Gratuity: Check Gratuity Formula, Eligibility, Calculation

What is Gratuity?

Gratuity may be a benefit which is payable under the Payment of Gratuity Act 1972. Gratuity may be a sum of salary paid by an employer to an employee for services rendered in the company. However, gratuity is paid only to employees who complete 5 or more years with the corporate . It will be understood as a sort of tip paid by employer to the worker for services offered in the company. Since tips are a function of culture, various countries have various gratuity limits that are apportioned by employers.

An employer may offer gratuity to his/her employees from his/her own pocket or may take a group gratuity plan with an insurance provider. Annual contributions are then paid by the employer to the insurance provider for this. The employee can also contribute to his/her gratuity amount. The gratuity paid by the insurance company is based on the clauses in the group insurance scheme.

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Few Significant Points about Gratuity:

Following are some of the most prominent points about payment of gratuity by an employer to an employee.

  • An employee can receive a gratuity amount higher than Rs.10,00,000 from his/her employer, the exemption for tax in this case will be calculated as per the points listed above under taxation.
  • In the recent Interim Budget of 2019, interim finance minister, Mr. Piyush Goyal has announced that the existing tax-free gratuity limit will be increased to Rs.30,00,000.
  • The employer has the right to reject payment of gratuity to an employee if he/she has been asked to leave his/her job owing to any misconduct.
  • In case of death of the employee, the nominee or heir of the employee is paid the gratuity amount. The taxation for this is calculated for the receiver under the head – income from other sources.
GRATUITY

Gratuity Act, 1972:

The payment of Gratuity Act was passed during the year 1972 and covers employees engaged in mines, factories, oil fields, plantations, companies, ports and other such establishments which have more than ten employees. The gratuity amount unlike provident fund is completely paid by the employer with none contribution from the worker.

Gratuity Rules

Forfeiture of Gratuity

According to the Payment of Gratuity Act of 1972, an employer holds the proper to forfeit their gratuity payment, either wholly or partially despite the worker having completed 5 and more years of service in a company. The only situation where this works is when the employee has been terminated due to disorderly conduct wherein, he/she tries to physically harm individuals during his/her employment.

Timeline for Gratuity payment

There are three steps involved regarding gratuity payment. These include:

  • Initiation: An individual or a person authorised must send in an application to an employer regarding the gratuity he/she is owed by a company.
  • Acknowledgement and calculation: As soon as the application is received, the company which owes gratuity will calculate the amount and also provides a notice of the same to the individual and the controlling authority with the amount specified.
  • Disbursal: The employer, having sent the acknowledgement, features a period of time of 30 days to pay the gratuity amount to the individual.

Gratuity Eligibility:

Following are the few instances once you are eligible to receive gratuity.

  1. An employee should be eligible for superannuation
  2. An employee retires
  3. An employee resigns after working for five years with one employer
  4. An employee passes away or suffers disability because of illness or accident

Gratuity Formula:

Listed below are the components that enter calculation of gratuity amount. The amount is totally dependent upon the amount of years served within the company and therefore the last drawn salary.

Gratuity = N*B*15/26

N = number of years of service in a company

B = last drawn basic salary plus DA

Example: How to Calculate Gratuity:

For example, if Amit is an engineer who has worked with SF Company for 25 years of service and had Rs.25,000 as his last drawn basic plus DA amount, then,

Gratuity Amount for Amit = 25*25,000*15/26 = Rs.2,88,461.54

However, an employer can choose to pay more gratuity to an employee (since it is a form of tip as mentioned in the beginning) but then the amount as restricted by the Gratuity Act cannot exceed over Rs.10 lac. Anything above the quantity Rs.10 lac is understood as ex-gratia which may be a voluntary contribution and not something compulsorily imposed by the law.

Also, for the number of months from the last year of employment, anything above 6 months is rounded off to subsequent number while anything below 6 months within the last year of employment is rounded off to the past lower number. So, employment held for 6 years 7 months will fetch you gratuity amount for 7 years while that held for 6 years and 4 months will fetch you gratuity amount for 6 years.

Calculation of gratuity for the employees who are not covered under the Gratuity Act:

When it comes to paying gratuity to an employee, an employer is not restricted by the law even if the organisation is not covered under the Gratuity Act. The gratuity amount which is payable to the worker is calculated on the idea of half month’s salary for every complete year of service. Salary, in this case, is calculated including basic pay, commission on sales, and dearness allowance.

The following formula is taken into account for the calculation of gratuity amount for those workers who aren’t covered under the Gratuity Act:

Gratuity Amount = (20 * Last drawn salary amount * period of service) / 30

Example:

Mr. X is a worker of ABC Pvt. Ltd. which is not covered under the Gratuity Act. The last main salary that he has drawn is Rs.50,000 per month. He has been working in the organisation for 10 years and 8 months. Thus, the gratuity amount for Mr. X will be as follows:

Gratuity Amount: (20 * 50,000 * 11) / 30 = Rs.2.75 lakh.

The period of service of an employee is taken as an entire year for the calculation. In case the number of months worked in the last year is less than 6 months, the previous number of completed years is considered. However, if the number of months completed in the last year of service is more than 6 months, the year is considered to be a full year for the purpose of calculation. In this case, Mr. A has worked for 10 years and 8 months. Thus, his working tenure has been considered as 11 years. If the service period had been 10 years and 4 months (or anything but 6 months), the amount of years of service would are considered as 10 years only.

