Employees covered under the Payment of Gratuity Act, 1972 - The employees covered under the Gratuity Act who receive gratuity have been given an exemption, which is the minimum of the following amounts. Gratuity received in excess of the minimum of the amounts mentioned below is included in the gross salary for the purposes of taxation. The amount of gratuity actually received. Fifteen days' salary (7 days in the case of seasonal employment) for every completed year of service provided the employment is more than six months.
3) Other employees - In the case of other employees, the gratuity received or receivable on his retirement or on his becoming incapacitated prior to such retirement or termination of his employment or any gratuity received by his heirs is exempt to the extent of the minimum of the following amounts. The amount received in excess of the sums mentioned below is included in the gross salary of the employee for the purposes of taxation. Actual amount of gratuity received. Half month's average salary for every completed year of service. (Average salary means the average of the salary drawn by the employee for 10 months immediately preceding the month in which he retires).
Regards,
Ashish