Gain comprehensive knowledge about Gratuity - a financial benefit that employers offer to employees who have served for five years or more. Explore eligibility, calculation, tax implications, and use the Gratuity Calculator to estimate your amount.
Overview
Gratuity is a monetary amount paid to an employee by the employer as a sign of appreciation for the work they have done in the company. This payment is secured by the Payment of Gratuity Act 1972. It is essential for an employee to know about the amount of gratuity he will receive. Gratuity payment is included in the gross salary of an employee. If you want to calculate the amount of gratuity you will receive from your employer, you can check out the VakilSearch Gratuity Calculator. Even though the Payment of Gratuity Act 1972 applies to all companies and industries, there are some rules and regulations associated with the gratuity payments set up by the Government of India. In this blog, you’ll learn about the Applicability Payment of Gratuity Act 1972, its rules, forfeiture of gratuity & timeline for gratuity payment.
What is Gratuity?
Gratuity is a monetary sum that employers give their employees for serving the company for at least five years. It’s a retirement benefit plan included in an employee’s salary to provide them with financial support during their retirement years.
What is Gratuity in Salary?
Gratuity is a type of financial compensation that employers give to recognize their employees’ loyalty to the company. It is part of the employee’s salary and can be considered a retirement benefit plan.
When an employee leaves a company after working for at least 5 years, the employer pays gratuity as a gesture of gratitude for the employee’s loyal service. Essentially, it’s a financial token of appreciation for their long-term dedication.
Payment of Gratuity Act: How Does Gratuity Work?
An employer has two options to provide gratuity to their employees – they can either pay the gratuity amount directly from their account or opt for a gratuity insurance plan with a third-party provider. If the latter is chosen, the company makes annual contributions to the service provider who is responsible for paying out the gratuity amount to the employee as per the policy’s terms and conditions. It’s worth noting that the gratuity amount is solely funded by the employer, and no contribution is required from the employee.
What is the Eligibility Criteria for Payment of Gratuity?
Here are some examples of when an individual may be eligible to receive gratuity:
- When an employee reaches the superannuation age
- When an employee retires from their job
- When an employee resigns from a job after serving a single employer for a minimum of 5 years
- When an employee experiences disability or passes away due to an illness or accident.
Few Significant Points About Gratuity
Payment of Gratuity Act – Here are some key points regarding the payment of gratuity by an employer to an employee:
- If an employer pays gratuity to an employee in excess of ₹ 10 lakh, the tax exemption will be based on the criteria mentioned earlier. In the 2019 Interim Budget, the interim finance minister, Mr. Piyush Goyal, raised the tax-free gratuity limit to ₹ 30 lakh.
- An employer can deny gratuity payment to an employee who has been fired for any wrongdoing.
- In case of an employee’s demise, the nominee or legal heir is eligible to receive the gratuity payment, and the tax liability of the beneficiary is calculated under the ‘income from other sources’ category.
What is a Gratuity Calculator?
The Gratuity Calculator employs the gratuity calculation formula to approximate the gratuity sum an individual may get upon resigning from a job after rendering continuous service for at least five years.
The formula for calculating gratuity is as follows:
| (15 * Last Drawn Salary * Tenure of Working) / 26 |
The tool is useful for computing the gratuity amount an individual may receive upon retirement from a company, and it necessitates providing certain information such as the last drawn salary, which includes basic salary, dearness allowance, and any earned sales commissions, as well as the duration of continuous service with the company.
You can easily use the gratuity calculator by entering the necessary details, and it will generate the estimated gratuity amount in a matter of seconds. Moreover, it can be used multiple times whenever necessary.
Gratuity Calculation Formula
Payment of Gratuity Act – The gratuity amount is determined by taking into account factors such as the employee’s length of service with the company and their final salary.
| Gratuity = N*B*15/26 |
where,
- N = Number of Years Serviced in the Organization
- B = Basic Salary including DA
How to Calculate Gratuity?
For instance, let’s say Akil’s last drawn basic salary including DA was ₹ 25,000, and he worked with the company for 20 years. In this case,
Gratuity Amount for Akil = 20 * 25,000 * 15/26 = ₹ 2,88,461.54
It is important to mention that employers have the option to provide a gratuity amount higher than the legally required sum. Moreover, while calculating the number of months served during the final year of employment, any duration exceeding six months is rounded up to the nearest whole number, whereas any period less than six months is rounded down to the preceding whole number.
