Introduction 

 Gratuity is a gesture of appreciation, acknowledging an employee’s extended service. In India, the Payment of Gratuity Act of 1972 regulates this benefit. The act outlines the eligibility criteria for receiving gratuity, the calculation methods, and the obligations of employers to provide it promptly.

What is gratuity?

Gratuity is a financial reward given by an employer to recognize an employee’s service, available to those who have completed at least five years with the company. The Payment of Gratuity Act of 1972 sets the guidelines for this benefit, covering sectors such as government departments, defense, local governing bodies, and specific private organizations that meet certain criteria.

Gratuity Eligibility Criteria – 

Minimum Service Period: Employees must have completed at least five years of continuous service with the same employer.

Type of Employment: Both full-time and part-time employees are eligible, provided they meet the continuous service requirement.

Applicable Sectors: The Payment of Gratuity Act of 1972 covers various sectors, including government departments, defense services, local governing bodies, and specific private organizations that meet the specified criteria.

Retirement: Employees who retire after completing the minimum service period are eligible for gratuity.

Resignation: Employees who resign after at least five years of continuous service are entitled to receive gratuity.

Termination: If an employee’s service is terminated after completing five years, they are eligible for gratuity, unless the termination is due to misconduct.

Death or Disability: In cases where an employee passes away or becomes disabled due to illness or accident, the gratuity is paid to the employee or their nominees, even if the five-year service requirement is not met.

How to Calculate Gratuity?

The gratuity amount is determined by the employee’s last salary and their duration of service. The calculation varies depending on whether the organization is covered under the Payment of Gratuity Act, 1972.

Calculation for Employees Covered Under the Gratuity Act:

According to Paisa Bazaar, the formula is:

Gratuity Formula = (15 × Last Drawn Salary × Number of Working Years) / 26

• Last Drawn Salary includes Basic Salary plus Dearness Allowance (DA).
• A Working Year is recognized if the employee has completed six months or more in a year.

Example:

• Working Period of Ms. X: 11 years and 8 months
• Number of Working Years: 12 years
• Last Drawn Salary: ₹75,000

Total Gratuity=2615×75,000×12​=₹519,230

Calculation for Employees Not Covered Under the Gratuity Act:

The formula for employees not covered by the Act is slightly different:

Gratuity Formula= (15 × Last Drawn Salary in Last 10 Months × Number of Working Years) × 300

• Last Drawn Salary includes Basic Salary, DA, and commissions.
• A Working Year is counted only upon the completion of each full year.

Example:

• Working Period of Mr. Y: 14 years and 7 months (counted as 14 years)
• Last Drawn Salary in Last 10 Months: ₹75,000

• Total Gratuity=15×75,000×14×30=₹525,000

Key factors – 

Gratuity Limit – The maximum gratuity amount is capped at ₹20 lakh. Any amount above this is considered ex-gratia, which is voluntary and not legally required.

Rounding Off Tenure – For gratuity calculation, service extending beyond six months is rounded up to the next full year.

In the Event of an Employee’s Death – The gratuity is paid to the nominee or heir as per the regulations.

Employer’s Right to Forfeit Gratuity – Gratuity can be denied if the employee is terminated for misconduct.

Gratuity During Bankruptcy – Organizations must fulfill their gratuity obligations even in the case of bankruptcy.

Delayed Gratuity Payment – If the gratuity is not paid within 30 days from the termination of employment, the employer must pay interest, as specified by the Central Government for long-term deposits.

Gratuity Rules

The Payment of Gratuity Act, 1972, outlines specific rules governing the payment of gratuity to employees. Here are the key rules:

Eligibility Criteria: 

Employees must have completed at least five years of continuous service with the same employer.

 The five-year service requirement is waived in cases of death or disability due to accident or illness.

Calculation Formula:

 Gratuity = Last drawn salary * (15/26) * Number of years of service. 

The last drawn salary includes the basic salary and dearness allowance (DA).

Gratuity Limit:

The maximum gratuity amount is capped at ₹20 lakh. Any amount above this is considered ex-gratia and is voluntary.

Rounding Off Tenure:

For the purpose of gratuity calculation, any service period exceeding six months is rounded up to the next full year.

Payment Timeline:

Gratuity must be paid within 30 days from the date it becomes payable (i.e., from the date of termination or retirement of the employee).

In case of a delay, the employer is required to pay interest on the gratuity amount, as specified by the Central Government.

Nomination:

Employees are required to nominate one or more family members to receive the gratuity in the event of their death.

The nomination can be updated or changed by the employee at any time.

Employer’s Right to Forfeit Gratuity:

Employers can forfeit gratuity partially or fully if the employee is terminated for misconduct, violent acts, or offenses involving moral turpitude.

Gratuity During Bankruptcy:

Organizations must fulfill their gratuity obligations even if they declare bankruptcy. Employees’ gratuity is protected and must be paid out.

In the Event of an Employee’s Death:

The gratuity is paid to the nominee or heir of the deceased employee as per the regulations, irrespective of whether the employee had completed five years of service.

Tax Exemption:

Gratuity received by an employee is exempt from income tax up to a certain limit, as specified under the Income Tax Act.

By following these rules, employers can ensure compliance with the Payment of Gratuity Act, 1972, and employees can be aware of their rights and entitlements regarding gratuity.

Conclusion 

Gratuity under the Payment of Gratuity Act, 1972, serves as a significant acknowledgment of an employee’s dedicated service to their organization in India. Governed by clear regulations, this benefit ensures that employees who meet the eligibility criteria receive a financial reward upon retirement, resignation, or termination, provided they have completed a minimum of five years of continuous service. The calculation of gratuity, based on the employee’s last drawn salary and years of service, follows specific formulas depending on the organization’s coverage under the Act.

FAQ – 

Is gratuity taxable under the Income Tax Act?

According to the Payments of Gratuity Act 1972, gratuity received by private employees is considered to be a part of his/her salary and is taxable as per the Income Tax Act.

Is gratuity part of CTC?

Yes, gratuity is typically considered a part of the Cost to Company (CTC) package in India. According to the Payment of Gratuity Act, 1972, gratuity is a statutory benefit provided to employees by the employer as a token of gratitude for the services rendered by the employee

Is gratuity compulsory in salary structure?

The Payment of Gratuity Act, 1972 is an act that makes the payment of gratuity mandatory for employers to their employees. Employees working in mines, oilfields, railways, factories, ports, and shops or establishments are covered under this Act and stand to benefit from its provisions.