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.
Employees Covered under Gratuity Act, 1972
When you are working for an organisation, you would be curious to know as to who is covered under the Payment of Gratuity Act. As per the Payment of Gratuity Act, 1972, one is entitled to get gratuity if she or he has furnished service continuously for a minimum of 5 years with a particular establishment or organisation. The employee will receive the gratuity either on his superannuation or when the employee resigns from the company or retires. With regard to the condition of being employed in the same organisation for 5 years, there is an exception.
This Act covers any employee who works in the above-mentioned establishments. In this context, an employee refers to an individual who is employed on wages, and it does not include an apprentice. These employees can be involved in skilled, unskilled, semi-skilled, technical, manual, or clerical work in the entities. Whether the employment terms are implied or express, the person is considered as an employee under the Act. The employee can be working in administrative or managerial capacity. However, one should note that an employee does not include a person working in the state or central government, or a person who is administered by any other type of Act.
The Payment of Gratuity Act, 1972 applies to entities like Oilfields, mines, ports, factories, railway companies, and plantations. Any establishment or shop in which 10 or more individuals were/are employed.
When an Employee Dies or gets Disabled
If an individual’s services come to an end because he or she passes away, or suffers from a disability due to an illness or accident, then his or her employer is compulsorily required to offer the gratuity amount to the employee or the legal heir or nominee of the employee, depending on the situation. In these two cases, the number of working years will not be considered. This is where the exception to the above-mentioned condition comes into the picture.
When the Employee’s Nominee is a Minor
In case the employee’s minor is a nominee, then the funds will be invested in a term deposit by the Assistant Labour Commissioner in the name of the nominee. This deposit will be opened only with State Bank of India or any other nationalised bank. This is done until the minor becomes a major.
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.
Confiscation of Gratuity
Gratuity can sometimes be confiscated depending on the circumstance. When an employee engages in any act, negligence, or intentional omission that results in loss, damage, or destruction of the employer’s property, he or she can get terminated. In this case, the gratuity will be cancelled depending on the degree of the loss or damage.
The complete gratuity amount may be confiscated when an employee has been asked to leave the organisation if he or she has engaged in an offence that includes moral turpitude or showed any disorderly or violent behaviour.
A very significant rule regarding gratuity is that it has to be paid by the company to the employee no matter what. This holds true even if the organisation starts to suffer from heavy losses.
When you are eligible to earn your gratuity amount, you will be allowed to apply for it within 30 days from when it becomes payable. Also, if you know the date of your superannuation or retirement, then you can apply for your gratuity before a timeframe of 30 days.
Gratuity Payment Formula
- For Employees under Gratuity Act
- For Employees not 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|
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.
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
- 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.
|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|
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|
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.
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).
Gratuity 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.
- If individuals resign after completing of 4.5 years, are they eligible for gratuity?
- Is there any upper limit to the gratuity that an employee receives?
- Is there any specific time by which the gratuity must be paid?
- Is it possible to add a nominee for gratuity?
- Are contractual and temporary employees eligible for gratuity?
- What if the employee is eligible to get more than Rs.20 lakh gratuity?
- When is an individual paid gratuity?
No, individuals are not eligible for gratuity after completing 4.5 years. However, as per a ruling made by the Madras High Court, individuals who have completed 240 days in their fifth year of service are eligible for gratuity. The legal heir of an employee is eligible for gratuity if he/she dies during employment.
Yes, there is an upper limit to the gratuity that an employee can receive. The company cannot pay an employee more than Rs.20 lakh, regardless of the number of years the employee has been in service.
Usually, the gratuity must be paid by the employer within 30 days of the full and final settlement. If there is a delay in payment, the employer is liable to pay interest from the due date to the day the gratuity is paid.
Yes, it is possible to add a nominee for gratuity. At the time of joining the organisation, the employee must fill Form F to add a nominee.
Yes, temporary and contractual employees are eligible for gratuity. However, apprentices are not eligible for gratuity.
If an employee is eligible for more than Rs.20 lakh gratuity, the employer will only pay Rs.20 lakh as gratuity.
Individuals are paid gratuity under the following circumstances:
- Termination or resignation
- Layoff or retrenchment
- Death due to an accident or illness
- Voluntary Retirement Scheme (VRS)
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