Gratuity is a monetary benefit provided by an employer to an employee for the services rendered to the organization. It is paid at the time of retirement or resignation, provided the employee has completed at least 5 years of continuous service before leaving the organization. In certain circumstances, such as death or disablement, the rule of continuous 5-year service is relaxed. Here we will talk about the gratuity act, eligibility criteria, gratuity formula, calculation, and taxation rules on gratuity in detail.
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What is Gratuity in Salary?
Gratuity is a benefit which is payable under the Payment of Gratuity Act, 1972. It is a financial component offered by an employer to an employee in recognition of his or her services rendered to the organization. It is typically a portion of the salary an employee receives and there is no set percentage of the gratuity amount an employee can receive.
How does Gratuity work?
The employer may either pay their employees the gratuity amount from their own account or may opt for a general gratuity insurance plan with a service provider. The company then pays an annual contribution to the service provider, and in return, the insurance company can pay the gratuity amount to the employee, by following policy rules and regulations. The gratuity amount is totally paid by the employer without any contribution from the employee.
Gratuity Act
The Payment of Gratuity Act came into force in 1972. The act covers all employees working in mines, companies, ports, plantations, and other such organizations that have more than 10 employees. Unlike the provident fund, the gratuity amount is fully paid by the employer without any contribution from the employee.
About Payment of Gratuity Act 1972 |
|
| Gratuity Act | For government and non-government employees |
| Minimum years of service | 5 years |
| Minimum number of employees | 10 |
| Gratuity payable | After Retirement / Resignation/ Death |
| Tax exemption on gratuity | Rs. 20 lakh |
| Last drawn salary means | Basic Salary, Dearness Allowance, and Commission received on Sales |
Gratuity Rules
1. Forfeiture of Gratuity- An employer has the right to forfeit the gratuity payment, either partially or completely even if the employee has completed 5 years of service. But this situation can only work if the employee has been terminated because of misconduct
2. Timeline for Payment of Gratuity- The 3 important points regarding payment of gratuity are given below:
- Initiation: The employee has to send an application to the employer regarding the gratuity amount to be received from the organization
- Calculation and Acknowledgement: Once the employer receives the application, the company calculates the amount of gratuity that is payable and send an acknowledgment to the concerned employee and the controlling authority, mentioning the specific amount
- Disbursal: The employer has a time period of 30 days to pay the gratuity amount after sending the acknowledgment
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Eligibility Criteria for payment of Gratuity
You are eligible for gratuity only if you fulfill any of the following eligibility criteria:
- You should be eligible for superannuation (means attainment of the maximum age of service as fixed by the organization)
- You should have retired from service
- You should have resigned after continuous employment of 5 years with the organization
- Upon your death or disablement, the amount is paid to the nominee
Gratuity Formula
The gratuity amount depends on the number of service years in the same company and the last drawn salary. The formula for calculating gratuity is-
Gratuity= n x b x 15 / 26 |
Here,
n= The service tenure completed by an individual in a company
b= Basic Salary last drawn by an individual + Dearness Allowance
No set percentage is provided by the law for calculating the actual gratuity amount that an employee gets after retirement or resignation.
Important Points To Note:
- According to the Gratuity Act, the gratuity amount can never be more than Rs. 20 lakh. Any excess amount is known as ex-gratia
- If the last remaining months in the last year of one’s employment are more than 6 months, then it is rounded up to the next number. For example, if your service tenure is 15 years 8 months, then you would get the gratuity of 16 years.
How to Calculate Gratuity amount?
To calculate how much gratuity is payable, the Payment of Gratuity Act has divided non-government employees into two categories-
1. Employees covered under this act
For employees who are covered under the act, the gratuity amount is calculated using the following formula-
| 15 x last drawn salary x tenure of working / 26 |
Let’s understand this with help of an example:
|
For example, the last drawn salary (Basic + DA) of A is Rs. 50,000 per month and his employment with ABC company was for 26 years. In this case, the gratuity will be: Gratuity Amount= 15 x last drawn salary x tenure of working / 26 Gratuity Amount of A= (15 x 50,000 x 26) / 26= Rs. 7. 5 lakh |
2. Employees who are not covered under this act
For employees who are not covered under the act, the gratuity amount is calculated using the following formula-
| 15 x last drawn salary x tenure of working / 30 |
Let’s understand this with help of an example:
|
For example, B is working with a firm that does not come under the Payment of Gratuity Act but, the basic salary that he drew was Rs. 40,000 per month, and has been in the company for 25 years. In this case, the gratuity will be: Gratuity Amount= 15 x last drawn salary x tenure of working / 30 Gratuity Amount of A= (15 x 40,000 x 25) / 30= Rs. 5 lakh |
Gratuity Computation in case of demise of an employee
In case of demise of an employee, the gratuity amount is calculated based on the terms of service of that employee. However, the amount is subject to a maximum of Rs. 20 lakh. Given below is the tabular description of rates at which gratuity will be paid to the beneficiary or the family member in case of the death of an employee.
| Term of Service | Amount Payable Towards Gratuity |
| Less than 1 year | 2 x Basic Salary |
| 1 year or more but less than 5 years | 6 x Basic Salary |
| 5 years or more but less than 11 years | 12 x Basic Salary |
| 11 years or more but less than 20 years | 20 x Basic Salary |
| 20 years or more | Half of the Basic Salary for each completed 6-month period. However, it is subject to a maximum of 33 times of Basic Salary |
Taxation rules on Gratuity
The tax levied on gratuity amount depends on the type of employee who has to receive the gratuity-
- The amount of gratuity received by any government employee (whether central / state / local authority) is exempted from income tax
- Any other eligible private employee whose employer is covered under the Payment of Gratuity Act. The least of the following three amounts will be exempted from income tax:
- Rs. 20 lakh
- The actual amount of gratuity received
- The eligible gratuity
For example, Mr. Z received a gratuity of Rs. 18 lakh after leaving an organization. Following that, he joined another company that paid him a gratuity of Rs. 5 lakh. The total gratuity received was Rs. 23 lakh. Hence Mr. Z will be liable to pay income tax on Rs. 3 lakh (Rs. 23 lakh – Rs. 20 lakh).
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Frequently Asked Questions (FAQs)
I am a contract employee in a company. Will I get gratuity if I resign or retire after 5 years?
If you are on the company roll and are considered an employee of the company, then you will receive gratuity. However, if you are under a contract that is separate from the company then the gratuity should come from the contractor and not the company.
How many days will it take for the employer to remit the gratuity amount?
Usually, gratuity is released along with or just before/after your full and final settlement is done. The government mandates employers to pay the amount within 30 days. If there is any delay in payment, the employer has to pay simple interest on the amount from the due date until the date when the payment is made.
Is the notice period considered for gratuity?
Gratuity is calculated from the day you have joined an organization till the last working day including your notice period as you get salary for that time as well.
Can I get gratuity if I resign?
As per the Gratuity Act, gratuity is payable only after the completion of 5 years of your service. If you resign before 5 years of service, then you are not eligible to get gratuity.
Does the gratuity amount have an upper limit?
For government employees, the upper limit of gratuity amount has been increased to Rs. 20 lakh (according to amendments made after the 7th pay commission). However, for non-government employees, the limit of gratuity is Rs. 10 lakh as of now.