Calculation of Gratuity

Details of Gratuity Scheme.

What is Gratuity?

Gratuity is a reward scheme for salaried employees at the time of retirement/death/resignation.

Gratuity is a “Defined” benefits scheme in which a lump sum amount will be paid to the employees by the employer when he/she leaves the organisation after serving for certain numbers of the year.

Gratuity is a part of an employee’s salary and it is paid by the employer for the services offered by the employee.

It is more like a prize from the organisation appreciating the employee’s service.

Features of Gratuity?

  • This scheme is a full benefit scheme at the time of retirement or resignation.
  • No contribution from the employees, the employer pays full contribution also.
  • Income Tax benefits
Gratuity benefits for employees.
Retirement benefits.

History of Gratuity.

In the year 1972, The Indian Government had launched the payment of “Gratuity Act“.

Before 1972, Gratuity was not compulsory for an employer to provide some reward to an employee when he leaves the organisation.

According to the “Gratuity Act“, if the employer is having more than 10 employees, then gratuity is a compulsory benefit.

The employer should pay gratuity when the employee leaves the organisation after serving certain numbers of years.

How does Gratuity Work?

When an employee joins an organisation, he has automatically become a part of Gratuity Scheme.

The employer should have specified about the Gratuity benefits on the offer letter which have given to the employee.

An employer contributes to the Gratuity fund on his own or through a life insurance company.

While the employee leaves the organisation after serving for at least 5 years, the employer pays Gratuity amount as a one-time lump sum amount of appreciating employees service.

If an employee leaves the organisation before completing 5 years, then an employee will not eligible to get benefits of Gratuity Scheme.

Eligibility

If an employee serves the organisation for at least 5 years of continuous service as a full-time employee, then he/she is eligible to get Gratuity Benefits.

But an employee leaves the organisation before 5 years of his service period, in that case, no Gratuity will be paid.

In case of death or disability of the employee before 5 years, the eligibility rules don’t apply here.

In case of death an employee who has completed 5 years of regular service, then employee’s nominees will get the Gratuity benefits.

When an employee will get Gratuity?

Gratuity is a one-time lump sum payment and it is paid to the employee when he leaves the organisation after serving for at least 5 years as a full-time employee.

The cause of leaving the organisation can be one of the following:

  1. Superannuation
  2. Resignation
  3. Voluntary Retirement
  4. Death
  5. Disability due to accident or disease
  6. Laid off by the employer

How to calculate Gratuity?

The gratuity benefit amount is calculated based on the following 2 things:

  1. Employees covered under the Gratuity Act.
  2. Employees NOT covered under the Gratuity Act.

Lets to see the details of the calculation:

1. Employees covered under the Gratuity Act.

For this category, it is calculated using the following formula.

Gratuity = (Last drawn (Basic+DA) x years of service x 15) / 26

where,

  • Last drawn (Basic+DA) is the amount of received in last month salary.
  • “Years of service” is the total numbers of years of the service period of the employee.
  • If the employee’s service period is more than 6 months, then it will be counted as 1 year also.
  • If the employee’s service period is less than 6 months, then it will be ignored.
  • for example, if an employee’s service period is 12 years and 10 months, then it will be considered as 13 years. If an employee’s service period is 12 years and 5 months, then it will be counted as 12 years.

    Gratuity Calculator

2. Employees NOT covered under the Gratuity Act.

For this category, it is calculated using the following formula.

Gratuity = Average monthly (Basic +DA) x years of service x 15) / 30

where,

  • Average monthly (Basic +DA) is the amount of received in the last 10 months average salary.
  • “Years of service” is the total numbers of years of the service period of the employee.
  • Only the completed numbers of years will be considered, months will be ignored.
  • For example, if an employee’s service period is 7 years and 10 months, then it will be considered as 7 years. If an employee’s service period is 7 years and 5 months, then it will be counted as 7 years.

 

Income Tax Benefits.

The income tax impact on Gratuity amount is based on whether the employee is Government or non-Government.

Let us discuss the details of each category.

1.Government Employees:

The Gratuity amount received is completely 100 % tax-free for Government employees.

2. Non-Government Employees:

The tax effect for non-government employees can be divided into the following 2 categories:

a) Non-Government employees covered under the Gratuity Act.

b) Non-Government employees NOT covered under the Gratuity Act.

The details of each category are given below.

a) Non-Government employees covered under the Gratuity Act.

