In general, certain retirement benefits are provided to an employee due to voluntary or involuntary early termination of services. Termination benefits are given to an employee over and above the normal salary or CTC (or cost to the company). The extent of these benefits varies per the company’s policy, or they may be negotiated on a case-to-case basis. One of the most common termination benefits in India is gratuity.
What Is Gratuity?
The word gratuity means ‘graciousness.’ The Payment of Gratuity Act 1972 defines gratuity as a monetary benefit that the employer designates to the employees upon termination of services as a token of appreciation for the services rendered. However, it was only after the enactment of the Gratuity Act in 1972 that the payment of gratuity was made mandatory for employers.
This amount can be defined as a monetary benefit plan where the employee makes no contributions. The gratuity amount payable to an employee is determined by the employee’s last drawn wage and the total number of years of service provided.
Eligibility Rules for Gratuity Payment – Employees
Any person fulfilling the following eligibility criteria is liable to receive gratuity under the Payment of Gratuity Act, 1972:
- The individual must be eligible for superannuation.
- The individual must have resigned after rendering at least five (05) years of continuous employment in the same company.
- According to Section 4 of the Gratuity Act, in case of termination of service due to death or disability, an exception is made to the five years continuous service criteria.
- Furthermore, if an employee dies in harness, the beneficiary or nominee is considered for gratuity payment.
Eligibility Rules for Gratuity Payment – Organisations
Following are the organisations that fall under the purview of the Payment of Gratuity Act of 1972:
- Organisations employing 10 or more employees
- Every factory, mine, oilfield, plantation, port, or railway company with 10 or more employees
- Every shop or establishment employing 10 or more people on any day of the preceding 12 months (as specified by the State Government or Central Government)
- Every shop or institution subject to the Gratuity Act whose employee count has decreased below 10 since becoming eligible
Gratuity Calculation
For gratuity computation, there is a standard formula followed by all organisations. The formula considers two factors:
- The active years of service (excluding sabbatical or loss of pay period)
- The last drawn wage or salary
The employee’s period of service is important for determining the gratuity amount. Anything longer than 6 months is rounded up to the next number. For example, if Mr. A has worked for 10 years and 9 months, his total service period will be rounded off to 11 years. On the other hand, if employee Mr. B works for only 10 years and 4 months, his service period will be counted as 10 years. Once this is calculated, it is easy to calculate the gratuity payable.
While discussing the gratuity formula, it is important to understand that employers are categorised into two types based on their coverage under the Gratuity Act.
- For organisations covered under the Gratuity Act (with 10 or more employees)
Gratuity = Number of years of employment X (Last wage drawn, including Dearness Allowance) X (15/26) *
*The number of working days each month is stated as 26 days, and the gratuity is calculated at the rate of 15 days’ wages.
For example, Mr. ABC has worked for 10 years and 7 months, and the last drawn salary and dearness allowance account for INR 50,000. In that case, the gratuity calculation formula will be as under:
Gratuity = 11 x 50,000 x (15/26) = INR 3,17,308
Here, the number of years of the service is taken as 11 because part of the service exceeds six months and hence, rounded off to the next number.
Please note that labour laws mandate weekly offs for all employees. Hence, the maximum number of working days per month does not exceed 26 days. An employee’s monthly wage is for 26 days of work. As a result, the formula for calculating gratuity considers the per day wage to be the entire monthly compensation divided by 26 (rather than 30).
- For organisations not covered under the Gratuity Act
Gratuity (G) = Number of years of employment X (Last drawn wage, including Dearness Allowance) X (15/30) **
**Employees covered under the act are given the advantage of a lower denomination to generate a greater gratuity amount. Hence, the working days for the employees not covered under the act are taken as 30 and 26.
Gratuity Calculation When Employee Dies in Harness
If an employee dies in harness (during the employment period), the benefits of gratuity are calculated as half of the basic salary for each completed six-monthly period of employment.
|
Years of Service |
Gratuity Amount |
|
Less than a year |
2 * basic salary |
|
>= 1 year but <5 years |
6 * basic salary |
|
>=5 years but < 11 years |
12 * basic salary |
|
>=11 years but < 20 years |
20 * basic salary |
|
>=20 years or more |
You will be paid half your base wage for each completed six-month term. However, the amount is limited to 33 times the base pay. |
Tax Implications Applicable to Gratuity
The tax applicable on gratuity depends on the type (or sector) of employer you are working for. Employees in India belong to two different sectors – private and government. Taxation rules differ for both.
Government employees will receive a 100% tax-exempted gratuity. In contrast, for private employees, the least of the following three amounts will determine the taxable gratuity amount, given that your employer comes under the Payment of Gratuity Act:
- INR 20 lakhs
- The actual gratuity value received
- The eligible gratuity
Tax exemption can be claimed only up to INR 20 lakhs on the gratuity value. For example, suppose the employer pays a gratuity of INR 12 lakhs. As per the gratuity calculation in the earlier example, the employee will be eligible to receive a gratuity amount of INR 3,17,308. The government has set INR 20 lakhs as the upper limit for tax-free gratuity. The lowest of the three figures is INR 3,17,308, which is exempt from tax. You must pay tax on the remaining amount of INR 8,82,692 as per the income tax deduction slab.
It should also be noted that in an employee’s entire working life, the maximum tax-exempt gratuity amount that can be claimed cannot go beyond INR 20 lakhs. Organisations can use sound attendance monitoring and payroll system documentation to ensure all payroll taxations are handled efficiently.
Wrapping Up
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FAQs
- Will an employee with 4 years and 8 months of service be eligible for payment of a gratuity?
For an employee to be eligible for gratuity, the minimum service period required is 5 years of continuous service in the same company. However, organisations falling under the Payment of Gratuity Act’s purview will consider this period to be 5 years only. Hence, the employee working with such an organisation will receive a gratuity.
- Is there a period specified for releasing gratuity to an employee?
The employer must inform the employee of the gratuity amount payable within 15 days from the date of receipt of the application. The employer is required to pay the amount within 30 days of receiving the application form. If an employer fails to pay the gratuity within the specified time frame, they must pay interest. A biometric attendance and payroll management system can speed up gratuity computation.
- Can an employer refuse to pay gratuity?
An employer is permitted to forfeit gratuity if an employee:
- Destroys or vandalises the employer’s property
- Behaves violently or is disorderly
- Commits an offence of moral turpitude
The Payment of Gratuity Act of 1972 permits an employer to forfeit an employee’s gratuity payment, either partially or whole, despite the employee having completed five or more years of service with the organisation. However, this is applicable only in cases wherein the employee has committed the above insubordination.
