Gratuity in India: Essential Guide

Gratuity in India: Essential Guide

Gratuity is a thank-you gift from an employer to an employee for their hard work and loyalty. Understanding gratuity rules is crucial for both employers and employees in India. This guide explains the Payment of Gratuity Act, 1972, including who qualifies, how to calculate it, and tax implications.

Who is Eligible for Gratuity?

The Payment of Gratuity Act applies to various organizations:

Central and State Government Departments: All government employees qualify.

Defence establishments cover personnel working in them.

Local Authorities: Local governing bodies entitle their employees to gratuity.

Private companies with 10 or more employees in the previous year must follow the Act.

Qualifying for Gratuity Payment

Employees generally need to complete 5 continuous years of service to be eligible. However, exceptions exist:

If an employee dies or becomes disabled due to an accident or illness, they will receive a gratuity. This applies regardless of how long they have worked.

Calculating Gratuity

The gratuity amount depends on your last drawn salary (basic salary + dearness allowance) and completed years of service. The formula differs based on the type of organization:

Organizations Covered Under the Act

For companies with at least 10 employees:

Gratuity = (15/26) * Last Drawn Salary * Number of Completed Years of Service

Here's what each part of the formula means:

•      15/26: This factor represents 15 days' wages for every completed year of service.
•       Last Drawn Salary: This includes your basic salary and dearness allowance.
•       Number of Completed Years of Service: Any year with more than 6 months of service counts as a full year. For instance, we consider 12 years and 8 months as 13 years.

Example:

Mr. X worked for a covered company for 13 years; his last drawn salary was Rs. 77,000. His gratuity would be:

(15/26) * 77,000 * 13 = Rs. 5,77,500

Organizations Not Covered Under the Act

For companies with less than 10 employees (or not covered by the Act):

Gratuity = (15 * Average Salary of Last 10 Months * Number of Years Employed) / 30

Here's what each part of the formula means:

•       15: This factor represents 15 months' salary.
•       Average Salary of Last 10 Months: This includes basic salary, dearness allowance, and commissions.

For the number of years employed, consider only complete years of service. For instance, we would consider 15 years and 8 months as 15 years.

Important Points to Remember

Employees can forfeit gratuity for misconduct such as moral turpitude or violence.

•      Even during bankruptcy, employers are liable to pay gratuity.

In 2021, companies can give tax-free gratuity up to Rs. 20 lakh under the Act (excluding government departments).

Tax Implications

The tax exemption for gratuity depends on the organization type and the total gratuity received:

The Rs. 20 Lakh Tax Exemption is Cumulative

The Rs. 20 lakh tax exemption applies to the total gratuity received throughout your career. Let's say you receive Rs. 17 lakh from Company A and Rs. 5 lakh from Company B (total Rs. 22 lakh). You'll be liable to pay tax only on Rs. 3 lakh (Rs. 22 lakh - Rs. 20 lakh).