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Gratuity was introduced by the Indian Government through the Gratuity Payment Act, 1972. Before this, there was no mechanism in place that would allow such a payment. Gratuity is paid as a form of gratitude to employees for their extended service of 5 years or more to an organization.
As per the current rules of Gratuity Payment Act, there are two possible sources from which an employee can receive gratuity:
The first case is a company managed account including a specific gratuity account that can contain funds to provide gratuity pay out. On the other hand, the company gratuity insurance plan works by covering the group i.e. employees in the organization, in case there is a need for gratuity payment.
All companies that have more than 10 employees are covered under the rules mentioned in the Gratuity Payment Act, 1972. Additionally, all employees working in mines, shops, factories, ports, railways, plantations, or any other organization with 10 or more workers are also liable to receive a gratuity in salary.
If the employee fulfils the employment requirements and has been part of the company’s payroll for 5 years or longer, gratuity payment has to be made by the employer irrespective of the employee’s profession.
The basic requirement for gratuity in salary eligibility is that the employee should have rendered continuous service of a minimum of five years to a single organization. Apart from this basic criteria, here are some other rules that are applicable as part of the eligibility criteria for receiving gratuity in India:
Companies with an employee size of at least 10 on any single day in the past 12 months will be required to pay gratuity to their workers. The organization will need to do gratuity salary calculations even if the employee size reduces to less than 10 at a later date.
To receive gratuity, employees need to cease employment with the organization. One reason for this is retirement. Additionally, gratuity is also paid out under the following conditions provided the other criteria mentioned above are fulfilled:
As long as an employee fulfils all the above criteria, he/she will be eligible for gratuity payment. Under current rules, gratuity payments need to be made to eligible employees even by organizations who declare themselves as bankrupt.
There are however certain circumstances in which an employer might not need to pay gratuity to an employee even if all the above mentioned criteria are met. Common reasons why an otherwise eligible employee have to forfeit gratuity include:
Apart from the reasons mentioned above, gratuity payments may also be lost in case of other proven workplace offences. In cases of proven negligence leading to damage to company property, the employer can deduct the cost of damages from the gratuity amount payable.
The gratuity calculation formula as prescribed by the Gratuity Payment Act, 1972 differs based on the type of employment. The Act classifies employees eligible for gratuity payments into two distinct categories:
The below section discusses the calculation formula for gratuity in both cases:
Gratuity (G) = N x B x (15/26)
Here,
N= number of years of continuous service in the organization
B= last drawn basic salary
In this case i.e. for employees working in organizations covered under the Act, the number of working days in a month is considered as 26.
You are eligible to receive gratuity even if you work for an organization which is not covered under the Gratuity Payment Act, 1972. However, the gratuity calculation formula will be slightly different in this case as shown below:
Gratuity (G) = N x B x (15/30)
Here,
N= number of years of continuous service in the organization
B= last drawn basic salary
However, the difference in this case is that the gratuity is calculated using 30 days period as the working month instead of the 26 days period used in the case of employees covered under the Gratuity Payment Act.
Now that you have a clear idea about gratuity calculation formula. Let us look at a few examples to understand gratuity calculations better.
Example 1:
Mr. Ravi works for ABC organization, which has an employee strength of over 100. He has resigned from the organization after working for 5 years 3 months. Ravi's basic salary was ₹80,000 according to last drawn salary. What will be Ravi’s gratuity amount?
Ravi’s gratuity payment = N x B x (15/26) = 5*80000*15/26 = ₹2.32 lakh
In the above case, 5 years 3 months has been rounded off to the nearest whole year i.e. 5 years.
Example 2:
Mr. Sachin has worked for XYZ organization not covered under the Act for 9 years 10 months. His basic salary for a month was ₹90,000 as per last drawn salary. What will be his gratuity in salary amount?
Gratuity (G) of Mr Sachin = N x B x (15/30) = 10 x 90000 x (15/30) =₹4.5 lakh
In the above case, the 9 year 10 months service period has been rounded to nearest whole year i.e. 10 years for the purpose of the gratuity calculation.
Gratuity in salary is exempt from tax in many cases as long as you have submitted Income Tax Form 10E to submitting your Income Tax Return. There is also an upper monetary limit of Rs. 20 lakh up to which gratuity payments are exempt from tax. So if an employee receives gratuity in excess of ₹20 lakh during his/her lifetime, the incremental amount will be taxable as per the slab rate for the applicable financial year.
Let's have a detailed understanding of conditions in which tax is not levied on gratuity payments:
1. The gratuity amount is received by central and state employees, defense forces employees, and municipality employees
2. Any gratuity amount under the maximum limit of ₹20 lakh is disbursed tax-free.
Conditions in which tax applies to payments are:
1. The cumulative gratuity amount received during the employees’ lifetime exceeds ₹20 lakh. Tax will be applicable only on the amount exceeding the ₹20 lakh limit.
2. The gratuity amount is received by the nominee in the case of the employee's death. In this case, gratuity is taxed under the head Income from Other Sources.
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