Applicability & Calculation of Gratuity in India

Gratuity refers to the sum of money paid by the employer to the employee for the services rendered by him at the time of leaving the company as a token of gratitude. Unlike the Provident Fund, the employee makes no contribution to the installments of the Gratuity. Also, you must be an employee for a term of 5 years or more in the same place to be eligible to claim or receive gratuity. It is only payable on cessation of employment by virtue of resignation, death, retirement or wrongful termination, etc. 

There existed no law prior to 1972 to provide for gratuity. In 1972, the Payment of Gratuity Act was enacted and enforced in India making it mandatory for the employer to pay gratuity to his employee on leaving the company if certain conditions are fulfilled.

Table of Content:

• Applicability of the Gratuity Act, 1972
• What are the prerequisites of the Gratuity Act to claim the benefit?
• Who are the recipients of the Gratuity Act?
• Gratuity Eligibility
• Gratuity Formula
• Explanation
• How to Calculate Gratuity in India?
• Tax Exemptions on Gratuity 
• Gratuity Rules 
• Frequently Asked Questions

Applicability of the Gratuity Act, 1972

The Payment of Gratuity Act, 1972 is applicable to every factory, oilfield, mine, plantation, port, and railway company; every shop or establishment within the meaning of any law in which ten or more persons are employed, or were employed, on any day of the preceding twelve months. Further, the Act is applicable to the entire country excluding the State of Jammu and Kashmir.

What are the prerequisites of the Gratuity Act to claim the benefit?

The following conditions need to be fulfilled by the employee to claim the gratuity:

• The employee must have rendered service for a period of 5 years or more at the same place. 

• The service must be “continuous” in nature i.e. without any intervals.

• Also, the rule of 5 years of continuous service is not applicable where gratuity is payable by virtue of death or disablement of the employee.

Who are the recipients of the Gratuity Act?

The recipients of the Gratuity Act are:

• The employee;

• Nominee of the employee, in case of his/ her death;

• Heirs of the employee, in case of his/ her death where no nomination was made;

• If any such nominee/ heir are a minor, their share is to be deposited with a Controlling Authority. Such authority is responsible to invest the funds in a financial institution or bank until the nominee/ heir attains the majority.

Gratuity Eligibility: 

To be eligible to receive Gratuity under the Payment of Gratuity Act, 1972 one must have to be an employee in the Company/ Organization for a period of 5 years or more as “Continuous service” and not an addition of different intervals of employment.  It is pertinent to note that the gratuity is payable only on cessation of employment and not during the continuance thereof. However, the said criteria are not applicable where the cessation of employment is by virtue of the death or the disablement of the employee.   A retired person is not exempted from receiving gratuity on the grounds that he receives a pension. Pensionary benefits can include both gratuity and pension amount, wherein gratuity is a statutory mandate as upheld the case of Allahabad Bank and Ors. vs. All India Allahabad Bank Retired Employees Association.

An employee holds a right to receive a gratuity for services rendered, however, this right of an employee can be curtailed in two conditions:

• If the cessation of employment is by reason of willful omission or negligence of the employee owing to which the employer had to suffer loss or damage, or there was the destruction of property belonging to the employer.

• If the cessation of employment is because of some riotous or disorderly conduct which is unapproved or constitutes an immoral offence.

Gratuity Formula: 

Gratuity = Last Drawn Salary x 15/26 x Number Of Years Of Service

Explanation:

• The ratio 15/26 used as a multiplier signifies 15 days out of the 26 working days in a month.
• The term’s last drawn salary includes Basic Salary and Dearness Allowance.
• The number of Years of Service is to be taken as a whole and not a decimal or fraction. It is to be rounded off to the nearest full year. For example,
  • If the actual years of continuous service are 6 years 9 months, 7 will be substituted for the number of years of service. 
  • If the actual years of continuous service are 6 years 3 months, 6 will be substituted for the number of years of service. 

How to Calculate Gratuity in India?