Benefits of Using the Gratuity Calculator
Payment of Gratuity Act 1972: Some of the advantages of using a gratuity calculator are given below:
- Accurate Calculation: A gratuity calculator is created to precisely calculate the gratuity amount based on the employee’s basic wage and number of years of service. It eliminates the potential for human error when figuring out the tip amount by hand.
- Time-Saving: Calculating gratuity can take a lot of time, especially if you have to do it manually for several staff. You may save time by rapidly calculating the amount of gratuities due to each employee using a tip calculator.
- Easy to Use: Calculators for gratuities are simple tools that everyone can use. To utilise them, you don’t have to be an expert in maths. The calculator will do the rest if you only enter some basic data, including the number of years of service and the base income.
- Transparent: Calculators that show you how the tip is calculated are known as gratuity calculators. You can see the method used to determine the gratuity amount as well as the considerations made.
- Avoids Disputes: Employers and employees may occasionally disagree on the amount of the gratuity. By accurately calculating the gratuity amount based on the legislation and regulations, a gratuity calculator can assist prevent such arguments.
Purpose of Introducing Gratuity
The importance of gratuity is mainly realised after retirement. The primary purpose of introducing gratuity is to help employees live comfortable life after retirement. It does not matter if the retirement was due to a physical disability, superannuation rules or impairment of the body. Gratuity is paid to the employee after retirement
The gratuity amount given to the employee is not associated with any evaluation. It is simply a token of appreciation for the years of service to the company provided by the employee.
Applicability of Gratuity Payment
As per the Payment of Gratuity Act 1972, gratuity must be paid by all the following entities:
- All the factories, mines, oilfields, ports, railways, and plantations
- All the establishments and shops that have been registered under the Shops and Establishments Act
- All the establishment that has hired 10 or more employees
- If the Payment of Gratuity Act 1972 is applicable to an establishment, it does not matter if the number of employees goes below 10; the establishment must continue to pay the gratuity.
Under the Payment of Gratuity Act 1972, any employee who has served an organisation for five or more years before the termination of his/her employment contract is to receive a gratuity payment.
If the employee does not work underground (for eg: in mines), a year is approximated as 240 working days for the calculation of gratuity. However, if the employee works underground, a year is approximated as 190 days. This is probably due to the health risks associated with working underground.
- NOTE 1: The competence of 5 years of continuous service is not applicable to an employee if his/her services have been discontinued because of death.
- NOTE 2: Earned leaves, maternity leaves and leaves taken due to disability are considered as days worked while calculating the gratuity payments.
Applying Gratuity Rules
The rules for gratuity are set by Section 4 of the Payment of Gratuity Act 1972.
- Gratuity must be paid by companies which have hired ten or more employees.
- Employees must have completed 5 years of continued service within an organisation to be qualified for gratuity.
- An employee can avail his/her gratuity payment in other situations than just upon retirement. For e.g.: death, termination, etc.
- The last salary and the total number of years served by an employee determine the amount of gratuity.
- There are situations where the gratuity payments can be forfeited. For e.g., participation in illegal activities
- Even if the organisation has declared bankruptcy, it must pay gratuity payments to all employees.
- Gratuity payments of ₹ 20 Lakhs and less are exempted from taxation by central and state governments. Previously, this limit was fixed to ₹ 10 Lakhs.
- Taxation on gratuity payment is different for employees working for organisations covered under the Payment of Gratuity Act 1972, and the ones who are not covered by the Act.
- The tax exemption rule for up to ₹ 20 Lakhs is applicable for the cumulative gratuity obtained by an employee. For e.g.: If an employee receives a gratuity payment from Employer X of ₹ 15 Lakhs for 20 years of her services, and then he/she receives another gratuity payment from another Employer Y of ₹ 10 Lakhs for 10 years of service, he/she has to pay income tax on ₹ 5 Lakhs (15 10 – 20).
- In the event of the death of an employee, the gratuity payment paid to the employee’s nominee or legal heir must also be exempted from taxation.
Payment of Gratuity Act: Forfeiture of Gratuity
The gratuity payment to an employee can be forfeited partially or completely on in the following cases:
- When an employee has been discontinued due to negligence, loss or damage that resulted in the loss of the employer, the gratuity can be forfeited up to the limit of the loss caused by the employee.
- When an employee has been fired because of disruptive conduct or any act of violence.
- When an employee has been terminated because of participation in illegal activities, given that the activity was carried out by him during his employment tenure.
