All About Gratuity – Rules, Eligibility & Calculation

What is Gratuity?

Gratuity is paid by the employers to the employees as gratitude for the services rendered during their employment. It is a part of the employees' salaries and is a component of their gross remuneration.

The amount is paid to the employees when their employment ends and is an acknowledgment given to them for providing their services to the organization. Read on to know everything about it.

What is Gratuity in Salary?

Gratuity in salary is a financial component paid to the employees by the organizations recognizing their services. As part of the salary, it is a benefit aimed to help the employees during their post-retirement years.

The amount is generally paid at the time of retirement; however, every employee who has worked for the company for five consecutive years is eligible to receive this benefit.

How Does Gratuity Work?

The Payment of Gratuity Act, 1972 governs this benefit. Implemented in 1972, the act aimed to cover people working in mines, plantations, factories, fields, ports, and other establishments for more than 10 years.

According to the act, the entire amount is payable by the employer; however, employees can also contribute towards this payment to increase the accumulated corpus.

Some organizations pay the benefit through the companies' resources while others may tie up with insurance providers for group plans. Moreover, the benefits depend on the terms and conditions of such plans.

What Are the rules of Gratuity?

The three important rules related to the timeline for the payment of this benefit are as follows:

• An employee must send an application to the company about the money due as this benefit.
• On receiving the application, the organization calculates the amount and replies to the employee and the controlling authority.
• The company has to pay the entire amount within 30 days from the date of sending the acknowledgment.

Forfeiture Rules

Employers reserve the right to forfeit this benefit partially or even fully if the employee has completed five years of consecutive services. However, this is only if the employee’s termination is due to disorderly behavior like physically harming others during their employment.

Number of Employees

Every organization that employs 10 or more people on a single day during the preceding 12 months is liable to pay this benefit. Even if the number of personnel reduces below 10, the company will still have to pay the benefit as per the rules of the act.

Gratuity Eligibility Criteria

As per the new gratuity rules, the following are the eligibility norms.

• Employees eligible for receiving superannuation
• Individuals who have completed at least five consecutive years of employment with the same organization
• Retiring personnel
• Any employee who passes away or faces disability due to an accident or ailment

How to Calculate Gratuity?

The amount is calculated based on the number of years of employment and the last drawn salary. Additionally, it varies among individuals covered and not covered under the act.

Formula to calculate gratuity for employees covered under the Payment of Gratuity Act, 1972

Companies that hire 10 or more people on a single day during the 12 preceding months are covered under the act. The formula to calculate the amount is as follows:

Gratuity = (15 x last drawn salary x number of years of service) / 26

• The last drawn salary includes the basic remuneration plus the dearness allowance (DA); no other component is included in the calculation
• Completed years means when you have worked for more than six months during the year

Formula to calculate gratuity for employees not covered under the Payment of Gratuity Act, 1972

The formula for calculating gratuity amount is as follows:

Gratuity = (15 x average salary for previous 10 months x number of years employed) x 30

• The last drawn salary includes the basic remuneration plus DA and any commissions
• The number of employment years includes only the completed years of service

Formula to calculate gratuity for deceased employees

The amount depends on the tenure of the service of the deceased employee subject to a maximum amount of INR 20 lakhs. The table below shows the amount payable to the beneficiaries of a deceased employee:

Types of Gratuity Forms

Gratuity Tax Exemptions

The taxable gratuity rules are as follows:

Any amount received by the government employees except those employed with statutory corporations is fully tax-exempt.

For employees covered under the act, the lowest of the following is tax-exempt:

• Actual amount received
• INR 10 lakhs
• Gratuity = (15 x last drawn salary x number of years of service) / 26

For employees not covered under the act, the lowest of the following is tax-exempt:

• Actual amount received
• INR 10 lakhs
• Gratuity = (15 x average salary for previous 10 months x number of years employed) / 30

Frequently asked questions (FAQs)

Who Is Eligible to Receive Gratuity?

