How Does Gratuity Work?
Gratuity is a reward for your long-term loyalty towards your organization. It is governed by the Payment of Gratuity Act, 1972, and this act covers any factory, mine, oilfield, plantation, port, railway, shop, or other premises employing ten or more workers.
Once an employee joins an organization, their employer automatically sets aside a portion of funds as part of a gratuity scheme. Once the employee leaves the organization, this amount is paid to the employee, provided all the conditions are met. The amount of the gratuity is calculated based on the employees’ last drawn salary and their years of service.
What are the Benefits of Gratuity?
Gratuity is a well-earned lump sum amount provided to employees in recognition of their dedication and long-term service to an organization. It offers several benefits that enhance overall employee satisfaction while also supporting employers in building a committed and motivated workforce.
Benefits for Employees
- It serves as a financial cushion for employees during retirement or job transition periods.
- It rewards loyalty and motivates employees to stay with the organization for a longer duration.
- The gratuity earned up to ₹20 lakh is exempt from taxes if the employee falls under the Payment of Gratuity Act, making it a tax-efficient benefit.
- In case of the death or disability of an employee, the gratuity amount becomes highly helpful for the family’s financial security.
Benefits for Employers
- A well-structured gratuity scheme helps attract and retain talent, as employees value long-term financial security.
- Contributions made by employers towards an approved gratuity fund are eligible for tax deductions according to the Income Tax Act.
- It builds a culture of trust and commitment within the organization, improving overall employee morale.
- It demonstrates that the company values its workforce beyond just day-to-day productivity.
Who is Covered Under the Gratuity Payment Act, 1972?
If you work in a company with 10 or more employees, your employer is required to follow the rules of the Gratuity Payment Act, 1972. This applies to jobs in places like mines, shops, factories, ports, railways, plantations, and similar organizations. To be eligible for gratuity, you need to have worked continuously with the same company for at least 5 years and 1 year for fixed-term employees.
Eligibility Criteria for Gratuity in India
The primary eligibility criterion to claim gratuity as per the employee’s salary is that he/she should have served in the same organization for a minimum period of five years. Along with this primary requirement, there are certain other conditions that you must fulfill to claim gratuity in India.
Minimum Employee Strength
All companies that have a minimum strength of 10 employees on any single day in the last 12 months must provide gratuity to their employees. Even if the number of employees drops below 10, the company is required to pay gratuity.
Conditions for Payment
Gratuity is disbursed when an employee ceases employment with the organization due to various reasons, including:
- Retirement
- Resignation
- Voluntary Retirement Scheme (VRS)
- Layoff
- Termination
- Disability due to an accident or illness
- Death
If an employee meets these criteria, they can receive gratuity payments. Even if a company goes bankrupt, it still has to make these payments to eligible employees as per current regulations.
Reasons for Forfeiture
Sometimes, even when an employee fulfills all the necessary conditions, the employer may refuse to pay them their gratuity payment. Some of the possible reasons for doing so can include:
- Being charged with corruption at the place of work
- Engaging in violent acts or disorderly conduct at or outside of the workplace
- Other proven workplace offenses, such as negligence resulting in damage to company property, where the employer may deduct repair costs from the gratuity amount payable.
How to Calculate Gratuity
After understanding what gratuity meaning is, the next question that often comes up for employees is how gratuity can be calculated. The gratuity formula differs slightly as it depends upon whether or not your employer is covered under the Payment of Gratuity Act. You can also calculate gratuity online using various gratuity calculators available on financial websites, which make the process quick and straightforward.
Here is a simple example to understand how the gratuity is calculated:
| Detail |
Value |
|---|
| Employee Name |
Rajesh Kumar |
| Monthly Basic Salary + DA |
₹40,000 |
| Years of Service |
10 years |
| Gratuity (Act Covered) |
₹40,000 x 15/26 x 10 = ₹2,30,769 |
| Gratuity (Not Act Covered) |
₹40,000 x 15/30 x 10 = ₹2,00,000 |
Calculation for Employees Covered Under the Payment of Gratuity Act
For those employees who work within the organizations covered by the Act, the gratuity formula for calculating the payment is:
Gratuity = (Last Drawn Basic Salary + DA) x 15/26 x Number of Years of Service
In this gratuity formula, 15 refers to 15 days of wages for each completed year of service, whereas 26 refers to the number of days worked in a month (assuming the employee works six days a week). The calculation of gratuity for private employees in covered establishments follows this exact formula.
