What is ex-gratia?
Ex-gratia is a voluntary payment made by an employer out of goodwill, beyond what is legally required, and is usually taxable as salary income.
Ex-gratia is a Latin term that means 'out of goodwill'. In payroll, it refers to a payment made by an employer that is not required by law, contract or company policy. Employers use it to help an employee during retrenchment, separation, medical hardship or as a special performance reward.
Because ex-gratia is not a statutory benefit, there is no fixed formula. The amount is decided by the employer and documented in a separation letter or internal memo. It is usually paid as a lump sum. The payment is generally taxable as salary income under the Income Tax Act, 1961 because it is received from an employer. In some cases it may be treated as 'profits in lieu of salary' under Section 17(3).
Ex-gratia should not be confused with gratuity, which is a statutory payment under the Payment of Gratuity Act, 1972, or with retrenchment compensation, which is legally prescribed.
Because ex-gratia is voluntary, the employer should clearly label the payment in the full and final settlement. If it is not documented as ex-gratia, it may be treated as regular salary or retrenchment compensation, which changes the tax treatment. Companies often use it to maintain goodwill or to help employees who are not legally entitled to a larger separation payout.
Worked example
An employee is laid off due to restructuring. The employer pays a separation package of ₹3,00,000, of which ₹2,00,000 is legal retrenchment compensation and ₹1,00,000 is ex-gratia.
| Component | Tax treatment | |---|---| | Retrenchment compensation | Exempt up to prescribed limits | | Ex-gratia ₹1,00,000 | Taxable as salary income |
The employer includes the ₹1,00,000 in the full and final settlement and deducts TDS accordingly.
Related reading
Read the employee exit and settlement guide and use the tax regime calculator to understand the tax impact.
Frequently asked questions
- Is ex-gratia taxable?
- Yes. Ex-gratia is generally taxable under the head 'salaries' because it is received from an employer, unless a specific exemption applies.
- How is ex-gratia different from gratuity?
- Gratuity is a statutory payment under the Payment of Gratuity Act after 5 years of service. Ex-gratia is voluntary and not legally mandated.
- When do employers pay ex-gratia?
- Employers may pay it during retrenchment, resignation, performance bonus or hardship relief, depending on company policy.