Gratuity - Gratuity Calculation, Eligibility & Gratuity Formula

Gratuity is a one-time monetary benefit given by the employer to the employees.

Although considered an act of kindness or generosity, gratuity is an obligation on the employer and is covered under the Payment of Gratuity Act of 1972. Typically, gratuity is paid at the time of retirement, along with the full and final settlement amount. Still, it can also be paid to the employee who switches the job after 5 years.

In simpler terms, gratuity is payable only after employees have completed at least five years of service with the company. It is one of the superannuation benefits employees can derive from their employers.

Note: Sometimes, an employee may get the gratuity before completing the gratuity period. These situations may include being disabled in an accident or due to a disease.

The Payment of Gratuity Act 1972 was implemented to provide monetary benefits to employees for their contribution toward their employer for extended years of service. This act applies to employees of all types of industries and organisations in India except State and Central government employees, as they follow a different set of gratuity rules.

As per the gratuity rules, organisations with over 10 employees are automatically covered under the Payment of Gratuity Act of 1972. The gratuity rule still applies to organisations that do not fall under the Gratuity Act.

Gratuity is a component of an employee's gross salary. Although it is not paid out in the monthly salary, the employee receives this as a lump sum amount only on fulfilling specific conditions. A closer look at the CTC breakup shows gratuity as a part of it. Companies may deduct a certain gratuity percentage, around 4.81% of the basic and dearness allowance towards gratuity. The formula for which is explained in detail in the article below. Hence, gratuity deduction from salary happens before one receives their in-hand salary.

There are two ways employers can pay this gratuity amount.

• Direct payment to the employee from their account

• Opt for a gratuity insurance provider and make regular contributions

To receive the gratuity, one must meet the following gratuity eligibility criteria:

• If the employee is eligible for superannuation

• If the employee resigns from the organisation after working for a minimum of five years

• If the employee retires from the organisation

• If the employee suffers from a disability due to an accident or illness or passes away

Since the monetary amount payable as a gratuity to an employee is covered under the Payment of Gratuity Act 1972, the act sets the gratuity rules and calculations. Employees are classified under two major categories:

• Those who are covered under the act

• Those who are not covered under the act

It must be noted that the gratuity calculation formula for both these categories is different, which is explained below.

Gratuity Calculation for Employees Covered Under the Act

A specific mathematical formula exists for the gratuity calculation for employees covered under the Payments of Gratuity Act. The calculation is based on the 15 times of last drawn salary, for every completed year of service over six months or in part after that.
Gratuity calculation formula: Gratuity = N x B x 15/26
Where,

N = number of years of service completed in the organisation

B = Last drawn basic salary + dearness allowance

Let's take an example to understand this gratuity calculation formula.

A person worked at a company covered under the act for 10 years. When leaving the job, his last drawn salary was ₹60,000 (basic + dearness allowance). In this case, the amount of gratuity calculated would be:

Gratuity = 10 x ₹60,000 x 15/26

= ₹3,46,154

Important points to remember:

• As per the act, the gratuity amount should not exceed ₹20 lakhs and any amount beyond this limit is treated as ex-gratia.

• If the number of days worked in the last employment year exceeds six months, it will be rounded off to the nearest number. For example, if the tenure of service is 10 years 8 months, then the employee receives gratuity for 11 years, and if the tenure is 10 years 3 months, he shall receive gratuity for 10 years.

**Gratuity Calculation for Employees Not Covered under the Act **

As mentioned earlier, employees working for organisations not covered under the Payment of Gratuity Act are also eligible to receive gratuity under certain eligibility conditions. For such cases, the gratuity calculation formula changes slightly with the total working days taken as 30 instead of 26. Thus, the gratuity amount calculation depends on the half month's salary (basic + dearness allowance) on each completed year of service. The formula used is:

Gratuity calculation formula: Gratuity = (15 x last drawn salary x Number of years of service) / 30

For example, an individual with a last drawn basic and dearness allowance salary of ₹40,000 worked at an organisation not covered under the act for six years. In this case, the amount of gratuity calculated would be:

Gratuity = (15 x 40,000 x 6) / 30

= (36,00,000) /30

= ₹1,20,000

The rounding norms are the same as discussed in the above section.

