Gratuity is a retirement and loyalty reward scheme for the salaried employees. It is more like a reward from the employer appreciating the employee’s service. Basically it is a retirement or resignation benefit scheme wherein the employer pays a lump sum amount upon retirement or resignation.
What is Gratuity and when it is paid?
Gratuity is a defined benefits scheme in which the employer will pay a lump sum amount to the employee, when he leaves the organization after serving for a minimum of 5 years.
Gratuity is a part of an employee’s salary and it is paid for the services offered by the employee.
Also read more about Salary Slip
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How Gratuity works
When an employee joins an organization, he automatically becomes a part of the employer’s Gratuity scheme. The gratuity benefits are fully specified in the Offer Letter given to the employee on joining.
Employer may contribute to the Gratuity fund on his own or through a life insurance company.
When the employee leaves the organization after serving for at least 5 years, the employer pays the gratuity amount as a one time lump sum amount appreciating the employee’s service.
In case the employee leaves before 5 years, then employee will not get any gratuity benefits
The employees do not need to contribute to the Gratuity scheme. The Employer pays the entire contribution
Gratuity Eligibility
- An employee is eligible to receive gratuity benefits if he serves the organization for at least 5 years of continuous service as an employee.
- If an employee leaves the organization before 5 years, then no gratuity will be paid.
- In case of death or disablement of the employee before 5 years, the eligibility rules are not applicable.
- In case of death, employee’s nominees will get the gratuity benefits
Gratuity Rules
Gratuity is a one time lump sum payment and it is paid to the employee when he leaves the organization after serving for at least 5 years of continuous service as an employee.
The reason for leaving the organization can be one of the following.
- resignation
- laid off by employer
- voluntary retirement
- Retirement
- disability due to accident or disease
- death
How to Calculate Gratuity?
Gratuity benefit amount is calculated based on the following factors:
- Employees covered under Gratuity Act
- Employees NOT covered under Gratuity Act
How Gratuity is Calculated for each category.
1. Gratuity Calculation-Employees covered under Gratuity Act
For the employees covered under the Gratuity Act, it is calculated using the following formula.
Gratuity formula = (number of years of service x last drawn monthly salary x 15) / 26
where
“number of years of service” is the total number of years of service of employee to the employer
How number of years calculated for Gratuity Calculation formula
- if the employee’s service is more than 6 months, then it will be considered as 1 year
- if the employee’s service is less than or equal to 6 months, then it will be ignored
For example, if an employee’s service is 6 years and 7 months, then it will be considered as 7 years.
or
If employee’s service is 6 years and 5 months, then it will be considered as 6 years only.
Last drawn monthly salary is the amount employee received just before leaving the organization
Monthly salary includes Basic Pay and DA (Dearness Allowance) only
2. Gratuity Calculation- Employees NOT covered under Gratuity Act
For the employees who are NOT covered under the Gratuity Act, it is calculated using the following formula.
Gratuity formula= (number of completed years of service x average monthly salary x 15) / 30
where
“number of completed years of service” is the total number of completed years of service of employee to the employer.
How number of years calculated for Gratuity Calculation
For Gratuity calculation for those who are not covered under Gratuity Act – the number of years are the total number of years ONLY. For calculation purpose the additional months will not be considered.
For instance, if the employee’s service is 9 years and 10 months, then only 9 years will be considered. Average monthly salary is the average of last 10 months’ salary just before leaving the organisation
Monthly salary includes Basic Pay +DA (Dearness Allowance) and commissions, if any, only
There is an upper limit on the Gratuity benefit amount payable to the employees. The limit details are given below.
Gratuity Limit
For Government employee
The maximum Gratuity amount limit is Rs. 20 Lakhs from 01-Jan-2016. Earlier this limit was Rs. 10 Lakhs.
The employer can pay a maximum of Rs. 20 Lakhs only as per the law. However, the employer can choose to pay the amount in excess of Rs. 20 Lakhs, in the form of Bonus or other salary components.