Calculation for Employees Not Covered Under the Payment of Gratuity Act
For employees in organizations not covered under the Act, the formula for gratuity is slightly different:
Gratuity = (Last Drawn Basic Salary + DA) x 15/30 x Number of Years of Service
Here, 30 is used instead of 26, as the calculation assumes a 30-day month. Even if your employer is not legally obligated to follow the Act, many organizations choose to pay gratuity voluntarily as a matter of good practice.
Calculation of Gratuity in Case of Death of an Employee
In the tragic event of an employee’s death, the gratuity is paid to the nominee or the legal heir. The five-year service requirement does not apply in such cases. The amount is calculated based on the years of service completed, subject to the following rates:
| Years of Service Completed |
Gratuity Payable |
|---|
| Less than 1 year |
2 times the monthly basic salary |
| 1 year or more but less than 5 years |
6 times the monthly basic salary |
| 5 years or more but less than 11 years |
12 times the monthly basic salary |
| 11 years or more but less than 20 years |
20 times the monthly basic salary |
| 20 years or more |
Half of the monthly basic salary for each completed six-month period, subject to a maximum of 33 times |
What are the Gratuity Rules that Need to be Followed?
The criteria for gratuity are governed by the Payment of Gratuity Act of 1972. If a firm that employs ten people or more is expected to pay gratuity, regardless of whether the number of employees decreases below 10. For one to be eligible for gratuity, an employee has to be employed by the firm for a minimum period of five years continuously.
If an employee dies, the gratuity payment will be made to his/her nominee or lawful heirs; there will be no tax deducted on these payments. An employee who has been disabled due to any kind of illness or injury is also eligible for gratuity benefits.
However, if an employee is dismissed due to misconduct, fraud, theft, or assault, they lose their right to claim gratuity from the company. In the case of an employer filing for bankruptcy, they fulfill gratuity payments and cannot deny them.
How is the Gratuity Amount Taxed?
Gratuity enjoys tax advantages up to specified limits under the Income Tax Act. The employees should be aware of the tax considerations associated with gratuity for proper financial management. The tax exemptions depend on whether the employee is working in the government or private sector:
- Government Employee: Employees working in central government, state government, or local authorities are fully exempt from tax on their gratuity amount.
- Covered Private Employee: For other eligible private sector employees, the exempted amount is the least of the following:
1. ₹20 lakh
2. Actual gratuity received
3. [Last drawn salary * 15/26] * Completed years of service
Any gratuity exceeding this limit is taxable according to the employee’s income tax bracket.
- Not Covered Employee: Employees not covered under the Gratuity Act have different exemption limits:
1. ₹10 lakhs
2. Actual gratuity received
3. [Average salary for the last 10 months * 15/30] * Number of completed years of service
FAQs
1
When is an employee eligible for gratuity?
An employee becomes eligible for gratuity benefits after working for five consecutive years with the same employer, or one year in the case of fixed-period employees. This requirement will not be relevant in cases when the employee dies or becomes permanently disabled. Continuity of employment would imply that there was no break during the period of employment by virtue of absence on leave or any other reason.
2
Is there a maximum limit on gratuity payable to an employee?
Yes, there is a maximum limit on gratuity paid by employers to their employees under the Payment of Gratuity Act, 1972. The current maximum limit on gratuity payment is ₹20 lakh under the Act. Employers may choose to pay more than this amount, but the same will not be tax-free.
3
Does gratuity apply to all employees in an organization?
The gratuity scheme covers all employees who work in organizations employing 10 or more people. It includes both managerial and non-managerial staff who meet the gratuity eligibility criteria. Employees must complete the minimum service requirement to qualify. However, apprentice workers might not fall under this benefit scheme.
4
In case I resign after 4.5 years of service with my employer, can I get gratuity?
According to the standard rule, 5 years of service is mandatory for receiving gratuity. Sometimes, in certain cases, courts have interpreted eligibility as 4 years and 240 days of service. This all depends upon company policy and legal interpretation. Therefore, it is not guaranteed in every situation.
5
How do I nominate the rightful person to receive gratuity in case of my death?
You can appoint a nominee who could be your family member by submitting Form F to your employer. This nomination can be made after completing one year of service. There are no restrictions imposed on modifying or renewing your nomination, and it can be submitted anytime. If no nomination is made, the amount gets paid to your legal heirs.