As per the rules recorded on the pensioner’s portal of the government, the amount of gratuity at the time of retirement is calculated as follows:

Gratuity Amount is equal to one-fourth of the last-drawn basic salary of an employee for each completed six-month period. The retirement gratuity amount which is payable is 16 times of the essential salary. However, it is subject to a cap of Rs.20 lakh.

Calculation of gratuity just in case of death of an employee:

In case of death of an employee, the gratuity benefits are calculated on the premise of the tenure of service of the worker . The amount is, however, subject to a maximum of Rs.25 lakh. The following table shows the rates at which the gratuity will be payable in case of death of an employee:

Tenure of service Amount payable towards gratuity
Less than a year 2 * basis salary
1 year or more but less than 5 years 6 * basic salary
5 years or more but less than 11 years 12 * basic salary
11 years or more but less than 20 years 20 * basic salary
20 years or more Half of the main salary for each completed six-monthly period. However, it’s subject to a maximum of 35 times of the essential salary.

Tax on Gratuity:

The taxation process for gratuity depends upon the worker who is receiving the gratuity amount. Two standard cases arise for the calculation of income tax on gratuity:

  1. Government Employee Receiving Gratuity Amount:

In case any employee under the government , central government or the government office receives gratuity amount than the quantity is fully exempt from tax .

  1. Any Other Salaried Individual Receiving Gratuity Amount from an Employer who is roofed by Payment of Gratuity Act:

In case of gratuity received by any employee whose employer is roofed under the Gratuity Act, the subsequent amount is exempt from tax.

  • 15 days salary/Income as per the last drawn salary of the individual
  1. Any Other Salaried Individual Receiving Gratuity Amount from an Employer who isn’t Covered by Payment of Gratuity Act:

In such a case the least of the following three amounts is exempt from tax.

  • Rs.10,00,000
  • Gratuity actually received by employee
  • Half month’s salary for each year of service that the worker has completed with the employer

Tax Exemptions on Gratuity

Based on the policy changes made during the 2016 budget, here’s what gratuity laws looks like:

  • According to Article 10 (10) in the Income Tax Act, any gratuity received by government employees, apart from statutory corporations, is fully exempt of tax.
  • According to Article 10 (10) ii of the tax Act, death and retirement gratuity receivable by an employee covered under Gratuity Act 1972 is that the least of the following that is exempt from tax:
    • (*21/26) X Last drawn salary** X completed year of service or part thereof in excess of 6 months.
    • Rs.10 lakhs.
    • Gratuity amount that is actually received.

* 7 days in case an individual is an employee of a seasonal establishment.

** Salary amounts to the total salary received by an employee including Dearness Allowance and excluding any other benefits like bonus, HRA, commission, and any other such perquisites.

  • According to Article 10 (10) iii of the Income Tax Act, exemption for gratuity amount received by individuals who are not covered under Gratuity Act of 1974 are as follows:
    • Half month’s Average Salary* X Completed years of maintainance.
    • Rs. 10,00,000 3. Gratuity actually received.

*Average salary = Average Income of last 12 months immediately preceding the month of retirement ** Income = Basic Pay + Travelling Allowance (to the extent it forms a part of retirement benefits)+ turnover based commission

FAQs about Gratuity

  1. If I resign from an organization after 4.5 years of service, am I eligible for gratuity?No, you have to serve at least 5 years in a company to get gratuity payment. A Madras supreme court ruling held that you simply can avail gratuity if you’ve got completed 240 days of service within the fifth year. It is best to check with the HR of your company about this. However, if someone dies while in commission , the gratuity amount are paid to their legal heir although they need not completed 5 years of service. In addition, the quantity received by a nominee/heir won’t be taxed.
  2. I am a contract employee in a company. Will i buy gratuity if I resign or retire after 5 years?If you are on the company rolls and are considered an employee of the company, then you will receive gratuity. However, if you are under a contractor that is separate from the company then the gratuity should come from the contractor and not the company.
  3. What kind of employees does the Gratuity Act, 1972 cover?Payment of Gratuity Act, 1972, applies to employees of factories, mines, oilfields, plantations, ports, railway companies, shops or other establishments associated with them. All kinds of government jobs have also been included under the purview of this act. It is applicable in all states of India except Jammu and Kashmir.
  4. Is there any difference in calculation of gratuity for employees who are not covered under the Gratuity Act?Even if you are not covered by the Bonus Act, your employer may pay you bonus. The calculation for this is: Bonus = Average salary (basic + DA) * ½ * Number of service years. In this case, the service years aren’t rounded off to subsequent number. So if you’ve got a service of 12 years and 10 months, you get gratuity for 12 years and not 13 years.
  5. Is there a cap to the quantity I can receive as gratuity?Yes. A company cannot pay you more than Rs. 10 lakh as gratuity, irrespective of the number of years you have completed. This limit is additionally applicable to gratuity you’ll receive from different employers during your lifetime. If your company wishes to pay you more money, they can title it under ex-gratia or bonus.
  6. How do I nominate someone to receive my gratuity in case of my death?To nominate one or more heirs for your gratuity amount, you would like to fill in Form F when joining a corporation .
  7. How many days will it take for the employer to remit the gratuity amount?Usually, gratuity is released along side or simply before/after your full and final settlement is completed . The government mandates employers to pay the amount within 30 days. If there is any delay in payment, the employer has to pay a simple interest on the amount from the due date until the date when payment is made.

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