All employees who have worked for at least five consecutive years with the same organization are eligible to receive gratuity.

When can you receive the gratuity amount?

After serving for at least five years in the same company, the gratuity amount is payable on:

• Resignation, retirement, or termination
• Opting for a voluntary retirement scheme (VRS)
• Demise or disability due to an accidental injury or ailment*
• Layoff or retrenchment

Please note: Gratuity is payable to you or your nominee (in case of your passing away) even if you have not worked with the same company for five consecutive years.

Can you have a nominee in your gratuity?

Yes, you can include a nominee in your gratuity. You need to fill out Form F while joining the company and provide your details.

Under which heading is the gratuity amount taxed?

The gratuity amount received either on resignation or termination is taxed under the heading ‘Income from Salary’.

You must add the amount to your salary income and the rule is the same for the government as well as private-sector employees.

Can a company refuse to pay the gratuity amount in case of financial instability?

Companies covered under the Payment of Gratuity Act, 1972 are liable to pay the gratuity amount to their employees irrespective of their financial situation.
The company cannot refuse payment stating loss as the reason.

How is the gratuity amount taxed?

The Income Tax Act lays down the rules governing the taxation of gratuity and it depends on whether your employer is a government or a private sector company.
Government employees who receive the gratuity amount during their service are liable to taxes. However, if the money is received on retirement, the entire amount is tax-exempt.

The lowest of the following gratuity amount is tax-free for private-sector employees:

• INR 20 lakh
• Actual amount received
• Eligible amount is based on the gratuity formula

Can you receive a gratuity if you haven’t worked for five years with the same company?

No, you must work for a minimum of five consecutive years in a company to be eligible for gratuity. However, if you are suffering from an ailment or face disability in an accident, you are eligible to receive gratuity even if you have not worked with the same organization for five years. Your nominee can also receive the gratuity amount in case of your demise before five years of service.

If you are a contract employee, are you still eligible for gratuity after working for five years?

If you are on the company's payroll, you will receive the gratuity. However, if you are under a contract, the contractor is liable to pay you the due gratuity amount.

Do you lose your gratuity amount if your company goes bankrupt?

No, your employer is still liable to pay the gratuity amount and no court can put a stay on this payment even if the company goes bankrupt.

How long do employers take to release your gratuity payment?

If you are eligible for gratuity, you can submit your application within 30 days from the date the amount becomes payable. However, if you do not apply within this time, your claim does not become invalid.

The employer must provide the gratuity amount details within 15 days of receiving your application. The entire amount has to be paid within 30 days of receiving the application. The company is liable to pay simple interest if there is a delay in clearing the gratuity payment within 30 days.

Are contractual employees eligible for gratuity after five years of service?

If you are employed on the company’s payroll, you are eligible for the benefit after five years of service. However, if you are under a contract separate from the organization, the benefit is payable by the contractor.

What types of personnel are covered by the Payment of Gratuity Act, 1972?

The act applies to people employed in shops, factories, railway companies, mines, ports, plantations, oilfields, and other establishments. All government employees are covered under the act in all states except Jammu and Kashmir.

Is there any maximum limit on the gratuity amount?

The maximum limit for government employees is INR 20 lakhs and for non-government personnel is INR 10 lakhs.

What is the maximum amount of gratuity that is tax-exempt?

Tax exemption is capped at a maximum of INR 20 lakhs for the amount received from one or more employers.

How much time do employers take to release the gratuity amount?

The gratuity payment rules require the employers to release the amount within 30 days from the full and final settlement date. In case of a delay, the employers need to pay the interest from the due date until the payment is done.

Is the notice period included while calculating the number of years of service?

The amount is calculated from the joining date until your last working day, which includes the notice period since you are still receiving a salary from the company.

How can you nominate someone to receive the gratuity amount in case of your demise?

You will have to fill Form F at the time of joining to nominate one or more beneficiaries to receive the amount in your absence.