Gratuity

What is Gratuity?

Gratuity is the amount paid by an employer for the services rendered by an employee during their employment period. According to the law, employees have the right to avail gratuity after working in an organization for five continuous years. Generally, it is paid during employee’s retirement but can also be paid during their active employment years.

The ‘Payment of Gratuity’ Act passed by the Indian Parliament on 21st August 1972 and came into effect on 16th September 1972 applies to the following:

All the factories, oilfields, mines, railways, ports, and plantations.

Shops or establishments employing 10 or more during the preceding 12 months.

Any other shops or establishments employing 10 or more employees during the preceding 12 months.

It is important to note that organizations covered under the Act should pay gratuity to their eligible employees. Those not covered can choose to pay Gratuity of their own accord.

What are the eligibility criteria for the payment of gratuity?

Under Section 4 of the ‘Payment of Gratuity Act’, it is mandatory for organizations to pay gratuity to terminated employees who rendered 5 continuous years of service. The termination can be due to the following reasons:

  1. Superannuation of employees
  2. Retirement or Resignation
  3. On their death or
  4. Disablement due to accident or illness.

These individuals are protected by the act and organizations under the ‘Payment of Gratuity Act’ must adhere to the provisions of the act.

eligible for gratuity

What is a Gratuity Calculator?

A gratuity calculator is a tool used by individuals to calculate their gratuity. The calculator finds its more prominent usage among small business owners and employees. While they provide a rough estimate, the final amount depends on multiple factors like legal and governmental regulations.

How to calculate Gratuity?

The Gratuity Calculation formula is interdependent on the act and varies according to the following criteria:

  1. Gratuity Calculations for the employees who are covered under the Payment of Gratuity Act 1972.
  2. Gratuity Calculations for the employees who are not covered under the Payment of Gratuity Act 1972.

Calculating Gratuity for the employees who are covered under the Act:

Gratuity = Salary last drawn * Number of completed years of service * 15 / 26

Where,

Salary last drawn = Basic Salary + Dearness Allowance

Number of completed years of service = Total number of years for which service provided

And,

15 Days = Number of days the employee has worked

26 Days = Total number of working days in a month

Calculating Gratuity for the employees who are not covered under the Act:

Gratuity = Last 10 months average salary * Number of completed years of service * ½

Well, sounds confusing?

Let’s try to understand it with an example.

For instance, Alice works at XYZ firm (covered under the Gratuity Act) and receives a monthly package of Rs. 75,000 (including Basic Salary and DA). She has worked in the firm for 7 years and is considering moving into a new challenge. Assuming she worked for 200 days each year and 26 days each month, her gratuity is Rs. 4,03,846 (approx.).

Detailed calculation:

Gratuity = Salary last drawn * Number of completed years of service * 15 / 26

Now, inserting the values in the formula:

Salary last drawn – Rs. 75,000

Number of completed years – 7 years

Gratuity = Rs. 75,000 * 7 * 15/26 = Rs. 75,000 * 7 * 0.5769

Gratuity = Rs. 4,03,846

In another instance, Priyank works as a marketing executive for ABC Corp. (not covered by the Gratuity Act). His salary varies from Rs. 40,000 to 45,000 due to performance incentives, and he completed 12 years of service. His gratuity amounts to around Rs. 2,55,000.

Detailed Calculation:

Gratuity = Last 10 months average salary * Number of completed years of service * ½

Now, inserting the values in the formula:

Last 10 months average salary – Rs. 42,500

Number of completed years – 12 years

Gratuity = Rs. 42,500 * 12 * ½ = Rs. 42,500 * 6

Gratuity = Rs. 2,55,000

Well, does all this sound too complicated?

Alice and Priyank thought the same too…

But they used a tool to simplify their calculations!

Don’t be surprised, use Keka’s Gratuity Calculator – to calculate your gratuity in seconds!

A sneak peek into the free tool:

Try Free Gratuity Calculator: https://www.keka.com/free-tools/calculators/gratuity-calculator

What are the advantages of using a Gratuity Calculator?

Using Gratuity Calculator benefits both an employee and the employer. A few key benefits offered by it are:

  • Accurate calculations
  • Saves time and resources
  • Consistent results
  • Avoids legal worries

Accurate calculations:

Gratuity calculations involve complex formulas, and using a calculator reduces manual errors by making the process efficient and accurate.

Saves time and resources:

Calculating gratuity manually for employees with a long service history and complex salary structures is time-consuming. Using a calculator saves time and resources by reducing human efforts, miscalculations, and constant corrections and adjustments.

Consistent results:

A calculator helps make the results consistent across various employees and scenarios, assisting organizations maintain fairness and equity in gratuity payouts.

Avoids legal worries:

Gratuity calculators are designed to comply with local laws and regulations, ensuring organizations’ adherence to legal requirements and avoiding potential lawsuits and other non-compliance risks.