Calculation of Gratuity for the Employees Who Are Not Covered Under the Gratuity Act
If an employer is not covered under the Gratuity Act, they may still choose to provide gratuity to their employees. In such cases, the gratuity amount is calculated based on half of the employee’s monthly salary for each year of completed service, including basic salary, dearness allowance, and any commission earned.
The formula used for calculating gratuity amount for non-Gratuity Act employees is as follows:
Gratuity Amount = (15 * Last drawn salary amount * period of service) / 30
For instance, if an employee has worked at a company for 10 years and 8 months with a salary of ₹ 50,000, their gratuity amount can be calculated as follows:
Gratuity Amount: (15 * 50,000 * 11) / 30 = ₹ 2.75 lakhs.
To calculate an employee’s gratuity, a complete year of service is counted as one year. If an employee has worked for more than six months but less than a year in their last year of service, the completed years of service are considered. However, if an employee has worked for more than six months in their last year of service, it is considered as a full year of service. For instance, if an employee has worked for 11 years and 4 months, the period of service would be considered as 11 years. But if the duration of service is 10 years and 4 months (or less than 6 months), the number of years of service would be calculated as 10 years only.
The pensioner portal of the government states that the retirement gratuity amount is calculated by taking 1/4th of the employee’s last drawn basic salary for each completed 6-month period. The payable gratuity amount at the time of retirement is equivalent to 16 times the basic salary, with a maximum cap of ₹ 20 lakhs.
Calculation of Gratuity in Case of Death of an Employee
If an employee becomes disabled or passes away due to illness or an accident, they are entitled to receive gratuity. The gratuity amount in such unforeseen circumstances is calculated based on the employee’s length of service. However, it is important to note that the maximum amount of gratuity payable in such cases is ₹ 20 lakhs.
| Employment Tenure | Amount Payable Towards Gratuity |
| Less than 1 year | 2 times the employee’s basic salary |
| More than 1 year but less than 5 years | 6 times the employee’s basic salary |
| More than 5 years but less than 11 years | 12 times the employee’s basic salary |
| More than 11 years but less than 20 years | 20 times the employee’s basic salary |
| 20 years or more | Half of the basic salary for each completed 6-month period (subject to a maximum of 22 times the employee’s basic salary) |
Tax on Gratuity
The taxation of gratuity depends on the employee receiving it, and there are two standard cases for calculating tax:
- Government Employees Receiving Gratuity: If an employee works for the state government, central government, or local authority, their gratuity amount is fully exempt from income tax.
- Salaried Individuals Receiving Gratuity from an Employer Covered by the Gratuity Act: If an employee’s employer is covered under the Gratuity Act, then the following amount is exempt from tax:
- 15 days of salary as per the last drawn salary of the individual.
- Salaried Individuals Receiving Gratuity from an Employer Not Covered by the Gratuity Act: If an employee’s employer is not covered under the Gratuity Act, then the least of the following three amounts is exempt from tax:
- ₹ 20 lakhs
- Gratuity actually received by the employee
- The gratuity amount is eligible to be received.
Tax Exemptions on Gratuity
Payment of Gratuity Act: The gratuity laws have been updated following the policy changes made during the 2016 budget. As per Article 10(10) of the Income Tax Act, government employees, excluding statutory corporations, are fully exempt from tax on the gratuity they receive.
For employees covered under the Gratuity Act 1972, the gratuity amount exempt from tax is the least of the following:
(*15/26) x Last drawn salary x completed years of service or part thereof in excess of 6 months.
-
- ₹ 20 lakh.
- Gratuity amount that is actually received.
- (For employees of seasonal establishments, this is 7 days of salary.)
The salary includes the total salary received by an employee, including Dearness Allowance, but excluding other benefits like bonus, HRA, commission, and any other such perquisites.
Employees who are not covered under the Gratuity Act of 1974 are exempt from tax on the following:
-
- Half month’s average salary x completed years of service.
- ₹ 10 lakhs.
- Gratuity amount that is actually received.
- (Average salary is the average of the last 10 months’ salary preceding the month of retirement. Salary includes Basic Pay, Dearness Allowance (to the extent it forms part of retirement benefits), and turnover-based commission.)
Timeline for Gratuity Payment
The process of gratuity payment involves three steps as follows:
- Initiation: An individual or an authorized person must submit an application to the employer, stating the amount of gratuity owed by the company.
