What is Gratuity and how to calculate your eligible amount?

What is Gratuity?

Gratuity is defined as a sum of money that is paid to the employee over and above the decided salary at the time of his retirement. It is paid by the employer in gratitude for the services rendered by the employee in the company if he has worked at least 5 years for that company.

Prior to 1972, there was no law where it was mandatory for the employer to pay employees gratuity at the time of retirement. In the year 1972, the Government of India enacted the Payment of Gratuity Act, which made it mandatory for the employers to pay his employees the gratuity at the time of quitting subject to the conditions that certain conditions are met. 

Who is eligible for Gratuity?

Gratuity is payable to an employee who:

• Is eligible for superannuation: When an employee reaches the age of superannuation as per the organization's policies or government regulations, they are entitled to receive gratuity.
• Retires: Upon retirement from their employment, an employee is eligible to receive gratuity as a form of retirement benefit.
• Resigns: If an employee voluntarily resigns from their job, they may be eligible to receive gratuity if he has completed five years of employment with an organization.
• Has worked for at least 5 years: A employee must complete a minimum of 5 years of continuous service with an employer to become eligible for gratuity payments. 
• Death: If an employee dies while in service, their nominee or legal heir is entitled to receive the gratuity amount, regardless of the duration of their employment.
• Disability: If an employee becomes disabled due to a disease or accident and is unable to continue working, they may be eligible to receive gratuity before completing five years of service, as per the terms and conditions of their employment contract or applicable laws.

How to calculate Gratuity for employees covered under Gratuity Act?

For the purpose of calculation of employees, the non-government employees have been divided into two categories-

a) Employees covered under the Payment of Gratuity Act, 1972.

b) Employees not covered under the Act.

An employee is supposed to be under the cover when the organization employees more than 10 persons on a single day in a preceding 12 months and once the organization come under the category of the gratuity Act, then it always remain under it even if the number of employees fall below 10. The payment of Gratuity Act follows the rule of ‘once covered, always covered'.

There is no set percentage or formula that has been stipulated by law for the amount of gratuity an employee is supposed to get. An employer can use a formula-based calculation.

For calculating gratuity, salary includes basic pay, dearness allowance, and commission based on sales.

The formula is - (15 * last drawn salary * tenure of working) / 26

Here, the tenure includes each completed year of service or part of thereof in excess of 6 months. 

For instance - if an employee has worked in an organization which is covered under the Act for 20 years and 7 months at the last salary of Rs. 50,000.

His gratuity fund would be - (15 * 50,000 * 21) / 26 = 6,05,770

How to calculate Gratuity for employees NOT covered under Gratuity Act?

There is no law that restricts the employer from paying a gratuity to his employees, even if his organization is not covered under the Act. For calculating gratuity, salary includes basic pay, dearness allowance, and commission based on sales. The amount of gratuity payable to the employee can be calculated based on the formula- (15 * last drawn salary * tenure of working)/ 30

For instance - if an employee has worked in an organization which is not covered under the Act for 20 years and 7 months at the last salary of Rs. 50,000,

His gratuity fund would be - (15 * 50,000 * 20 ) / 30= 5,00,000

Here the number of years is taken as each completed year, so his tenure is taken as 20 years and not 21 years.

What is the gratuity amount payable to nominee in case of death of employee?

In case of death or permanent disability of an employee, an employer is mandated by law to pay gratuity to him or his legal heir as the case may be, irrespective of the number of years of continuous service. The gratuity is paid on the basis of the length of the service rendered to the institution where the maximum benefit is restricted to Rs. 20 lakh.

Length of service and Rate

• Less than one year - 2 times of basic pay
• One year or more but less than 5 years - 6 times of basic pay
• 5 years or more but less than 11 years - 12 times of basic pay
• 11 years or more but less than 20 years - 20 times of basic pay
• 20 years or more - Half of salary for every completed 6 monthly period subject to maximum of 33 times of salary.

What are gratuity payment rules?

Here are the few gratuity payment rules-

• The payment rules of gratuity says that once the employee becomes eligible to receive gratuity, he can apply within 30 days from the date it becomes payable. Moreover, if the date of retirement or superannuation is known, then too, the application can be made before 30 days.
• No claim can be stated as invalid merely due to the reason that the claimant has not filed his application within the stipulated period. 
• An employer is required to specify the amount along with the date of payment within 15 days of receipt of application.
• The payment needs to be made within 30 days from the date of receipt of application.
• In case the employer rejects the application for the payment of gratuity, he needs to specify the reason for the same.
• The payment of gratuity can be made in cash, or demand draft or cheque.  
• If the claim of gratuity is made to the legal heir or nominee, the employer may ask for a witness or evidence to ensure the genuineness of the claimant.
• An employee or legal nominee can complain to the controlling authority (Assistant Labor Commissioner) in case of any dispute due to the refusal of the application, or underpayment of the gratuity amount or failure to make the payment within the stipulated period.
• The gratuity is still payable even if the employer goes bankrupt and no court order can put a stay on it.

What are the conditions in which gratuity is forfeited?

If the service of the employee is terminated due to any act, willful omission, or negligence causing damage or loss to the property of the employer, the employee's gratuity shall be forfeited to the extent of loss or damage. 

The entire amount of gratuity can be forfeited if an employee's service have been terminated due to his violent or riotous act of committing an offense involving moral turpitude.

What forms should be used in Gratuity at various instances?

Forms to be used for Gratuity are listed below

1) Form I-Application for the payment of Gratuity
2) Form J-Application for the payment of Gratuity by NOMINEE
3) Form K-Application for the payment of Gratuity by LEGAL HEIRS.
4) Form F-Nomination Form
5) Form G-To make a fresh nomination
6) Form H-Modification of the nominee
7) Form L-Issued by the employer to the employee stating amount and date of payment.

What is the tax implication of the gratuity amount received?

The rules of taxation of gratuity amount are different for government and non-government employees.

1) As per current law, gratuity received by the government employees is totally tax-exempt. The maximum amount they can receive through gratuity is Rs. 20 lakh as per the amendments made after following the 7th Pay Commission recommendations.

2) For the non-government employees, the minimum of the following is exempt from tax-

a) 20 lakh or
b) Actual gratuity received or
c) Amount of gratuity an employee is eligible to receive

3) Any gratuity received by the employee's widow or legal heirs is completely tax-free in their hands.

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