What is Gratuity?
Gratuity is a statutory benefit provided by employers to employees as a token of appreciation for their continuous service. It is a lump-sum amount paid to an employee at the time of retirement, resignation, or termination, as long as they have completed at least five years of continuous service with the organization. The ‘Payment of Gratuity’ Act was assembled by the Indian Parliament on August 21, 1972, and implemented on September 16, 1972.
Industries and Establishments: This includes factories, oilfields, mines, railways, ports, and plantations.
Shops and Businesses: Any shop or business that employed 10 or more people in the last 12 months.
Other Organizations: Any other type of establishment with 10 or more employees at any point during the previous year.
What are the Eligibility Criteria to Receive Gratuity?
For an employee to be eligible for gratuity, they must meet these requirements:
Minimum Continuous Service
The employee must have completed at least five years of continuous service with the organization. Exceptions apply in cases of death or disability, where the five-year rule is waived.
Employment Type
The employee should be working under a formal employer-employee relationship, which typically includes both full-time and part-time employees, as long as they meet the continuous service requirement.
Applicable Establishments
Gratuity applies to organizations such as:
Factories, mines, oilfields, ports, plantations, and railways.
Shops or businesses with 10 or more employees in the past 12 months.
Separation from Employment
Gratuity payment is done when the employee leaves the organization due to:
- Retirement
- Resignation or Termination
- Death or Disability (the five-year rule is waived).
These criteria ensure gratuity serves as a reward for loyalty and service continuity.
How to Calculate Gratuity?
The method of calculating gratuity depends on the act that applies and has the following characteristics.
- Calculation of gratuity for those employees who are entitled under the Payment of Gratuity Act 1972.
- Calculation of gratuity for those employees who are not entitled under the Payment of Gratuity Act 1972.
Gratuity is calculated for employees who are entitled under the Payment of Gratuity Act 1972, using the following gratuity calculation formula:
Gratuity = (15 / 26) × Last Drawn Salary × Years of Service
Here’s what each term means:
Last Drawn Salary: This includes the basic pay and any dearness allowance (if applicable).
15/26 Factor: Represents 15 working days of gratuity for every completed year of service, calculated based on 26 working days in a month.
Years of Service: The total number of years the employee has worked for the organization. For calculation purposes, any period over six months is rounded up to a full year, while less than six months is ignored.
Example Calculation:
Last Drawn Salary: ₹50,000
Years of Service: 10 years
Gratuity Calculation:
Gratuity= 15 / 26 ×50,000 × 10 = ₹288,461.54
Important Notes:
Gratuity is limited to ₹20 lakh for employees who fall under the Payment of Gratuity Act, 1972.
The formula may vary slightly for establishments not covered under the Act.
Gratuity is calculated for employees who are not entitled under the Payment of Gratuity Act 1972, using the following formula:
Organizations that are not bound by the Act may still offer gratuity as a goodwill gesture, following their internal policies. The calculation differs slightly:
Gratuity = (½) × Last Drawn Salary × Years of Service
Explanation:
Last Drawn Salary: Includes only the basic salary (and possibly dearness allowance, depending on the employer’s policy).
½ Factor: Represents half a month’s salary for every completed year of service.
Years of Service: Total years worked are considered. The rounding of service years depends on the employer’s discretion.
Example Calculation:
Last Drawn Salary: ₹40,000
Years of Service: 8 years
Gratuity Calculation:
Gratuity= ½ × 40,000×8 = ₹1, 60,000
The above are the gratuity formulae to calculate gratuity in different cases.
What is a Gratuity Calculator?
A Gratuity Calculator is a tool that quickly calculates the gratuity amount an employee is entitled to, based on their salary and years of service. It uses a formula to estimate the gratuity an employee is entitled to upon leaving their job. It is especially useful for small business owners and employees who want to get an estimate of their gratuity payments.
What are the Benefits of using a Gratuity Calculator?
The Gratuity Calculator is advantageous for both the employee and the employer. Some of the top benefits it brings are:
Accurate Calculations
Usually, gratuity calculations are a little complex so, the calculator makes sure the gratuity is right based on how long someone worked and their pay, avoiding mistakes and making sure it’s done right.
Saves Time
Manually calculating gratuity for employees with long service and complex salaries is time-consuming. A calculator saves time by reducing errors and minimizing manual effort.
Clear and Easy to Understand
Employees can easily see how their gratuity is figured, making it easier to trust and understand everything between them and the employer.
Helps Follow the Law
Gratuity calculators are created to make sure businesses comply with local laws. This reduces the chances of legal problems, such as lawsuits or penalties for not following the correct procedures.
But the amount it comes up with is only an estimate. The final payment gratuity isn’t always the same because it can be influenced by laws, company rules, and state regulations.
What are the Taxation Rules for Gratuity Payment?
If you’re wondering what gratuity tax means, it refers to the tax applied to the gratuity amount an employee receives after leaving a job, depending on the applicable tax laws.
| Category | Taxability of Gratuity | Exempt Amount |
|---|---|---|
| Government Employees | Fully Exempt | Not Applicable |
| Non-Government Employees (Covered under the Payment of Gratuity Act, 1972) | Exempt up to the least of the following: | 1. ₹20, 00,000 (lifetime limit). |
| Non-Government Employees (Not Covered under the Payment of Gratuity Act, 1972) | Exempt up to the least of the following: | 1. A maximum limit of ₹20 lakhs, which was increased from ₹10 lakhs following a recent amendment. |
| Others (e.g., employees receiving gratuity from private funds or in unauthorized cases) | Fully-taxable | Not Applicable |
Source: Cleartax
Who is Exempt from Receiving Gratuity in India?
- Gratuity received by government employees (both State and Central), defense personnel, and employees of local authorities upon retirement, superannuation, or termination is completely exempt from tax according to current gratuity laws.
- The tax exemptions on the gratuity of employees in the private sector depend on whether they come under the Payment of Gratuity Act, of 1972. The tax treatment varies based on this factor.
What is Gratuity Nomination?
A gratuity nomination is when an employee selects a person to receive their gratuity after they pass away. The employee fills out Form F and gives it to the employer. Employees can also revise or update their nominations at any time during their employment.
What Does Compulsory Insurance Mean for Gratuity?
Under the Payment of Gratuity Act, of 1972, all private employers covered by the law must get insurance to cover gratuity payments. If an employer does not follow this rule or fails to pay the insurance premiums they are subject to legal action. Failure to do so leads to a penalty of ₹10,000, plus ₹1,000 for each day the contravention continues.
Frequently Asked Questions
An employee must complete five years of continuous service with the same employer to be eligible for gratuity.
In some organizations, gratuity is shown as part of the employee’s CTC, but it is not part of the monthly salary. It’s provided as a lump sum upon leaving the company.
No, gratuity is only payable when the employment relationship ends due to resignation, retirement, termination, death, or disability. It cannot be withdrawn during active employment.
Employees face a few usual problems with gratuity, such as unclear calculations, delayed payments, and uncertainty about their benefits.
Yes, every country has its own laws that define eligibility, how gratuity is calculated, and when it should be paid.
In case of failure of an employer to pay gratuity, the employee can present their grievances to the Labour Commissioner or seek legal redress. The employer may suffer penalties and be in a position to pay interest on the delayed sum. The employees should also have records to support their claims.