Gratuity is to be calculated by the formula aforementioned. It is calculated by the employer on the employee’s application on cessation of employment. Gratuity is calculated for two sets of employees i.e. those covered under the Payment of Gratuity Act and those not covered under it. For the employees covered under the Payment of Gratuity Act, 1972 the formula aforementioned is used to calculate gratuity. For the employees not covered under the Payment of Gratuity Act, 1972, the law does not restrict or forbid the payment of gratuity. The amount of gratuity payable to the employee can be calculated based on half a month's salary for each completed year.

Example of gratuity calculation:

Mr. X is a government employee. His last drawn salary is INR 15,000 (Basic Pay + Dearness Allowance). He has been in continuous service for 6 years and 9 months. Since the number of years of service is in months, it is rounded off to the nearest full year in the formula for calculation of gratuity.

Gratuity = Last Drawn Salary x 15/26 x Number Of Years Of Service

Gratuity= 15,000 x 15/26 x 7

Gratuity= INR 60,577/-

Calculation of gratuity in the event of the death of an employee:

In the event of death, the rule of minimum 5 years of continuous service is waived off and the employee is eligible even if the period of employment is less than 5 years. The gratuity is paid on the basis of the duration of the service. The maximum benefit of gratuity is restricted to Rs 20 lakh.

Tax Exemptions on Gratuity :

• Government employees irrespective of place of employment i.e. Central or State or local authority is exempted from payment of tax on gratuity. 
• An employee whose employer is covered under the Payment of Gratuity Act, 1972 is exempted from income tax to the extent of only fifteen days of their last received salary for each completed year of service or INR 20 Lakhs.  
• An employee whose employer is not covered under the Payment of Gratuity Act, 1972, is exempted to the extent of the least of the undermentioned three amounts: 
  • INR 20 Lakh; or
  • The actual amount of gratuity received; or
  • Half month’s salary in correspondence to the total number of years of service.

It is pertinent to note that the tax exemption limit prior to 2018 was INR 10 Lakhs. However, vide a Government notification issued on March 29, 2018, the Labour Ministry enhanced it to INR 20 Lakhs.  

Gratuity Rules :

Forfeiture of Gratuity 

Section 4 (6) of the Payment of Gratuity Act, 1972 allows an employer to forfeit gratuity wholly or partially on the following grounds:

• If the cessation of employment is due to omission or negligence by the employee which caused any loss or damage or destruction to the property which belongs to the employer; or
• If the cessation of employment is because of any violent conduct or misbehavior or riotous attitude in the premises; or
• If the cessation of employment is because of a commission of an offence by the employee involving moral turpitude during the course of employment.

Timeline for Gratuity Payment 

The timeline for gratuity payment is 30 days from the day it becomes due i.e. on the filing of the application by employee and calculation of the gratuity amount by the employer. In case of failure or delay not attributable to the employee, the employer is bound to pay simple interest on the gratuity amount for the period of delay.

When is gratuity paid to an employee?

Gratuity is only payable to an employee on the cessation of employment and not while he is in service. The cessation maybe by resignation, retirement, superannuation, death, disability or termination. 

Frequently Asked Questions:

How is gratuity calculated in India for private companies?

Private Companies which are covered under the Payment of Gratuity Act, 1972 follow the given formula to calculate gratuity: 

Gratuity = Last Drawn Salary x 15/26 x Number Of Years Of Service  

Terminology defined:

• Last drawn salary: It includes Basic Salary and Dearness Allowance.
• Years of Service: It needs to be taken as a whole and not a decimal or fraction. It is to be rounded off to the nearest full year. 

Note: Private Companies that are not covered under the Payment of Gratuity Act, 1972 may calculate gratuity on a case to case basis. 

How is an employee’s gratuity calculated?

Employee gratuity for employees covered under the Payment of Gratuity Act, 1972 is calculated by the formula:

Gratuity = Last Drawn Salary x 15/26 x Number Of Years Of Service

Note: Employee gratuity for employees not covered under the Payment of Gratuity Act 1972 is calculated on a case to case basis by the Employer.

How are 15 days and 26 days gratuity calculated?

The term 15 days refers to the wage of that time period while 26 days refers to the total working days in a month. This is then used as a multiplier in the formula for calculation of gratuity.

Are 4 years 7 months eligible for gratuity?

