Gratuity is something which is given voluntarily or beyond the obligation usually for some service. Whether it be having a cup of coffee in a café, or getting a haircut done in a salon, or dining at a fine restaurant. It can be anything. Similarly, in legal terms gratuity is a sum of money that the employer pays to the employee in return for the services offered to the company. Not many people are aware of this term. Therefore in this article, we will be talking about the gratuity, its eligibility criteria, the procedure to calculate the gratuity and much more.
- 1 What is a Gratuity?
- 2 Who pays the Gratuity?
- 3 How is Gratuity calculated in India?
- 4 Gratuity Calculator
- 5 Applicability of Gratuity in India
- 6 Payment of Gratuity
- 7 Gratuity Amount Exempted from the Tax
- 8 Forfeiture of Gratuity
- 9 Important Points to Remember In case of Gratuity Benefits
What is a Gratuity?
A gratuity is a retiring benefit given to the employee or a worker after serving the employer to the fullest and giving the best years of his/her life for the benefit and prosperity of the employer.
Gratuity is provided to the Government employees and employees of the private sector and is tax-free. An employee becomes eligible for gratuity if they complete 5 years of full service with the same employer. The Payment of the Gratuity Act, 1972 came into force with effect from 16th of September 1972. This Act conquers the whole part of India except Jammu and Kashmir.
This is applied to every factory, mines, oilfield, Railway Company to every shop or establishment, employing 10 or more persons.
Who pays the Gratuity?
The gratuity is paid by the employer and where the employee does not have to make any contributions, unlike EPF. The employer can pay from his own fund or seek help from the life insurer or purchase a group gratuity plan. In case of a group gratuity plan, the employer has to make annual payments to the insurer and the employee can make contributions to the gratuity, but this is not necessary or mandatory.
How is Gratuity calculated in India?
Calculating gratuity is not that hard. Every salaried employee whether be it a private employee or a government employee, everybody receives a gratuity. The employer can pay as much gratuity as he wants. But there is a minimum gratuity amount that has to be paid to an employee. Tax concession is also available on the gratuity if it is in accordance with the gratuity formula and it is taxable if it exceeds the formula.
The formula of the gratuity is different for the people who are covered under the Gratuity Act. The calculation completely depends on your last drawn salary and the period of service.
Gratuity= Number of years * Last drawn salary of 15 days
= Number of years * 15/26 * monthly salary
Gratuity Payment Formula for Those Who Do Not Fall Under the Act of Gratuity:
It is not compulsory to pay gratuity for those companies that do not fall under the Gratuity Act. But the employer has the power to choose to pay gratuity to the employee for their service. The gratuity is always tax-free. Even in this case, the employee can calculate the gratuity in advance even though the formula is different for this one. Given below is the formula for gratuity calculation for the employees who do not fall under the Gratuity Act.
Gratuity= One day salary*15* Length of the service
= (Average salary of last 10 months /30)*15 complete years
=Average salary of last 10 months *Complete years *15/30
=Average salary of the last 10 months * Complete years*1/2
= Half of the 10-month average salary* Complete years
The Gratuity Calculator is a tool to calculate the gratuity payments in advance. The tool is very easy to use and is very handy. To calculate the gratuity from a gratuity calculator one has to provide the following information – Basic Salary, Dearness Allowance, and Length of Service in years or month.
Salary for Gratuity Calculation
In order to calculate the gratuity of an individual, the last drawn salary is a key element. The entire salary is not considered as the gratuity calculation. The calculation of the gratuity depends upon the following two basic components:
- Basic Salary
- Dearness Allowance (Optional)
This implies that the bonuses, HRA, special allowances are not considered as the part of the Gratuity calculation. The Private sector employers keep the basic salary of the employees to a minimum in order to ensure that the gratuity payments are lower.
Period of Service for the Gratuity Payment
The amount of gratuity received is directly proportional to the service period of an employee. According to the rules, an employee must complete a service period of 5 years in the company (or more than 4 years and 6 months) in order to avail this benefit. For the gratuity calculation, the number of years of service must be rounded off to the nearest integer. So for an example, if you have already completed 8 years and 7 months of service in the same company then it will be rounded off to 9 years of service and if in case you have completed 7 years and 4 months of service, then it will be calculated as 7 years of service period only.
Gratuity for the Employees Who Does Not Fall Under the Gratuity Act
The establishments that do not fall under the Gratuity Act, are not necessary to pay the gratuity to the employees. However, if an employer wants to pay gratuity to the employees, then the amount will be free of tax as long as it is paid according to a slightly different formula.
