Gratuity - A Comprehensive Guide
What is Gratuity?
Gratuity is a form of financial benefit provided by an employer to an employee as a reward for long-term service. In India, it is governed by the Payment of Gratuity Act, 1972, which ensures that employees who have worked for an organization for a certain number of years are entitled to a lump sum payment once they leave the company, either due to retirement, resignation, or other reasons such as death or disability.
Eligibility for Gratuity
- Minimum Service Period: The employee must have completed a minimum of 5 years of continuous service with the same employer.
- Termination of Employment: Gratuity is payable on resignation, retirement, or death/disability.
- Exclusions: Employees working in seasonal or temporary establishments or unorganized sectors may not be eligible for gratuity.
How Gratuity is Calculated
The calculation of gratuity can vary depending on the laws in different countries, but the basic formula remains quite similar. In India, the formula typically involves the employee's last drawn salary, years of service, and a fixed multiplier.
Gratuity Formula:
Gratuity is calculated based on the following formula:
Gratuity = (Last Drawn Salary × Years of Service × 15) / 26Where:
- Last Drawn Salary: The salary the employee was drawing at the time of leaving the company, which includes basic salary and dearness allowance (DA).
- Years of Service: The number of completed years of service with the organization.
The constant multiplier (15/26) represents 15 days of wages for each completed year of service, calculated based on the standard number of working days in a month (26).
Let’s take example of Mr. Shyam has completed 10 years of service in the XYZ company. And, his last drawn salary along with dearness allowance (basic + DA) is ₹40,000.
The gratuity can be calculated as:
Gratuity = (n × b × 15) / 26
Gratuity = (10 × 40,000 × 15) / 26
Gratuity = ₹2,30,769.23Based on this calculation, Mr. Shyam will receive a gratuity of ₹2,30,769.23. This gratuity amount is a one-time payment that he is entitled to as per his years of service and salary at the time of leaving the company.
Taxation on Gratuity
- For Government Employees: Gratuity received by government employees is fully exempt from tax.
- For Private Sector Employees: If the amount of gratuity is below ₹10,00,000, it is exempt from tax. However, if the gratuity amount exceeds ₹10,00,000, the excess amount is taxable.
Gratuity in Case of Death or Disability
If an employee passes away or becomes physically disabled before completing the required years of service, the gratuity will be paid to the nominee or legal heir of the employee, even if they haven’t completed 5 years of service.
Gratuity Payment Process
- Application for Gratuity: The employee must submit an application for gratuity to the employer.
- Verification: The employer verifies the service record of the employee and confirms eligibility.
- Payment: The gratuity amount is paid as a lump sum.
Employer’s Obligation
Employers are obligated under the Payment of Gratuity Act to provide gratuity to their employees if they meet the eligibility conditions. Employers should:
- Maintain records of employees' service duration.
- Ensure timely payment of gratuity.
- Provide legal recourse if gratuity is not paid.
Key Points to Remember
- Gratuity is not a pension scheme; it’s a one-time payment.
- Employers contribute to a Gratuity Fund to ensure payment.
- Employees can seek legal help if gratuity is denied.