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Before we get into its eligibility, formula and calculation, let us first understand what gratuity is. This information will help you acknowledge its significance and understand the amount of gratuity payout you will be eligible for, along with the gratuity limit, the tax on gratuity and exemptions.
Gratuity refers to a one-time monetary benefit that the employer pays to their employee, after a certain period, for the services offered by the employee.
As the name suggests, gratuity is an employer’s way of expressing gratitude towards their employees for their long-standing service to the organisation. This act of generosity is made compulsory by law and is covered under the Payment of Gratuity Act, 1972. This act is also commonly known as the Gratuity Act. According to the act, to become eligible for the gratuity payout, the employee has to complete at least five consecutive years of service with the same employer.
Usually, gratuity is paid at the time of retirement, but you can also claim it if you change your job after five years. However, the five-year condition for gratuity payout is not applicable if the employee becomes disabled (due to accident or illness) or dies while still in service.
What is the Payment of Gratuity Act 1972?
The Payment of Gratuity Act 1972 was implemented in September 1972 with the fundamental idea of providing monetary benefits to employees who have offered extended years of service to one employer. This act applies to all organisations and industries across India.
The gratuity rules apply to both type of employees, viz,
- Employees covered under the gratuity act, and
- Employees not covered under the gratuity act.
According to the existing gratuity eligibility rules, companies/establishments that employ ten or more people are automatically covered under the Payment of Gratuity Act, 1972. State and central government employees, however, are covered under their own set of service gratuity rules which don’t come under the Payment of Gratuity Act, 1972.
Eligibility criteria for payment of gratuity
To receive the gratuity payout, one needs to meet the following gratuity eligibility rules:
- The employee must be qualified for retirement or superannuation benefits.
- The employee must be retired from service.
- The employee should have resigned from the company after being employed for a continuous period of five years.
- The employer has suffered disability from an accident or illness, or, in the case of death.
The formula to calculate gratuity, as mentioned in the Payment of Gratuity Act, 1972, comprises mainly of your 15 days salary for each completed year of continuous service with the same organisation and is based on the last salary received. The latter figure is the last basic salary drawn + dearness allowance. HRA is not included in the calculation. Thus, the gratuity formula works out to be as follows:
Gratuity = t*s*15/26
t = time of continuous service with the same company in years
s = sum of last basic salary received and dearness allowance
For instance, if a person has been employed in the company for 17 years, and, the total of last basic salary drawn and dearness allowance amounts to 40,000/- in INR, then, as per the formula, gratuity is as follows:
Gratuity amount = 17*40000*(15/26)
= 3,92,308/- in INR
Two important conditions that you should note are:
- According to the gratuity rule, the amount of gratuity payout should not exceed ten lakhs in INR. However, if the employer wishes, they can pay more than ten lakhs as a gratuity to the employee. The amount beyond the gratuity limit of ten lakhs will be termed as a non-obligatory contribution or ex-gratia.
- The total number of months worked in the last year of employment will also be considered in the calculation. If in the final year, you have worked for more than six months, then the employer rounds the service to a whole year. And, if it is less than six months, then that year is not considered in the calculation. For instance, if your service period is 17 years and seven months, then 18 years will be considered for gratuity calculation. Whereas, if the service period is 17 years and three months, then 17 years will be considered for gratuity calculation.
How is gratuity calculated for the employees who are not covered under the Gratuity Act?
Employers are not restricted by law in the means of gratuity even if the organization is not composed under the Gratuity Act. The gratuity amount is calculated based on half a month’s salary for completed service years. The salary component for the calculation is the sum of basic pay, sales commission and DA.
The formula for the calculating gratuity amount for employees who are not covered under the Gratuity Act is:
Gratuity Amount = (15 * Last drawn salary amount * period of service) / 30
If Mr.Abc is an employee of the company XYZ. XYZ is not covered under the Gratuity Act.
Mr. Abc’s last drawn salary = 50,000
His service years = 10.9 years
Gratuity amount will be: (15*50,000*11)/30 = 275,000/-
Note: Here instead of 10 years, 11 years are considered since the excess month count exceeds 6.