Gratuity benefits are calculated differently in case of the death of an employee or disability due to any illness or accident. In any of these situations, the maximum amount receivable should not exceed ₹20 lakhs. In case of the death of an employee, the gratuity amount will be given to the nominee or beneficiary of the employee.

The Payment of Gratuity Act 1972 not only safeguards the interests of an employee but also gives the employer control over the partial or whole gratuity amount payable. According to the act, the employer can forfeit the employee's gratuity in the following cases:

• If the services of the employee are terminated due to misconduct, wrongdoing, wilful omission or negligence which has caused damage or loss to the employer.

• If the employee gets terminated due to an offence that involves moral vileness.

However, to forfeit the gratuity amount, there are a few prerequisites. These include:

• The damages or loss suffered by the employer should be quantified.

• The principles of justice must be adhered to. Therefore, the concerned employee must be allowed to put forward his part.

• The employee can forfeit the gratuity, partially or wholly, by following the rules, laws and legal proceedings.

Thus the employer can forfeit the employee's gratuity after complying with the act's provisions and proper due discussion with the employee. If unable to do so, the employer may attract a penalty.

The tax on gratuity payout depends on the employee's employment type. Below are the three main employment categories for gratuity and their tax implications.

- Tax implication for government employees

The gratuity payout for state and central government and local authority employees is exempted from tax under the Income Tax Act.

• Tax implication for employees covered under the Payment of Gratuity Act

Employees working in any organisation, establishment, industry, plantation, factory, shop or any other establishment having 10 or more employees on any day in the previous 12 months are covered under the act and eligible for gratuity.

The least of the following amounts is exempted from tax:

• The eligible gratuity as per the formula (last drawn basic salary + dearness allowance x number of years of service completed in the organisation x 15/26)

• Maximum gratuity limit (₹20 lakh)

• Actual gratuity received

Let's take an example to understand the tax implication on gratuity.

Arun's last drawn salary (basic + DA) was ₹80,000, and employee Sameer's last drawn salary was ₹2,00,000. Both have recently retired after serving in an organisation for 20 years. Below are their gratuity calculations and the tax implications.

Tax implication for employees not covered under the Payment of Gratuity Act

Even if the organisation is not covered under the act, the employer can still pay gratuity. However, the gratuity calculation and the tax implication would have different treatments.
The least of the following amounts is exempted from tax:

• The eligible gratuity as per the formula is (15 x last drawn salary x number of years of service) / 30

• Maximum gratuity limit (₹10 lakh)

• Actual gratuity received

Let us consider the below example:

Nishant was employed in an organisation for 15 years and 8 months; at the time of retirement, his average salary (basic + DA) for the last 10 months was ₹75,000, and the actual gratuity he received was ₹8,00,000.

The gratuity calculator is an online tool that helps calculate the employee's gratuity due to the services given to the organisation based on the formula. This easy-to-use tool can give an employee an estimated gratuity amount that one would receive at retirement, job change, or any other situation provided they complete 5 years of service. Then, based on the inputs for the last drawn salary and the employable tenure, the calculator automatically applies the formula to display the final gratuity amount.

Benefits of using a gratuity calculator

• A gratuity calculator is an easy-to-use online tool.

• It helps determine the exact gratuity amount you are eligible to receive by the employee from your employer.

• The calculator typically requires only two input fields, the last drawn salary and the number of years of service. Based on these values, the final value is displayed. This makes its usage extremely easy.

• The receiver does not have to calculate the complicated gratuity calculation by themselves. Thus, it is free from human errors giving accurate results.

• The gratuity amount is calculated instantly within seconds.

