Understanding the Payment of Gratuity Act, 1972

Understanding the Payment of Gratuity Act, 1972

The Payment of Gratuity Act, 1972 is an Indian law that mandates employers to pay a one-time gratuity to eligible employees. This act offers financial security to employees in various sectors upon retirement, resignation, or other qualifying events.

Who is Covered by the Act?

The Act applies to employees working in a wide range of establishments, including:

• Mines
• Oilfields
• Railways
• Factories
• Ports
• Shops and other establishments

An organization becomes liable to pay gratuity under the Act if it has at least 10 employees on any day in the preceding year.

Employee Eligibility for Gratuity

To be eligible for gratuity under the Act, an employee (including contractual or temporary workers) must complete a minimum of five continuous years of service. Certain interruptions in service, such as leave, accidents, sickness, lockouts, strikes, layoffs, or terminations not caused by the employee, are counted towards the five-year period. The Act defines a year as follows:

• 240 working days for establishments that do not involve underground work.
• 190 working days for employees working underground (mines etc.).

The five-year service requirement is waived off in case of an employee's death or disability.

Nomination for Gratuity Payment

Employees can nominate a beneficiary to receive gratuity on their behalf in the event of their death. This nomination can be made within 30 days of completing one year of service:

• Employees with families can nominate one or more family members. Nominations to anyone else are invalid.
• Employees without families can nominate a third person. However, such nominations become void upon the formation of a family.
• If the nominated person dies, the employee can nominate another beneficiary.

Gratuity Payment Scenarios

• Retirement
• Voluntary Retirement Scheme (VRS) opt-in
• Death of the employee
• Employee disability due to accident or illness
• Resignation
• Termination or layoff due to retrenchment

Calculating Gratuity Amount

The gratuity amount is calculated based on the employee's last drawn salary (basic salary + dearness allowance) and the total years of service. The calculation formula differs depending on whether the organization is covered under the Act:

For Organizations Covered Under the Act

Formula:

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

Here, any year with more than 6 months of service is considered a complete year. Conversely, years with less than 6 months of service are excluded from the calculation.

For Organizations Not Covered Under the Act

While not mandated, organizations not covered by the Act can choose to pay gratuity to their employees. In such cases, the formula is:

Formula:

Gratuity = (15 x Average Salary for the Last 10 Months x Number of Years Employed) x 30

Here, the number of years employed is considered complete years only.

Tax Implications on Gratuity

The Income Tax implications on gratuity received vary depending on the category:

• Central/State Government, Defence, and Local Bodies: The entire gratuity amount is exempt from tax.
• Employees Covered Under the Act: The least of the following is exempt from tax:
• Actual gratuity received
• Rs. 20 lakhs
• (15 x Last Drawn Salary x Number of Completed Years of Service) / 26
• Employees Not Covered Under the Act: The least of the following is exempt from tax:

• Actual gratuity received
• Rs. 10 lakhs
• (15 x Average Salary for the Last 10 Months x Number of Years Employed) x 30

Gratuity Exemption in Special Cases

• Gratuity paid to a deceased employee's widow or legal heir is entirely tax-free.
• Gratuity paid as an ex-gratia payment to an employee or their family due to a work-related injury is also exempt from tax.