Payment of Gratuity in case of Death of an Employee
The gratuity benefits for a deceased employee are calculated based on his/her tenure of service. The amount is subject to a maximum of 20 lakh rupees. Here are the rates at which gratuity will be paid in such cases.
|<1 year||2 x Basic salary|
|1 – 5 years||6 x Basic salary|
|5 – 11 years||12 x Basic salary|
|11 – 20 years||20 x Basic salary|
|20+ years||Half of the basic salary for each completed 6 months
Subject to a maximum of 33 x Basic salary
Forfeiture of Gratuity in accordance with the Gratuity Act
According to the Payment of Gratuity Act 1972, the employer can forfeit the employee’s gratuity in the following cases.
- Employee is terminated by wilful omission or negligence causing damage or loss of employer’s property.
- Employee got terminated due to an offence involving moral vileness
The company can decide whether the gratuity should be partially or completely forfeited based on the offence the employee committed.
Different types of forms of gratuity
|I||Gratuity payment application|
|J||Gratuity payment application for the nominee|
|K||Gratuity payment application for legal heir|
|G||Make new/fresh nomination|
|L||Issued by the employer to employee stating date and amount of payment|
|M||Issued by the employer to employee stating the reason for rejection|
|N||Application made to the labour commission by an employee|
|O||Issued by the authority to appear for case hearing|
|P||Summons issued by authority to be present for hearing|
|R||Issued by the authority directing to make gratuity payment|
Tax deductions on Gratuity
- Any gratuity received by the public sector employees apart from statutory corporations is completely free of tax.
- The least of the following is exempted from tax according to the article 10 of the income tax act.
- Last salary (basic + DA)* no: of years of service* 15/26;
- Rs. 20 lakhs (which has been lifted from Rs. 10 Lakh as per the new amendment);
- Gratuity amount received
Basic timeline for the Gratuity payment
Initiation: The phase where the individual applies for gratuity by sending relevant form or application to the employer
Reception and Calculation: As soon as the employer gets a gratuity disbursal request, they should acknowledge and provide a notice to the employee stating the specified amount.
Disbursal: Employers should complete the disbursal of the complete amount within 30 days of releasing the notice.
Income tax rules on gratuity as per the Income Tax Act
The tax on gratuity and tax exemption on the gratuity payout depends on the nature of employment of the employee. The three major gratuity categories include:
- The eligible government employee:
The gratuity payout for government employees (state/central/local authority) falls under the tax exemption category of the Income Tax Act.
- The eligible employee of an employer covered as per the Gratuity Act:
Only 15 days salary out of the last received salary is eligible for tax exemption under the income tax rules
- The eligible employee for an employer not covered as per the Gratuity Act:
The minimum amount out of the three scenarios, as mentioned below, will be considered for tax exemption as per the income tax rules:
⇒10 lakhs in INR
⇒The actual gratuity amount
⇒Half a month’s salary for every full year of employment with the same employer
Nomination under The Payment of Gratuity Act 1972
All the employees completing one year of service are asked to make a nomination for the gratuity. The nominee can be one or more than one, and maybe changed anytime by the employee. If the employee fails to provide a nominee, the amount shall be paid to the closest legal heir of the deceased employee. If the heir turns out to be minor, the bank holds the amount until the child reaches maturity. The family or heir defined under the act can be Spouse, Children, Adopted child or Dependent parents.
With the help of this gratuity formula and calculation, employers can calculate the amount of gratuity that they have to pay to their eligible employees. Alternatively, you may hire a recruitment and staffing agency that will take care of all your compliance needs.
FAQs – Gratuity
- Does the Gratuity Act cover all states of India?The Gratuity Act 1972 covers all the states of India except Jammu & Kashmir.
- Is there any cap on Gratuity?According to the Payment of Gratuity (Amendment) Act, 2018, the cap on Gratuity was raised from 10 lakhs to 20 lakhs.
- What is the penalty of delay in Gratuity payment?The employer should pay simple interest for the gratuity amount for the period of delay.
- How to nominate someone for claiming my gratuity incase of my death?Nominations can be made by filling Form F while joining or amid the career.
- When is Gratuity should be paid?
- Superannuation or Retirement.
- Resignation or Termination.
- Death or Disablement due to accident or disease.
- Retrenchment or Layoff
- VRS (Voluntary Retirement Scheme).
- Is 5 years service applicable for all the mentioned cases?In the case of death of the employee, 5-year service is not mandatory and the amount will be given to the nominees or legal heir.