4 years and 7 months are eligible for gratuity. Any time period of work in addition to the base number of years, more than 6 months in that year of cessation of employment makes you entitled to gratuity benefits of that year. Further, since the Payment of Gratuity Act is a Welfare Legislation, it will be against principles of natural justice to devoid a person of the retirement benefit. 

What is the rule of gratuity?

The rule of gratuity is that every employee covered under the Payment of Gratuity Act, 1972 is statutorily entitled to receive gratuity on cessation of employment after 5 years of continuous service. The rule is subjected to various exceptions wherein gratuity is not payable even after the conditions are met; and relaxations where gratuity is payable in spite of the continuous service being less than 5 years. 

Is gratuity payable after 4.5 years?

Yes, gratuity is payable after 4.5 years. Though 4.5 years may be subject to gratuity in the interest of natural justice as 6 months of work in a particular year is summed up to the next year. However, it depends on a case to case basis.

Can I claim gratuity after 3 years?

No, you cannot claim gratuity after 3 years. Generally, gratuity is only payable on cessation of employment after 5 years of continuous service. However, in case of death or disablement of the employee, gratuity can be claimed earlier and the condition of 5 years of continuous service is inapplicable.

What is the gratuity limit in India?

The gratuity limit in India is INR 20 Lakhs.

How is ex gratia calculated?

Ex-gratia is a payment made out of gratitude by the Employer. It is calculated on a case to case basis and there is no fixed percentage whatsoever.

Is the gratuity amount taxable?

Yes, the gratuity amount is taxable. However, certain tax exemptions are provided. The gratuity of a government employee is fully exempted while that of other employees under the Payment of Gratuity Act, 1972 is exempted to the extent of INR 20 Lakhs or fifteen days of the salary for the total number of years of service.

How are pension and gratuity calculated?

The pension and gratuity calculated using the following formulas:

Pension = (Pensionable Salary x service period) / 70

Gratuity = Last Drawn Salary x 15/26 x Number Of Years Of Service

When is an individual eligible to receive gratuity?

An individual is eligible to receive gratuity after 5 years of continuous service with an employer, on the cessation of employment only. Gratuity is not payable during the continuance of the employment period. The cessation of employment can be by death, resignation, disability, retirement or superannuation.

While calculating gratuity, what is considered as salary?

Salary while calculating gratuity is the last received payment/ salary by the employee during the continuance of his employment. It includes the basic pay and the dearness allowance.

How much gratuity is tax-exempt?

The Gratuity limit in India has been enhanced from INR 10 Lakhs to INR 20 Lakhs vide a Government notification issued on March 29, 2018, by the Labour Ministry of India.  

What factors are used to calculate the gratuity?

The following factors are used to calculate gratuity:

• Number of years of service;
• The multiplier of 15/ 26, which denotes 15 working days of 26 days;
• Salary last received by the Employee, which includes the basic pay and dearness allowance.

Why is the gratuity part of the CTC?

Gratuity is a part of the CTC since it is one of the other retirement benefits extended by the employer to the employee. It is fixed and defined in nature. Further, no rule per se governs as to what are the components of CTC. Thus, the employer can include gratuity as your CTC on his whims and as he fancies.

How do I apply for the gratuity?

The person who is entitled to receive the gratuity amount has to send an application in writing to the employer. Thereafter, the employer calculates the gratuity amount according to the rules and provides a notice in writing to the employee/ his nominee/ his heir and the controlling authority. The payment should be made within 30 days from the date it is due to the employee. If there is any delay in the payment within the prescribed time limit except for any delay by mistake of the employee, the employer is bound to pay simple interest on the amount of gratuity. This is according to the decision of the Supreme Court in the landmark case of Y.K. Singla v. Punjab National Bank. 

Can an employer forfeit the gratuity amount of the employee?

Yes, an employer can forfeit the gratuity amount if the employee had caused damage or destruction to the property, is guilty of an offense involving moral turpitude or is involved in violent or riotous activities during the course of employment. The forfeiture can be complete or partial.

How many days does it take for the employer to remit the gratuity amount?

The employer should remit the gratuity amount within 30 days from the day it is due for payment. Any delay in payment beyond the prescribed time makes the employer liable to pay simple interest. However, this is not applicable if the delay is attributed to the employee.