Gratuity

Definition: Gratuity implies a sum paid to the employee by the employer organization as a form of gratitude, for the services rendered by him/her to the company, over the years. It is given under the Payment of Gratuity Act, 1972.

Gratuity is payable to an employee when the employment is terminated, and the completed years of service is five years or more. It becomes payable on his/her:

  • Superannuation
  • Retirement or Resignation
  • Death or Disability due to accident or disease

However, the completion of five years of service is not mandatory in case of demise or disablement.

Normally, the gratuity is paid to the employee, but in case of his/her demise, the gratuity is given to the nominee. But, in the absence of nomination, it is given to his/her legal heir.

The amount of gratuity is either paid by the employer from their own fund or the employer can go for general gratuity insurance plan. In a general gratuity insurance plan, the employer firm has to make annual contributions in the form of premium, towards the plan and the insurance company pays the amount of gratuity to the employees, as per the rules of the policy.

It must be noted, that, unlike provident fund, the employee does not contribute to the gratuity, i.e. only employer makes a contribution in it.

How to calculate the amount of Gratuity?

The law has not prescribed a fixed percentage, for the amount of gratuity, which an employee will receive. However, the employer can use the formula for calculating gratuity. The formula for calculating the amount of gratuity is given as under:

  • Employer Covered under Payment of Gratuity Act: The calculation of gratuity is given as under:
    gratuity-formula

In this case, the completed years of service may include any year where an employee has served for more than 6 months.

Therefore, if a person has worked for 6 years, 6 months and 10 days. It will be considered as 7 years, whereas if a person has worked for 6 years, 5 months and 20 days,  then 6 years will be considered as the completed years of service.

  • Employer Not Covered under Payment of Gratuity Act: The calculation of gratuity is given as under:
    gratuity-formula

In this case, the number of years employed is considered as per the completion of each year of service. This means that if a person has worked for 10 years 8 months, then only 10 years will be regarded as the number of years employed.

Note: For the calculation of gratuity, Last drawn salary covers basic salary plus dearness allowance and commission received (if any).

Tax Treatment of Gratuity

Tax treatment of the amount of gratuity is based on the type of organization, i.e. Government or non-government. The bifurcation is made in three categories:

  1. The gratuity amount received by a government employee is fully exempt from tax. This means that gratuity amount paid to any government employee whether employed under central, state or local government, it will remain tax-free.
  2. If the employer is covered under the Payment of Gratuity Act, 1972, gratuity paid to any eligible employee will be exempt up to the least of the following:
    • Rs. 20 Lakh.
    • Actual gratuity received.
    • Last drawn salary × Number of completed years of service × (15/26)
  3. If the employer is not covered under the Payment of Gratuity Act, 1972 and gratuity paid to any eligible employee, then the least of the following amount will be exempt from tax:
    • Rs. 10 Lakh.
    • Actual gratuity received.
    • Half month’s average salary × Number of years employee

Note: Here, Average salary is equal to the Average Salary of last 10 months immediately preceding the month of retirement

Forfeiture of Gratuity

The employer organization has the right to forfeit gratuity, either in part or full, or to the extent of the damage only, due to the following reasons:

  • Forfeiture to the amount of loss: In case if the services of an employee have been terminated due to any act, wilful omission, or negligence, which results in the damage to the property of the organization, then the amount of gratuity will be forfeited to the extent of the damage caused to the employer.
  • Full or partial Forfeiture: On the other hand, if the reason for the termination of service is any riotous act or misconduct or any act causing violence, or act causing moral turpitude. Then in such a case, the gratuity will be wholly or partially forfeited.

Non-payment of Gratuity

Gratuity must be paid within 30 days by the employer to the employee, however, if the employer fails to pay the amount of gratuity then simple interest on the gratuity amount will be charged, starting from the date it becomes payable, to the date, it is actually paid.

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