What is Gratuity?
Gratuity is a component of salary that not many people are aware of. Gratuity is a part of salary received by an employee from their employer in return for the services offered to the company. It is more of a retirement benefit and social security benefit received by the employee when they are leaving their job. Gratuity is provided to government employees and employees of the private sector and is tax free. An employee becomes eligible for gratuity when they complete 5 years of service or full time service with the same employer.
Who pays Gratuity?
The gratuity is paid by the employer and unlike in EPF , the employee doesn’t have to contribute in gratuity. The employer can either pay from their own fund or seek the help of a life insurer and purchase a group gratuity plan. In case of a group gratuity plan, the employer should make annual payments to the insurer and the employee can make contributions to gratuity in this case but it is not mandatory.
How to calculate Gratuity in India?
Calculating Gratuity is not hard. Every salaried employee who works for a private or a government sector is entitled to receive gratuity. The employer can pay as much gratuity as they want but there is a minimum gratuity amount that they must pay to the employee. Tax concession is available on the gratuity if it’s in accordance with the gratuity formula and it is taxable if it exceeds the formula.
The formula for Gratuity Payment is different for people who are covered under the gratuity act and for those who aren’t. Given below is the formula for gratuity payment for both the categories.
Gratuity payment formula for employees under Gratuity Act
Any employee that works in a place consisting of more than 10 employees will be covered under the gratuity act. Your last drawn salary and period of service are the two most important factors upon which the formula for your gratuity payment is calculated. Given below is the formula for gratuity calculation for those covered under the gratuity act.
|Gratuity = Number of years * Last drawn salary of 15 days= Number of years * 15/26*monthly salary|
Gratuity payment formula for employees who are not covered under Gratuity Act
It is not compulsory to pay gratuity for companies that don’t fall under the gratuity act. But, an employer can always choose to give gratuity to the employee for their service. The gratuity given will be completely tax free. Even in this case, the employee can calculate the gratuity in advance even though the formula is different for this one. Given below is the formula for the calculation of gratuity for employees who are not covered under the Gratuity Act.
|Gratuity = One day Salary * 15* length of service|
|? (Average salary of last 10 months/30) * 15 * completed years|
|? Average Salary of last 10 months * Completed years * 15/30|
|? Average Salary of Last 10 months * completed years *1 /2|
|? Half of the 10 month average salary * Completed years|
One can use the online Gratuity Calculator to calculate their gratuity in advance. This tool is very easy to use and is free of charge. One has to provide few details such as Basic Salary, Dearness allowance, Length of service in years and months to calculate the gratuity.
Salary for Gratuity Calculation
In order to calculate the gratuity of an individual, the last drawn salary is a key element. The entire salary is, however, not considered for gratuity calculation. The amount considered includes only the following components:
- Basic Salary
- Dearness Allowance, if applicable
This implies that the bonuses, HRA, special allowances, and reimbursements are not considered for the purpose of gratuity calculation. Private sector employers keep the basic salary of employees to a minimum in order to ensure that gratuity payments are lower.
Period of Service for Gratuity Payment
The amount of gratuity received is directly proportional to the service period of an employee. However, every employee must complete five years in the company (or more than 4 years and 6 months) in order to avail this benefit. For the purpose of gratuity calculation, the number of years of service is rounded off to the nearest integer. So, for instance, if you have completed 8 years and 7 months, it will be rounded off to 9 years of service. In case you have completed 7 years and 5 months, the number of years of service is considered to be 7 years only.
Gratuity for employees not covered under Gratuity Act
Establishments that do not fall under the Gratuity Act need not pay gratuity to employees. However, if such an employer decides to pay gratuity to its employees, the amount paid will be free of tax, as long as it is paid according to a slightly different formula.
- In this case, the calculation of the per day salary of an employee is different. In addition to the basic salary and dearness allowance, the commission can also be included in the calculation. It should be noted that the commission is usually a percentage of the sales.
- The last drawn salary is not considered in this calculation. Instead, the average salary for the last 10 months is used for calculation.
- When calculating the per day salary of an employee, the monthly salary is not divided by 26. Instead, it is divided by 30 to get the one day salary.
- The length of service is also not considered as the nearest integer. Instead, the number of years of service that has been completed is used for the calculations. So, if you have worked with the employer for 6 years and 10 months, the length of service is taken as 6 years.
As per the regulations above, the employees of an organization that is not covered under the Gratuity Act are at a disadvantage. Since the per day salary is calculated by dividing the monthly salary by 30, the average salary per day reduces. Similarly, the number of years of service also reduces when the employee has not completed the whole year.
