Gratuity is a benefit which is payable under the Payment of Gratuity Act 1972. Gratuity is the sum of money paid by an employer to an employee for his/her rendered services to the organization for the tenure of his/her services.

Out of the several components that make up the gross salary of a salaried individual, gratuity is one. Gratuity is a benefit payable under the Payment of Gratuity Act passed in the year 1972.

What is Mean by Gratuity?

Gratuity is a sum of money 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 company. It can be understood as a form of tip paid by an employer to the employee for services offered in the company. Since tips are a function of culture, various countries have various gratuity limits that are doled out by employers.

In another language Gratuity is a lump sum that a company pays when an employee leaves an organization and is one of the many retirement benefits offered by a company to an employee. In India, gratuity rules and requirements are set out under the Payment of Gratuity Act, 1972. An employer may also choose to pay gratuity outside of that which is required by this Act.

How does Gratuity Payment Work?

An employer may offer a 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 too can contribute to his/her gratuity amount. The gratuity paid by the insurance company is based on the clauses in the group insurance scheme.

Payment of Gratuity Act, 1972:

The payment of Gratuity Act was passed in 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 totally paid by the employer without any contribution from the employee

Eligibility Criteria for Gratuity Payment:

Following are the few instances when you will be eligible to receive a gratuity.

1. An employee should be eligible for superannuation

2. An employee retires

3. An employee resigns after working for 5 years with a single employer

4. An employee passes away or suffers disability due to illness or accident

A formula for Calculation of Gratuity Amount:

Listed below are the components that go into the calculation of gratuity amount. The amount is also dependent upon the number of years served in the company and the last drawn salary.

If,

N = number of years of service in a company

B = last drawn basic salary plus DA

then,

Gratuity = N*B*15/26

Gratuity Applicability as per Payment of Gratuity Act 1972:

Every person working in a factory, mine, oil field, port, railways, plantation, Shops & Establishments, or educational institution having 10 or more employees on any day in the preceding 12 months is entitled to Gratuity. It is applicable for only permanent employees and not for trainees/interns.

Once the Act becomes applicable to an employer – even if the number of employees goes below 10, gratuity is still applicable.

Income Tax Exemption on Gratuity payment to an employee as per Income Tax Act:

In the case of Gratuity received by a Government Employee

Any gratuity received by an employee of the Central Government, State Government or local authority, on death or retirement is fully exempt from tax.

In case of Gratuity received by an employee where the Employer is covered by the Payment of Gratuity Act.

The least of the following is exempt from Tax

· 15 days salary based on the salary last drawn for every completed year of service or part thereof in excess of 6 months. Therefore the amount that shall be exempt from total Gratuity paid is calculated as last drawn salary x number of years in employment x 15/26.

Last drawn salary is Basic salary and DA. The number of years in service is rounded off to the nearest full year. For example – if you have worked in an organization for 12 years and 2 months, the number of years in employment shall be considered to be 12 years. And in case you have worked for 12 years and 7 months, the number of years in employment shall be considered to be 13 years.

· Rs 10,00,000
Gratuity actually received

Let’s understand this by way of an example – Rahul worked for a company for 18 years and 7 months. His company is covered by the Payment of Gratuity Act. At the time of his retirement, his salary was Rs 20,000. He received Rs 8,00,000 as Gratuity from his employer.

Calculation of amount which is exempt from Rs 8,00,000 – lower of the following 3

· 20000 x 19 x 15/26 = Rs 2,19,230

· Rs 10,00,000

· Rs 8,00,000

The amount that is exempt from Gratuity payment for Rahul is Rs 2,19,230 and remaining amount of Rs 8,00,000 – Rs 2,19,230 = 5,80,769 is taxable for Rahul.

In case of Gratuity received by an employee where Employer is not covered by the Payment of Gratuity Act

The least of the following is exempt from Tax

· Half month’s salary for each completed year of service. While calculating completed years, any fraction of a year shall be ignored. For example – if you have worked in an organization for 14 years and 9 months, the number of years in employment shall be considered to be 14 years. Here salary is taken as an average salary of the 10 months immediately before the month in which the person retires.

· Rs 10,00,000 Gratuity actually received

For example – Sunil who works for XYZ Ltd. Retires after 30 years and 9 months of service. He receives Rs 8,00,000 as a gratuity. His average monthly salary of 10 months immediately preceding month of retirement is Rs 50,000.

For Sunil the minimum of these amounts shall be exempt from Tax

· 50,000 x ½ x 30 = 7,50,000

· 10,00,000

· 11,00,000

Therefore for Sunil Rs 7,50,000 shall be exempt from Tax and he will pay tax on Rs 8,00,000 – 7,50,000 = Rs 50,000. Rs 50,000 shall be taxed and included under the head ‘Income from Salaries’.

