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Introduction

Gratuity is a bonus sum payable to the employee by the employer as a Loyalty Award for the long-term contributions they have rendered for the company. Gratuity is offered to employees who have completed 5 years of service for the same company. The gratuity paid by the employer varies based on the number of years served and other conditions.

Gratuity is the monetary amount payable under the Payment of Gratuity Act 1972 to an organisation's employee. This is paid to the employee mainly as a gesture of gratitude for his /her contribution to the company. Some of the many elements that make up the employee's total income is gratuity compensation. It is necessary to learn what the entitlement is, and how much gratuity an individual can get.

One should note that an employee is entitled to earn the gratuity sum only after serving a period of 5 years or more with the company. It is usually a nominal sum paid by the employer that shows gratitude to the individual for their contribution to the organization.

The company will either pay the gratuity amount from their own account to their workers, or apply for a standard gratuity benefit package from a service provider. The employer then makes annual premiums to the service provider, and by following the contract laws and legislation, the insurance agent will pay the employee the gratuity payment in return. The employer pays the gratuitous amount in full without any contribution from the employee.

Payment of Gratuity Act, 1972

The Payment of Gratuity Act was passed in 1972 and encompasses employees working in mines, factories, oil fields, plantations, businesses, ports and other such establishments with more than ten employees. Unlike provident fund, the gratuity payment is paid out entirely by the company without any input by the employee.

Who is eligible to receive gratuity?

As stated above, employees who have completed 5 years are eligible to be covered under Gratuity. A few other criteria are:

  • The employee should be eligible for Superannuation
  • The employee has retired from the job
  • The employee leaves the job after completing 5 years of service in the job
  • The employee is affected by disability on account of sickness or accident
  • The employee’s death

How much gratuity is payable to an employee?

There is no fixed percentage decreed by statute for the amount of gratuity that an individual is expected to be paid. An employer may use a formula-based solution or even pay more than that. Two factors depend on the gratuity payable: the last salary is drawn and years of service. The Payment of Gratuity Act, 1972, separates non-government employees into two sections in order to determine how much gratuity is payable:

  • Employees covered under the Act
  • Employees not covered under the Act

An organization can be brought under the purview of the Act if it employs at least 10 persons on any single day in the preceding 12 months. And, once the company is entitled to the Gratuity Act, it will remain to be eligible even though the number of workers decreases below 10.

How to calculate gratuity amount?

Employers use a simple mathematical formula to calculate the gratuity amount they will be paying their employee. The gratuity formula is shown here:

Gratuity Amount = Y x S x 15/26

There are two ways to calculate Gratuity: 

A. For employees covered under the Act

Gratuity for employees covered under the Act follows a specific formula. The formula accounts for the 15 times of last drawn salary, for each completed year of service or part of thereof in excess of six months.

Gratuity = n*b*15/26

Where, 

n = Total number of years served in the company

b = Last drawn Basic Salary + Dearness Allowance

Let’s look at an example. Mr.A has worked with his company for a period of 15 years. His last drawn basic salary along with dearness allowance was Rs. 50,000.

The amount of gratuity = 15*50000*15/26 = Rs 4,32,692

Note: As per the Gratuity Act, the amount of gratuity cannot be more than Rs 20 lakhs; therefore, any excesses would be treated as ex-gratia

Any number of months in excess of 6 months will be rounded off to a year. For example, if the number of years in service are 12 years and 8 months, it will be taken as 13 years. Same way, if it is 12 years and 3 months, it will be taken as 12 years.

B. For employees not covered under the Act

Since the Company is not under the Act, there is no specific formula to calculate the Gratuity they can offer their employees. Most companies follow the below formula:

Gratuity Amount = (15 * Last drawn salary amount * period of service) / 30

Let us look at an example: 

Mr. B has been in service for 9 years and 10 months and his last drawn salary is Rs. 30,000. His Gratuity is calculated as below:

Gratuity = (15 * 30,000 * 10) / 30 = Rs. 1,50,000

Gratuity at the time of Retirement

According to the Pensioner’s Portal of the Government, the amount of gratuity at the time of retirement is determined as follows:

  • Gratuity Amount for each completed six-month period of service is equal to one-fourth of an employee's last-drawn basic salary.
  • The gratuity amount owed during retirement is 16 times the Basic Salary. 
  • However, it is subject to a maximum limit of Rs.20 lakhs.

Gratuity Amount Paid upon Death of the Employee

Gratuity payable due to the death of the employee is based on the number of years they have served with the Company. Here is a table that details the rates:

Number of years in serviceGratuity Amount Payable

Less than a year

2 times of basis salary

1 year or more but less than 5 years

6 times of basic salary

5 years or more but less than 11 years

12 times of basic salary

11 years or more but less than 20 years

20 times of basic salary

20 years or more

Half of the basic salary for each completed six-monthly period. However, it is subject to a maximum of 33 times of the basic salary.

Taxation Rules on Gratuity Amount

The Government brought in a new amendment to increase the tax exemption on Gratuity benefits. As per the CBDT Notification no. S.O. 1213(E), dated 8 March 2019, the exemption limit has been increased to Rs. 20 lakhs from the previous Rs.10 lakhs. It is applicable to all employees in the event of retirement or death or resignation or disablement on or after 29 March 2018.

Gratuity taxation is applied to 3 different categories: 

1. Government employees receiving Gratuity – Their gratuity is totally exempted from tax.

2. Employees of Companies registered under the Gratuity Act – The least of the following is exempt from tax:

  • Last salary (basic + DA) * number of years of employment* 15/26
  • Rs. 20 lakhs
  • Gratuity Actually received

3. Employees of Companies not covered under the Gratuity Act – For them, the least of the following are exempt from tax:

  • Last 10 months’ average salary (basic + DA) * number of years of employment * 1/2
  • Rs. 10 lakhs (the hike to Rs 20. lakhs is not applicable for employees not covered under the Payment of Gratuity Act)
  • Gratuity actually received

FAQs

1. Do contract employees receive gratuity?

​Employees who are on the rolls of the company are eligible for Gratuity. If you are on contract from another company, you may not be eligible.

2. What is Payment of Gratuity Act?

The Payment of Gratuity Act was passed in 1972 and encompasses employees working in mines, factories, oil fields, plantations, businesses, ports and other such establishments with more than ten employees.

3. What is the maximum gratuity amount payable?

An employee can receive a maximum Gratuity of up to Rs.20 lakhs.

4. Is there an age limit to receive gratuity?

There is no age limit to receive Gratuity. Gratuity is paid if you have completed 5 years of service with a company or at the time of retirement or death. Hence, there is no age limit.

End Note:

Gratuity can be considered as a kind of Loyalty Bonus given by the employer to his employee for the services rendered by them. It is usually paid at the time of retirement but can be paid earlier, provided certain conditions are met. Any employee who has completed 5 years of service is eligible for Gratuity as per the Companies policy.

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