- In this case, the calculation of the per day salary of an employee is different. In addition to the basic salary and dearness allowance, the commission can also be included in the calculation. it should also be noted that the commission is usually a percentage of sales.
- The last drawn salary is also not considered in the calculation. Instead, the average salary for the last 10 months is used for the calculation.
- When calculating the per day salary of an employee, the monthly salary is not divided by six but is divided by 30 to get one day salary.
- The length of the service is not considered as the nearest integer. Instead, the number of years completed in the service is used for the calculations.
So as per the Regulations above, the employees of an organization that is not covered under the Gratuity Act are at a disadvantage. Since the per day salary is calculated divided by 30, the average per day salary reduces. Similarly, the number of years of service also reduces when the employee has not completed the whole year.
Gratuity Calculator after Seventh Pay Commission
The Seventh Pay Commission has recommended that the upper limit of gratuity is raised from Rs 10 Lakhs to 20 Lakhs, starting from 1st of January 2016. The Commission also recommends that the upper limit might be increased up to 25% when the dearness allowance of an employee raises up to 50%. This is already been performed in the case of the allowances that are partially indexed to the dearness allowances.
Gratuity= [(Basic Pay + Dearness Allowance)*15days*Years of Service]/26
It has been seen that the Labor laws mandate weekly offs for all the employees. Hence, the number of working days per month is not more than 26 days. Therefore, the monthly salary of an employee has 26 days of work. Therefore, in the formula of the gratuity calculation, it is divided by 26, not 30.
After the Seventh Pay Commission, below are the following revisions of the Gratuity Payment after Death
|Length of the Service||Rate of the Death Gratuity|
|Less than 1 year||2 times the monthly emoluments|
|Between 1 year (inclusive) and 5 years||6 times the monthly emoluments|
|Between 5 years (inclusive) and 11 years||12 times the monthly emoluments|
|Between 11 years (inclusive) and 20 years||20 times the monthly emoluments|
|20 years or more||Half month of emoluments for every complete 6 monthly period of qualifying service, subject to a maximum of 33 emoluments|
Applicability of Gratuity in India
The Payments of the Gratuity Act 1971, is applicable to the employees who are engaged into activities like Oil Fields, Mines, Factories, Ports, Plantations, Shops and Other establishments or the Railway Companies that have 10 or more employees.
Gratuity amount is completely paid by the employer and there is no contribution from the employee.
The end of service benefits are applied to the following:
- An individual employed on the salary or wages.
- An individual who has served continuously for more than 5 years at the time of the retirement, resignation or superannuation.
- An employee who faces death or disablement at any point of time (even before completing 5 years of service)
Payment of Gratuity
The employer pays the gratuity amount to the employee within 30 days of the billing. If the amount is not paid at the particular time then a rate of simple interest is loaded on it from the date on which it is payable. The rate of simple interest is not higher than the rate specified by the Central Government. The gratuity is usually paid in cash. In case the payee desires, the payment can also be made through a demand draft or cheque.
Gratuity Amount Exempted from the Tax
The current tax-free gratuity is 10 Lakh, for the private and unorganized sector employees. The rule is also same for the Central Government Employees under the Central Civil Services (Pension) Rules until the 7th Central Pay Commission roll out in January 2017, when it was increased to 20 Lakh.
However, the Central Government approved the introduction of the Payment of Gratuity (Amendment Bill) 2017 saying to double the tax-free gratuity of the employees.
The main goal of this Act is to provide a social security to the employees after the retirement.
Forfeiture of Gratuity
The Gratuity of an employee can be terminated for the following instances:
- If the service of an employee is terminated for his/her disorderly conduct or any anti-social violence.
- If the service of an employee was terminated following an offense committed by him or her that involved a moral turpitude during the employment.
- For an employer to be able to forfeit the gratuity of an employee there must be a termination order that consists of the charges of his/her alleged actions. In the absence of such a termination order, the gratuity of an employee cannot be forfeited.
- There are no taxes levied on the Gratuity amount for the Government Employees.
- For the employees in the private sector companies, there will be no tax on the gratuity, subject to a maximum of Rs 10 Lakhs.
Important Points to Remember In case of Gratuity Benefits
- One can nominate a family member by filing the Form “F” at the time of joining the company.
- Even when the company is in the loss, it is compulsory to pay the gratuity amount.
- If you are planning to change your company just before 5 years then, rethink before making any decision as you can lose some huge amount of money which you are entitled to receive if you are in the 5th year.