Few Notable Points:

The employer can pay a Gratuity of more than Rs 10,00,000, the exemption shall be calculated in the same manner as listed above.

If the employee’s services have been terminated due to any misconduct, the employer has the right to reject payment of Gratuity to the employee.

In case of death of the employee, the Gratuity can be paid to the nominee or the legal heir of the employee. In this case, the exemption is calculated in the same manner as above and is taxed for the receiver under the head ‘Income from other sources’

More Example Below

Example of Gratuity Calculation:

For example, if Amit is an engineer who has worked with SF Company for 20 years of service and had Rs.25,000 as his last drawn basic plus DA amount, then,

Gratuity Amount for Amit = 20*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 more than Rs.10 lac. Anything above the amount Rs.10 lac is known as ex-gratia which is a voluntary contribution and not something compulsorily imposed by the law.

Also, for the number of months in the last year of employment, anything above 6 months is rounded off to the next number while anything below 6 months in the last year of employment is rounded off to the previous lower number. So, a job 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 organization is not covered under the Gratuity Act. The gratuity amount which is payable to the employee is calculated on the basis of half month’s salary for each complete year of service. Salary, in this case, is calculated including basic pay, commission on sales, and dearness allowance.

Formula for Gratuity calculation:

The following formula is considered for the calculation of gratuity amount for employees who are not covered under the Gratuity Act:

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

Example:

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

Gratuity Amount: (15 * 50,000 * 11) / 30 = Rs.2.75 lakh.

The period of service of an employee is taken as a whole 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 less than 6 months), the number of years of service would have been 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 basic salary. However, it is subject to a cap of Rs.20 lakh.

Calculation of gratuity in case of death of an employee:

In case of death of an employee, the gratuity benefits are calculated on the basis of the tenure of service of the employee. The amount is, however, subject to a maximum of Rs.20 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 basic salary for each completed six-monthly period. However, it is subject to a maximum of 33 times of the basic salary.

Taxation Process of Gratuity:

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

1. Government Employee Receiving Gratuity Amount:

In case any employee under the state government, central government or local authority receives gratuity amount than the amount is fully exempt from Income Tax.

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

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

· 15 days salary as per the last drawn salary of the individual

3. Any Other Salaried Individual Receiving Gratuity Amount from an Employer who is not Covered by the 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 an employee

· Half month's salary for every year of service that the employee has completed with the employer

Gratuity Rules

Forfeiture of Gratuity

According to the Payment of Gratuity Act of 1972, an employer holds the right to forfeit their gratuity payment, either wholly or partially despite the employee 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 authorized 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 acknowledgment, has a time period of 30 days to pay the gratuity amount to the individual.

Tax exemptions on gratuity for Assessment Year 2016-17

Based on the policy changes made during the 2016 budget, here’s what gratuity laws look 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 Income Tax Act, death and retirement gratuity receivable by an employee covered under Gratuity Act 1972 is the least amount of the following that is exempt from tax:
· (*15/26) X Last drawn salary** X completed a 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 service
· Rs. 10,00,000 3. Gratuity actually received.

*Average salary = Average Salary of last 10 months immediately preceding the month of retirement ** Salary = Basic Pay + Dearness Allowance (to the extent it forms part of retirement benefits)+ turnover based commission

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, the interim finance minister, Mr. Piyush Goyal announced that the existing tax-free gratuity limit will be increased to Rs.30 lakh.

· 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.

FAQs about Gratuity in India

1. If I resign from a company 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 High Court ruling held that you can avail gratuity if you have completed 240 days of service in the fifth year. It is best to check with the HR of your company about this. However, if someone dies while in service, the gratuity amount will be paid to their legal heir even if they have not completed 5 years of service. In addition, the amount received by a nominee/heir will not be taxed.

2. I am a contract employee in a company. Will I get 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 related to 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 Gratuity Act, your employer may pay you gratuity. The calculation for this is: Gratuity = Average salary (basic + DA) * ½ * Number of service years. In this case, the service years are not rounded off to the next number. So if you have a service of 12 years and 10 months, you get a gratuity for 12 years and not 13 years.

5. Is there a cap to the amount I can receive as a gratuity?

Yes. A company cannot pay you more than Rs. 10 lakh as a gratuity, irrespective of the number of years you have completed. This limit is also applicable to gratuity you can 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 need to fill in Form F when joining a company.

7. How many days will it take for the employer to remit the gratuity amount?

Usually, gratuity is released along with or just before/after your full and final settlement is done. The government mandates employers to pay the amount within 30 days. If there is any delay in payment, the employer has to pay simple interest on the amount from the due date until the date when payment is made.