Gratuity Calculator after Seventh Pay Commission
The Seventh Pay Commission recommended that the upper limit of gratuity is raised from Rs.10 lakh to Rs.20 lakh, starting 1st January, 2016. The Commission also recommends that the upper limit on gratuity may increase by 25% when the dearness allowance of an employee rises by 50%. This is already exercised in the case of allowances that are partially indexed to dearness allowances.
The formula for gratuity calculation remains the same, i.e.,
|Gratuity = [(Basic Pay + DA) * 15 days * Years of service] / 26|
It should be noted that labor laws mandate weekly offs for all employees. Hence, the number of working days per month is not more than 26 days. The monthly salary for an employee is for 26 days of work. Therefore, the formula for gratuity calculation considers the per day salary to be the total monthly salary divided by 26 (not 30).
After the Seventh Pay Commission examined the matter, they also recommended the following revisions on the gratuity payment at death.
|Length of Service||Rate of Death Gratuity|
|Less than 1 year||2 times the monthly emoluments|
|Between 1 year (inclusive) and 5 years||6 times the monthly emoluments|
|Between 5 years (inclusive) and 11 years||12 times the monthly emoluments|
|Between 11 years (inclusive) and 20 years||20 times the monthly emoluments|
|20 years or more||Half month of emoluments for every complete 6-monthly period of qualifying service, subject to a maximum of 33 emoluments|
Applicability of Gratuity in India
The Payment of Gratuity Act 1971 is applicable to employees engaged in activities at oil fields, mines, factories, ports, plantations, shops or other establishments, or railway companies with 10 or more employees. Gratuity is usually paid by the employer completely, and there is no contribution from the employee.
The end of service benefits are provided to:
- An individual employed on salary or wages.
- An individual who has served continuously for more than 5 years at the time of retirement, resignation, or superannuation.
- An employee who faces death or disablement at any point of time (even before completing 5 years of service).
The employer pays the gratuity amount to the employee within 30 days from billing. If this amount is not paid within the stipulated time, the employer will have to bear a simple interest on it from the date on which it is payable. The rate of simple interest calculation will not be higher than the rate specified by the Central Government. Gratuity is usually paid in cash. In case the payee desires, it may be paid through a demand draft or a cheque.
Gratuity amount exempt from Tax
The current ceiling on tax-free gratuity is Rs.10 lakh for private/unorganized sector employees. It was the same for central government employees under Central Civil Services (Pension) Rules, until the 7th Central Pay Commission roll out in January, 2017, when the ceiling was increased to Rs.20 lakh.
However, the central government recently approved the introduction of Payment of Gratuity (Amendment) Bill, 2017, in Parliament, seeking to double the tax-free gratuity amount for employees in the formal sector to Rs.20 lakh.
This amendment will put the maximum gratuity limit for private sector employees as well as those employed in autonomous government organizations and public undertakings, at the same level as those of employees of central government.
Government is considering increasing gratuity entitlement for all employees covered under the Payment of Gratuity Act, 1972, considering the fact that inflation and wage has increased in the case of private sector employees also. The Payment of Gratuity Act, 1972, applies to all organizations employing 10 or more than 10 people.
The main goal of this Act is to provide social security to employees after retirement, whether it’s because of superannuation rules, or physical impairment or a major disability.
The gratuity that an employee is eligible for can be forfeited in the following instances:
- The service of the employee was terminated for his/her disorderly conduct or any anti-social activity/violence.
- The service of the employee was terminated following an offense committed by him/her that involved moral turpitude during the employment.
For an employer to be able to forfeit the gratuity of an employee, there must be a termination order that contains the charges for which he/she was alleged. In the absence of such a termination order, the gratuity of the employee cannot be forfeited.
Example of Gratuity Calculation
Let us take the example of an employee, Mr. X, for whom we will analyze the gratuity calculation. Suppose Mr. X was working in an organization for the past 5 years and 9 months. His current basic pay is Rs.15,000 per month and dearness allowance is Rs.3,000 per month. For the purpose of gratuity calculation, the last drawn salary of Mr.X is the sum of the basic salary and the dearness allowance,
? Rs.15,000 + Rs.3,000 = Rs.18,000
Number of years of service = 5 years and 9 months = 6 years (rounded)
Hence, Total Gratuity = (Salary / 26) * 15 * Number of years of service
? (18,000 / 26) * 15 * 6 = Rs.62,308
Important Points to Remember
- There will be no taxes levied on the gratuity amount for Government employees.
- For employees of private sector companies, there will be no tax on the gratuity, subject to a maximum of Rs.10 lakh.