Calculating gratuity: All about gratuity, gratuity meaning and gratuity taxation

[ecis2016.org] Gratuity is a tax-free benefit given to employees in India, under the provisions of the Payment of Gratuity Act, 1972. This guide will tell you everything you wanted to know about this employment benefit.

Gratuity is one of the benefits enjoyed by salaried employees in India. However, they can enjoy this, only after working for a certain period with a single employer. As your gratuity is largely tax-free income, calculating gratuity should be a factor while switching jobs and deciding if this is worth it.

You are reading: Calculating gratuity: All about gratuity, gratuity meaning and gratuity taxation

Gratuity meaning

Gratuity is a benefit that salaried employees in India enjoy under the provisions of the Payment of Gratuity Act, 1972.

Delivering its ruling in the Delhi Cloth and General Mills Co Ltd versus their workmen, the Supreme Court said that “The objective of providing a gratuity scheme is to provide a retiring benefit to workmen, who have rendered long and unblemished service to the employer and thereby contributed to the prosperity of the employer.”

Under the provisions of the gratuity law, employees who have completed at least five years in a company, are eligible to claim the gratuity benefits. However, gratuity is also offered to employees without completing five years of service with a company, in case they become disabled due to an accident or illness during their work tenure with the company.

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Gratuity meaning in Hindi

Gratuity is known as आनुतोषिक in Hindi.

Do all companies provide a gratuity benefit?

In India, the gratuity benefit is offered by companies with over 10 employees. An employee working in a public sector company, private company, farm, factory, minefield, oil field, port, or plantation, can claim gratuity if his workplace employed more than 10 people on any day during the preceding 12 months. The gratuity law covers all skilled, unskilled, manual, supervisory, technical and clerical workers.

In April 2022, the Supreme Court ruled that Anganwadi workers and helpers appointed to work in Anganwadi centres were also entitled to gratuity as ‘Anganwadi centres also perform statutory duties and have become an extended arm of the government’.

Service period calculation to claim gratuity

To arrive at five years of continuous service, a period of more than 240 days of continuous service is considered as a full year under the provisions of the Payment of Gratuity Act. So, if you quit your job after four years and 240 days of service, you will get gratuity. In case, you work in a company which has less than a six-day work week, continuous service of over four years and 190 days is considered as a continuous service of 5 years. 

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Time of gratuity payment

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Gratuity is paid at the time of an employee’s retirement or termination or death.

Eligibility criteria for gratuity payment

Under Section 4 (1) of the Act, you need to meet one of the following criteria to claim gratuity from your employer:

1. You should have quit your job after 5 years of work
2. You are retiring
3. In case of your superannuation*
4. In case you suffer disability due to illness or accident
5. In case the employee passes away**

*Superannuation means the attainment of such age by an employee as is fixed in the contract or conditions of service about the age at which the employee shall vacate the job.

**If an employee dies, the gratuity is paid to his nominee. In case there is no nominee, the gratuity amount will be paid to the deceased’s legal heirs.

Calculating gratuity: Basic principles

1. For calculating the gratuity, salary includes your basic salary, dearness allowance and commission. Salary components like House Rent Allowance and Leave Travel Allowance are not considered while calculating salary for gratuity.
2. For each year of service, the company is liable to pay an amount equalling 15 days of last drawn salary.
3. More importantly, if an employee works for over 6 months in the last year of service, he will be paid for the entire year while calculating the gratuity. For example, if you complete nine years and six months of continuous service to a company, you will be paid gratuity for 10 years and not nine-and-a-half years.
4. For calculating gratuity, one month is counted as 26 days. This basically means that your 15-day salary will be calculated as (monthly salary*15)/26. This number multiplied by the number of years in service will be the gratuity amount.

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Calculating gratuity: Formula

If employed in companies covered under the Gratuity Act

Gratuity = n x b x 15 / 26

N stands for the employee tenure at the company

B stands for his last drawn salary

Supposing you worked for a company for 15 years and your last drawn basic salary was Rs 50,000, your gratuity would be:

15 x 50,000 x 15/26 = Rs 432,692

Calculating gratuity: Formula

If employed in companies not covered under the Gratuity Act

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Gratuity = 15 x last drawn salary x the working tenure/30

Suppose you worked for a company for 15 years, and your last drawn basic salary was Rs 50,000, your gratuity would be:

Gratuity Amount = (15 x 50,000 x 15) / 30 = Rs 375,000

In either of the cases, the gratuity amount cannot exceed Rs 20 lakhs.

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Calculating gratuity in case of death of an employee

Delay in gratuity payment

Under Section 7 of the gratuity law, your gratuity needs to be paid to you by your employer within 30 days of your last working day. In case the payment is delayed beyond 30 days, the employer will have to pay an interest on the amount.

While delivering its ruling in a related case, the Gujarat High Court, in April 2022, said that there was a clear mandate on the employer under the provisions of Section 7 to the Payment of Gratuity Act to pay gratuity within time or pay interest in case of delay. This payment on interest is mandatory in case of a delay and not discretionary, the HC said.

Tax on gratuity

India’s Income Tax (I-T) law treats gratuity as salary and taxes it under ‘income from salary’. In case the gratuity is paid to the nominee of an employee due to his death, the gratuity amount is paid under ‘income from other sources’.

In either case, your minimum payable gratuity is tax-fee under Section 10 (10) of the I-T Act. At least the following received by an employee is exempted from tax:

• Rs 20 lakhs*
• Actual gratuity received
• 15 days’ salary based on the salary last drawn multiplied by the number of years in employment

*In 2017, the union cabinet approved a proposal to enhance the limit of tax-free gratuity to Rs 20 lakhs from Rs 10 lakhs. On March 29, the Labour and Employment Ministry enacted the Payment of Gratuity (Amendment) Act 2018, doubling the tax exemption limit to Rs 20 lakhs from Rs 10 lakhs, a move that greatly benefitted those who spent many years working in an organisation. With the change in the exemption limit, employees who had paid taxes on gratuity exceeding Rs 10 lakhs, will be able to claim the exemption if they receive gratuity in future. Note that the exemption limit of Rs 20 lakhs is to be applied cumulatively to gratuities received by you in your lifetime.

In case the gratuity is paid for more than 15 days of each completed year of service, the excess amount will become taxable, irrespective of the overall amount of gratuity

However, gratuity received by an employee of a central, state, or local government agency is fully tax-exempted without any upper monetary limit.

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