What are the taxation rules for gratuities?

Under Section 10 (10) of the Income Tax Act,

1. Gratuity is tax-free for Government employees along with employees of local authorities.

2. Gratuity is taxable for non-governmental employees above a certain threshold limit. The lowest of either of these amounts would be tax-free;

  • Actual Gratuity received
  • Last Drawn Salary * 15/26 * Completed Years of Salary
  • Maximum amount of Rs. 20,00,000

Let’s understand this with an example:

Particulars Case Study 1 Case Study 2 
Completed years of service 30 years 25 years 
Annual Income Rs. 12,00,000 (1,00,000 per month) Rs. 18,00,000 (1,50,000 per month) 
Actual Gratuity received 18,00,000 (assumed) 18,00,000 (assumed) 
Calculation 
  1. 18,00,000
  2. 1,00,000*15/26*30 = 17,30,770
  3. 20,00,000
  1. 18,00,000 
  2. 1,50,000*15/26*25 = 21,63,462 
  3. 20,00,000 
Exempted Gratuity Rs. 17,30,770 Rs. 18,00,000 

Thus, the taxation rules on employee’s gratuity mainly varied based on their type of employment, i.e., government or non-government employees.

What are tax exemptions on gratuity?

The Gratuity exemption limit is mentioned under Section 10 (10) of the Income Tax Act, 1961. A recent change in the act mentions the revised exemption limit as follows:

Relevant Exemption Section Category of Employees Maximum Exemption Limit Relevant Period 
Section 10 (10) (ii) Employees who are covered under Payment of Gratuity Act Rs. 20,00,000 On or after 29th March 2018 
Rs. 10,00,000 Revised rate, post 29th March 2018 
Section 10 (10) (iii) Employees who are not covered under Payment of Gratuity Act Rs. 20,00,000 On or after 29th March 2018 
Rs. 10,00,000 Revised rate, post 29th March 2018 

What is Compulsory Insurance with regards to Gratuity? 

Under the Payment of Gratuity Act, 1971, all the private employers covered under the act should obtain insurance for Gratuity payments. Employers that fail to comply with this rule or fail to pay their premiums will face immediate legal action. Violations lead to fines that amount to Rs. 10,000.

Who are exempted from Gratuity in India?

The Act states the following classes of employees who are exempted from Gratuity:

  • Establishments where employees receive gratuity or pension benefits that are equal or more than the mandated amount by the Government.
  • Specific employees with superior gratuity or pension benefits than the mandated amount is also exempted.

What is gratuity nomination?

Under the Section 13 of the Payment of Gratuity Act, an employee can appoint nominees who will receive the gratuity benefits in the case of the employee’s death. This helps ensure the nominated individual receives the benefits without any delays or complications. Employees make the nominations when they join a new job and have the option to change nominees throughout their employment tenure.

What happens when Gratuity is not paid by employer?

If an employer fails to pay Gratuity within the specified period, the governing authority has the right to issue a Certificate of Recovery to the Collector. But it’s important to give the employer a chance to explain their case before any steps are taken.

Penalties like imprisonment and fines can be levied against the employer violating the Act with false claims to escape the payment of Gratuity. Employers can also be relieved from this liability if they prove their diligence in enforcing the act and the actual offender acted without their knowledge or consent.

Frequently Asked Questions (FAQs)

Q1. What happens to my gratuity if I change jobs or locations?

Gratuity is typically transferrable when shifting jobs or locations. However, the amount varies according to the laws of the new employer and employment policy.

Q2. What are the rules and regulations governing gratuity payments?

The labor laws of different countries usually govern gratuity payments. At the same time, regulations specify the eligibility criteria, calculation methods, and legal compliance for disbursement.

Q3. How can I calculate my gratuity entitlement based on my years of service?

You can calculate your gratuity by multiplying your last drawn salary by years served in the company and with 15/26.

Thus, Gratuity = Last drawn salary * Number of years served in the company * 15/26.

Q4. What is the role of an employer in ensuring gratuity compliance and payments?

Employers are responsible for ensuring compliance with labor laws, accurately calculating gratuity, maintaining transparency in the process, and timely disbursing the amount to employees.

Q5. What are the common challenges employees face regarding gratuity?

The most common challenges faced by employees regarding gratuity are unclear calculations, delayed payments, and lack of clarity regarding gratuity benefits.

Q6. Are there specific laws or regulations for gratuity in different countries?

Yes, each country has its own rules and regulations that govern the various aspects of gratuity like eligibility, calculation methods, and payment conditions.

Q7. What is the process for claiming gratuity after retirement or leaving a job?

Employees submit a written application to their employers mentioning important details like service terms, last drawn salary, and reason for leaving. After the approval of the application the employer processes the employee’s claims.

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