For Non-Government employee
The maximum Gratuity amount limit is Rs. 20 Lakhs from 29-Mar-2018. Earlier this limit was Rs. 10 Lakhs.
The employer can pay a maximum of Rs. 20 Lakhs only as per the law. However, the employer can choose to pay the amount in excess of Rs. 20 Lakhs in the form of Bonus or other salary components.
Gratuity Income tax in India
Income tax benefits on Gratuity are same on both old and new tax systems. However, income tax impact on Gratuity amount is based on whether the employee is Government or non-Government.
The details of each category are given below.
1. Government Employees:
The gratuity amount received is completely (100%) tax free for Government employees.
2. Non-Government Employees:
Tax treatment for non-Government employees can be divided into the following 2 categories.
- Non-Government employees covered under Gratuity Act
- Non-Government employees NOT covered under Gratuity Act
The details of each category are given below.
a) Non-Government employees covered under Gratuity Act:
For the non-Government employees covered under the Payment of Gratuity Act, the Gratuity amount received will be tax free to a certain limit.
That limit will be the lowest of the following 3 items.
- actual gratuity received
- (number of years of service x last drawn monthly salary x 15) / 26
- Rs. 20 Lakhs
If one receives any amount more than the above mentioned limit then it will be added under the head “Income from Salary” and it will be taxed as per employee’s income tax slab.
Gratuity Rules
The limit of Rs. 20 Lakhs was effective from 29-Mar-2018 onwards. Before that, the limit was Rs. 10 Lakhs only.
Rs. 20 Lakhs is the maximum tax free limit for an employee for his entire service. This Gratuity may be from one employer or from many employers.
If any tax free Gratuity amount is already received, then the current limit will be reduced from Rs. 20 Lakhs to the extent of the gratuity received.
For example, let us assume that an employee has received Rs. 5 Lakhs as Gratuity benefit in the past. It means, in current and future employment, his tax free limit will be Rs. 15 Lakhs only, not Rs. 20 Lakhs.
b) Non-Government employees NOT covered under Gratuity Act:
For the non-Government employees NOT covered under the Payment of Gratuity Act, the Gratuity amount received will be tax free to a certain limit.
That limit will be the lowest of the following 3 items.
- actual gratuity received
- (number of completed years of service x average monthly salary x 15) / 30
- Rs. 20 Lakhs
Any amount received more than the above mentioned limit will be added under the head “Income from Salary” and it will be taxed as per employee’s income tax slab.
Note:
The limit of Rs. 20 Lakhs was effective from 29-Mar-2018 onwards. Before that, the limit was Rs. 10 Lakhs only.
Rs. 20 Lakhs is the maximum tax free limit for an employee for his entire service. It may be from one employer or from many employers.
If any tax free amount is already received, then the current limit will be reduced from Rs. 20 Lakhs to the extent of the gratuity already received.
For example, let us assume that an employee has received Rs. 5 Lakhs as Gratuity benefit in the past. It means, in current and future employment, his eligible tax free limit will be Rs. 15 Lakhs only, not Rs. 20 Lakhs.
Death of employee
- In case of death of the employee, the eligible gratuity amount will be paid to his nominees or legal heirs.
- In such cases the eligibility criteria of 5 years of continuous service will not be applicable.
- The gratuity amount will be paid to his nominees, even if the employee’s service is less than 5 years,
Can employers refuse to pay gratuity payment?
In certain situations the employer may not pay gratuity to an employee even if the employee is eligible for gratuity.
The Employer can choose NOT to pay gratuity to an employee if he is laid off for reasons such as misconduct, violence, moral offense, causing damage to employer’s properties, etc.
Nomination
Nomination facility is available in Gratuity scheme. After 1 year of service, an employee can make a nomination to pay the Gratuity benefits.
Nominations can be made in the name of one or more family members. However, nomination should be in family members favor only. The Employee can’t nominate anyone outside of family.
The Employee can update nominations during the employment as and when family situation changes.
Maternity
For the calculation of continuous service in case of female employees, the maternity leave has been increased to 26 weeks from 12 weeks. This will be effective from 29-Mar-2018.
