Background

Gratuity Rules

Gratuity is a lump sum payment made by an employer to an employee as a token of appreciation for the services rendered over a period of time. In India, gratuity is governed by the Payment of Gratuity Act, 1972, which mandates employers to pay gratuity to employees who have completed a certain period of continuous service.

Eligibility Criteria for Gratuity

An employee is eligible to receive gratuity if:

  • They have completed at least 5 years of continuous service with the same employer.
  • The termination of employment is due to:
    • Superannuation (retirement).
    • Resignation.
    • Death or disablement due to accident or disease (in such cases, the 5-year rule is waived).

Note: Continuous service includes periods of leave, layoff, or absence due to sickness, accident, or any other reason not due to the employee’s fault.

Gratuity Calculation Formula

The formula to calculate gratuity depends on whether the employer is covered under the Payment of Gratuity Act, 1972.

1. For Employers Covered Under the Act

Gratuity = (Last Drawn Salary × 15 × Number of Completed Years of Service) / 26

  • Last Drawn Salary includes Basic Pay + Dearness Allowance (DA).
  • The number of years is rounded off: if an employee has completed more than 6 months in the last year, it is considered as a full year.

Example:

If an employee has a last drawn salary (Basic + DA) of ₹50,000 and has completed 10 years and 7 months of service:

Gratuity = (50,000 × 15 × 11) / 26 = ₹3,17,307.69

2. For Employers Not Covered Under the Act

Gratuity = (Last Drawn Salary × 15 × Number of Completed Years of Service) / 30

  • In this case, the number of years is not rounded off. Only completed years are considered.

Example:

If an employee has a last drawn salary of ₹50,000 and has completed 10 years and 7 months of service:

Gratuity = (50,000 × 15 × 10) / 30 = ₹2,50,000

Note: Employers not covered under the Act are not legally bound to pay gratuity, but many do so as a goodwill gesture.

Taxation on Gratuity

The tax exemption on gratuity depends on the type of employment:

  • Government Employees: Gratuity received is fully exempt from income tax.
  • Non-Government Employees Covered Under the Act: The least of the following is exempt:
    • Actual gratuity received.
    • ₹20,00,000 (as per the latest amendment).
    • Gratuity calculated as per the formula.
  • Non-Government Employees Not Covered Under the Act: The least of the following is exempt:
    • Actual gratuity received.
    • ₹10,00,000.
    • (Average salary of last 10 months × 15 × Number of years of service) / 30.

Any amount received over the exempt limit is taxable under the head “Income from Salary”.

Key Points to Remember

  • Maximum Gratuity Limit: The maximum gratuity payable is ₹20,00,000. Any amount beyond this is considered ex-gratia and is taxable.
  • Forfeiture of Gratuity: An employer can forfeit gratuity, wholly or partially, if the employee has been terminated for misconduct, riotous behavior, or any act of violence.
  • Payment Timeline: Gratuity should be paid within 30 days from the date it becomes payable. Delayed payment attracts interest.

Conclusion

Gratuity serves as a financial cushion for employees post-retirement or upon leaving an organization after long-term service. Understanding the rules, eligibility, and calculation methods ensures that employees can plan their finances effectively and claim their rightful dues.