• Not just while reaching retirement age, this calculator can help employees properly plan for short-term and long-term financial goals.

• Being an online tool, one can use this calculator any number of times and at the convenience of their home or anywhere.

The gratuity payment process consists of three main stages – initiation, acknowledgement and calculation and disbursal.

- Initiation: In this stage, the employee initiates the process by sending a relevant gratuity form to the employer.

- Acknowledgement and calculation: On receipt of the application, the employer acknowledges the receipt and carries out the calculation for gratuity. The calculated gratuity amount is then informed to the employee and the controlling authority.

- Disbursal: After sharing the acknowledgement with the employee, the employer has 30 days to pay the gratuity amount.

• The Parliamentary Standing Committee on Labour (the new Social Security and Industrial Relations Code) suggested that the gratuity timeframe of 5 years of service should be reduced to 1 year.

• Additionally, the committee suggested extending the gratuity to various other types of employees like contract labourers, daily and monthly wage workers, etc.

• To increase the amount of gratuity receivable, the New Labour Code also mandated to pay 50% of the gross salary as basic pay. Therefore, the employer will have to change the remuneration structure if the basic salary is less than 50%.

Why is gratuity paid?

The employer pays gratuity for rendering their contribution towards the organisation for a period equal to or more than 5 years. It is a benefit plan given mainly to help employees post-retirement. It is, however, not just paid at retirement. Thus, gratuity is like gratitude shown by the employer, and the amount can be used for any purpose.

Is there a cap on the amount of gratuity received by an employee?

Yes. As per the latest amendment to the Gratuity Payment Act 1972, the maximum gratuity for an employee covered under the act has been increased from ₹10 lakhs to ₹20 lakhs. However, for the employee not covered under the act, the cap is retained at ₹10 lakhs.

When is the Gratuity amount payable to an individual?

The gratuity amount is payable to employees after they complete at least 5 years of continuous service at a particular organisation. The payment is made under the following situations:

● At superannuation or retirement

● At the time of resignation or termination (under certain circumstances)

● Due to an employee's death or disablement due to disease or accident

● During downsizing or layoffs

● When an employee opts for a VRS (Voluntary Retirement Scheme)

If an employee resigns after working for 4.5 years, will he be eligible for gratuity?

Since the employee has yet to complete a minimum of 5 years of service with an organisation, he is not entitled to gratuity. However, a gratuity would be paid before the period of 5 years only in case of death or disablement of an employee due to a disease or an accident.

Are contractual employees entitled to receive gratuity upon completing 5 years of continuous service?

Any employee on the rolls of a company becomes an employee of that company and is eligible to receive a gratuity from the company. However, individuals working on contracts are technically not company employees, and it is the contractor's responsibility to pay gratuity.

Is gratuity taxable under the Income Tax Act?

Only Central and State government employees and the employees of local authorities are exempted from tax on gratuity. On the contrary, the gratuity amount received by private employees is considered a part of their salary and, thus, is taxable.

Will the employee receive a gratuity amount if the employer goes bankrupt?

Even if the employer goes bankrupt, he cannot deny paying gratuity to his employees.

When the gratuity payment is made to the nominee or legal heir, how will the tax liability be calculated for the recipient?

In the event of an employee's death, the nominee or the legal heir becomes the recipient of the gratuity amount. The gratuity amount received by the recipient in such cases will carry tax liability and be added to the heading - "income from other sources" for the recipient.

How long does it take for an employer to pay the gratuity amount?

As per the Government mandate, once the employer shares the acknowledgement of the receipt of the gratuity application, he must pay this amount within 30 days. In case of delay in payment, the employer faces a penalty wherein he has to pay interest on the gratuity amount from the due date until the payment is done.

Which form should one fill in to nominate someone to claim the gratuity amount in case of death?

An employee can nominate one or more than one individual as nominees. Form F is the correct form for appointing a nominee. If the employee fails to appoint a nominee, the gratuity amount shall be paid to the closest legal heir upon the employee's death.