For the non-Government employees covered under the Payment of Gratuity Act, the gratuity amount received will be tax-free to a certain limit. That limit will be the lowest of the following 3 items.

i) Actual Gratuity received.

ii) Last drawn (Basic+DA) x numbers of years of service period x 15/26

iii) Rs. 20 lakhs.

Any amount received more than the above-mentioned limit will be added under the head “Income from salary” and it will be taxed as per employee’s income tax slab.

Note:-

The limit of INR 20 lakhs was effective from 29th March 2018 onwards. Before that, the limit was Rs. 10 lakhs only. The maximum tax-free limit is up to Rs.20 lakhs for employees. It may be from one employer or from many employers. If any tax-free gratuity amount is already received, then the current limit will be reduced from Rs. 20 lakhs to the extent of the gratuity received.

For example, an employee has received Rs. 5 lakhs as Gratuity benefit in the past. It means, in current and future employments, his eligible tax-free amount limit will be Rs. 15 lakhs only, not Rs. 20 lakhs.

b) Non-Government employees NOT covered under the Gratuity Act.

For the non-Government employees NOT covered under the Payment of Gratuity Act, the gratuity amount received will be tax-free to a certain limit. That limit will be the lowest of the following 3 items.

i) Actual Gratuity received.

ii) Average monthly salary (Basic+DA) x numbers of years of service period x 15/30

iii) Rs. 20 lakhs.

Any amount received more than the above-mentioned limit will be added under the head “Income from salary” and it will be taxed as per employee’s income tax slab.

Note:-

The limit of INR 20 lakhs was effective from 29th March 2018 onwards. Before that, the limit was Rs. 10 lakhs only. The maximum tax-free limit is up to Rs.20 lakhs for employees. It may be from one employer or from many employers. If any tax-free gratuity amount is already received, then the current limit will be reduced from Rs. 20 lakhs to the extent of the gratuity have received.

For example, an employee has received Rs. 5 lakhs as Gratuity benefit in the past. It means, in current and future employments, his eligible tax-free amount limit will be Rs. 15 lakhs only, not Rs. 20 lakhs.

Limit of Gratuity Benefits.

There is an upper limit on the Gratuity amount payable to the employees. This amount varies depending upon whether the employee is Government or Non-Government.

  • For Government Employees:

The limit is Rs. 20 lakhs only. Earlier, the limit was Rs. 10 lakhs. It has increased to Rs. 20 lakhs w.e.f. 1st January 2016. Based on the above calculation, if the Gratuity benefits are more than Rs.20 lakhs, then the employer pays a maximum of Rs. 20 lakhs only as per Gratuity Act.

  • For Non-Government Employees:

The limit is Rs.20 lakhs only. Earlier, the limit was Rs. 10 lakhs. It has increased to Rs. 20 lakhs w.e.f. 29th March 2018. Based on the above calculation, if the Gratuity benefits are more than Rs.20 lakhs, then the employer pays a maximum of Rs. 20 lakhs only as per Gratuity Act.

However, the employer can choose to pay the amount in excess of Rs. 20 lakhs in the form of Bonus or other salary components.

Gratuity Scheme

In case of death of an employee

In case of death of an employee, who has completed a minimum of 5 years of continuous service period or more, the eligible gratuity amount will be paid to his/her nominees or legal heirs.

In case of death, if an employee’s service period is less than 5 years, the gratuity amount will not be applicable.

Nomination Facility

The Nomination facility is available in Gratuity Scheme. After one year of service, an employee can make a nomination with his /her employer to pay the Gratuity benefits in case of death before retirement. Nomination can be made in the name of one or more family members. Nominees should be family members only. employees can not nominate anyone outside of the family.

Employees can update their nomination during employment due to family conditions.

Maternity/Paternity leave for Gratuity

For male employees, the paternity leave is only 15 days each for two times in his life. This period will be calculated as regular service in Gratuity.

For Female employees, the maternity leave has been increased from 12 weeks to 26 weeks w.e.f. 29th March 2018. This is for the purpose of calculating continuous service in Gratuity Scheme.

Can employer refuse paying Gratuity?

There are certain situations where the employer will not pay gratuity to an employee even if the employee is eligible for gratuity. The employer can choose not to pay gratuity to an employee if he/she is laid off for reasons such as misconduct, violence, moral offence, causing damage to employer’s properties, etc.