- Acknowledgment and Calculation: Upon receiving the application, the employer will calculate the amount of gratuity owed and send a notice to the individual and the relevant governing authority, specifying the amount.
- Disbursal: After sending the acknowledgment, the employer is required to pay the gratuity amount to the individual within a period of 30 days.
Conclusion
To conclude, employees must complete five years of service. However, this condition is not applicable in the event of the death of an employee. The gratuity payments of up to ₹ 20 Lakhs are exempted from taxation by the Central and State Governments. The Payment of Gratuity Act, 1972 has set up rules and regulations associated with gratuity payments. You will receive your gratuity payments when you retire or resign from an organisation, given that you have rendered five years of service to the company.
FAQs
Is gratuity taxable under the Income Tax Act?
As per the Payment of Gratuity Act 1972, gratuity received by employees in the private sector is regarded as a component of their salary and is subject to taxation as per the Income Tax Act.
How is Gratuity Calculated?
Gratuity is calculated based on the employee's last drawn salary and the number of years of service completed with the employer. The formula for calculating gratuity is as follows: Gratuity = (15 x last drawn salary x number of years of service) / 26
How much is Gratuity in 5 years?
An employee who completes 5 years of continuous service is eligible to receive gratuity equivalent to 75 days of their last drawn salary, as per the Payment of Gratuity Act, 1972. The maximum amount of gratuity that an employee can receive is ₹ 20 lakh.
What does Gratuity mean?
Gratuity is a sum of money paid by an employer to an employee in recognition of the employee's long and meritorious service. It is usually given at the time of retirement or resignation, or in case of death or disablement due to an accident or illness.
Is 4 years 7 months Eligible for Gratuity?
To be eligible for gratuity, it is necessary to have completed at least five years of continuous service. However, gratuity can be paid before completion of five years of service in case of death or disability resulting from an illness or an accident.
Is Gratuity Payable after 4.8 Years?
No, as per the Payment of Gratuity Act, an employee must complete a minimum of 5 years of continuous service to be eligible for gratuity payment.
Is it mandatory to work for 5 years to get Gratuity?
Yes, as per the Payment of Gratuity Act, an employee must complete at least five years of continuous service with their employer to be eligible for gratuity payment.
Is Gratuity part of CTC?
Yes, gratuity is a part of the employee's Cost-to-Company (CTC). However, it is not paid out on a monthly basis like other components such as basic salary, HRA, etc. Instead, it is paid as a lump sum amount at the time of retirement, resignation, or death.
What is the maximum Gratuity limit?
The maximum amount of gratuity that an employee can receive is ₹ 20 lakh, as per the Payment of Gratuity Act, 1972.
Does fixed salary include PF and Gratuity?
In most cases, gratuity is not included in the fixed salary. However, some employers may offer a higher fixed salary that includes gratuity as an additional component.
If an individual is a contract employee, will he receive Gratuity on completing 5 years in service?
Contract employees are generally not eligible for gratuity, but some employers may offer it as a benefit in their employment contract. It's important to check the employment contract and seek clarification from the employer about eligibility.
Is there any upper limit on the amount of Gratuity that you will receive?
Yes, there is an upper limit on the amount of gratuity that can be received by an employee. As per the Payment of Gratuity Act in India, the maximum amount of gratuity that can be paid is ₹ 20 lakhs.
How much time does the employer take to release the Gratuity amount?
An eligible employee can apply for their gratuity within 30 days of it becoming payable, but failure to submit the application within the time limit does not invalidate the claim. The employer must specify the gratuity amount within 15 days of receiving the application, and it must be paid within 30 days of the application. If the employer misses this deadline, they must pay the gratuity amount along with simple interest.
What kind of employees does the Gratuity Act, 1972 cover?
The Payment of Gratuity Act, 1972, is applicable to employees working in various industries including factories, mines, oilfields, plantations, ports, railway companies, shops, and related establishments. The act also covers all types of government jobs. It is applicable in all states of India, except for Jammu and Kashmir.
How do I nominate someone to receive my Gratuity in case of my death?
When you join a company, you can nominate one or more heirs for your gratuity amount by filling out Form F.
How many days will it take for the employer to remit the gratuity amount?
Gratuity is typically paid alongside or just after the completion of an employee's full and final settlement. The government requires employers to pay the gratuity amount within 30 days of becoming due. If there is any delay in payment, the employer is required to pay simple interest on the amount from the due date until the payment date.
