1. HR Glossary
2. Gratuity

What is Gratuity? Meaning, Rules, Formula & Calculator

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What is Gratuity?

Gratuity is a statutory monetary benefit paid by an employer to an employee for rendering services for a continuous period of five years or more. It is governed by the Payment of Gratuity Act, 1972, and acts as a financial reward for an employee's long-term service.

In India, the Payment of Gratuity Act (1972) provides detailed conditions for gratuity. This act came into effect from 16/09/1972. Under the Payment of Gratuity Act, the following are required to pay gratuity to their employees.

• All the factories, oilfields, mines, railways, ports, and plantations, and,
• All the other shops and establishments employ more than 10 employees.

Notably, this act applied with retrospective effect for the preceding 12 months as well. Meaning, an employee who resigned in June 1972, was also eligible to avail gratuity.

Gratuity Calculator

What are the Eligibility Criteria for Gratuity in India?

As per section 4(1) of the Payment of Gratuity Act (1972), there are four major eligible criteria for gratuity in India. These criteria include superannuation, retirement/resignation, death, and permanent disability.

• Superannuation: Superannuation refers to the time when an employee reaches the age of retirement. This age is typically 58/60 years in India.
• Retirement/resignation: This criteria applies when an employee either voluntarily resigns or retires from an organization.
• Death of an employee: In the case of the death of an employee, his/her nominee or legal heir receives the gratuity amount.
• Disability: An employee is also eligible for gratuity if he/she become disabled due to an accident or illness. Notably, such employees are eligible for gratuity irrespective of the term of their service.

Is Gratuity Payable Before 5 Years? (The 240 Days Rule)

There is a common confusion regarding an employee’s eligibility for gratuity upon completing 4 years and 240 days of service.

According to a ruling by the Madras High Court, if an employee completes 240 days of service in the fifth year, it is often considered as a full year of continuous service for the purpose of gratuity calculation. However, this is a matter of legal interpretation, and most organizations are required to maintain compliance with the constant 5-year rule unless specific exceptions apply (for example, death or disability).

Gratuity Formula

Even though there are many formulas to calculate the gratuity amount easily, calculating it according to the Payment of Gratuity Act 1972 can be complicated.

As per this act, the payment of gratuity is categorized into two ways:

• When the employees are covered under the act.
• When the employees are not covered under the act.

The calculation of employees’ gratuity differs between these two categories, as explained below.

How to Calculate Gratuity for Employees Covered under the Act?

To calculate gratuity for employees covered under the act, you need their number of continuous employment years and the amount of their last drawn salary. Using these details, you can use the following gratuity calculation formula for employees covered under the act:

For employees covered under the Act, the formula is based on 15 days' wages for every completed year of service, calculated on a 26-day working month.

So, the gratuity would be ₹4,61,538 in the formula, 15 refers to 15 days’ salary for every year of service, and 26 refers to the total days worked in a month.

How to Calculate Gratuity for Employees Not Covered under the Act?

There are a few companies that are not covered under the Payment of Gratuity Act. However, these employees are still eligible to receive gratuity under gratuity conditions.

Employees not covered under the Act are still eligible for gratuity, but the calculation differs slightly. It is based on half a month's salary for every completed year of service (calculated on a 30-day month). Here is the gratuity calculation formula for employees not covered under the act:

Gratuity Calculation in Case of the Death of an Employee

In case an employee dies due to an accident or illness, their nominee will be eligible to receive gratuity from their organization, In such unforeseen circumstances the below-listed rates of gratuity will be paid by the organization:

How to Calculate Gratuity in Case of Death of an Employee?

In the unfortunate event of an employee's death, the 5-year continuous service rule is waived. This means the gratuity amount must be paid to the nominee or legal heir regardless of how long the employee worked.

Gratuity Calculation in Death Case: (Last Drawn Salary × 15/26) × Years of Service

Essential Gratuity Forms & Documentation

To process gratuity or file a nomination, employees must submit the prescribed forms under the Act.

Taxation Rules for Gratuity

Section 10(10) of the Income Tax Act (1961) lists the following taxation rules for gratuity.

• Employees of the central/state government need not pay taxes on gratuity. Notably, there is no monetary limit as well.
• For other employees covered under the Payment of Gratuity, gratuity/up to 20 lakhs is not taxable. Any access amount beyond this mentioned limit is taxable.
• For employees who are not covered under the Gratuity Act, gratuity/amount up to 20 Lakh is not taxable. Any amount above this is taxable.
• In case of the death of an employee, the amount received by the nominee/legal heir is completely exempt from tax/non-taxable.

Let’s understand these rules better with some examples.

Note that the employer is responsible for deducting TDS from the taxable gratuity portion under section 192 of the Income Tax Act.

FAQs

1. What Kind of Employees are Covered under the Gratuity Act 1972?

Payment of Gratuity Act 1972 covers employees working in mines, factories, plantations, oilfields, ports, railway corporations, or other establishments related to them. It also includes all government jobs.

2. How Many Days Will It Take for an Employer to Process the Gratuity Amount?

Generally, the gratuity amount is released along with or just after the employee's full and final settlement is done. The government has made it compulsory for employers to pay the gratuity amount within 30 days.

3. Whom and how the Employee Nominee for the Gratuity Can be Submitted?

According to the Gratuity Act, the employee should submit Form F for nomination within 30 days of completing one year of employment tenure. The employee can only nominate their family member if they don’t have any family, they can only nominate someone else.

4. Is There any Limit to the Amount of Gratuity a Company Can Pay to Their Employees?

According to the act, a company can not pay any employee more than Rs 20 lakhs as gratuity, regardless of the number of years that the respective employee has completed in the company.

5. What is the Gratuity Act?

The Payment of Gratuity Act (1972) is commonly known as the Gratuity Act. It is an Indian legislation that specifies the details of providing gratuity to employees. It lists the tenure, provisions for providing gratuity, the penalties for failing to provide gratuity, and even defines the key stakeholders. The key stakeholders include employees, employers, and other stakeholders as defined in the act.

6. How Much is Gratuity after 5 Years?

The amount you would receive in the form of gratuity depends on the number of years you’ve worked for an organization. Your gratuity would be calculated on the basis of your last drawn salary. This salary would also include DA (dearness allowance). You can calculate your gratuity by using this formula, provided in the Payment of Gratuity Act (1972)

Gratuity = (15 / 26) × Last drawn monthly salary × No. of years of service

7. What are the New Rules for Gratuity?

There were three major rules introduced by the Payment of Gratuity Amendment Act (2018):

1. The sealing limit of the gratuity amount was increased to 20 Lakh from 10 Lakh.
2. The provisions of the Gratuity Act were made applicable to the private sector as well.
3. 26 weeks of maternity leave were also considered as part of continuous service. This change was necessary to align the new provisions with the Maternity Benefits Amendment Act (2017)

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