Gratuity is a benefit received by employees as a token of appreciation for their service to the organization. It acts as a form of financial security, offering a lump sum to employees when they leave their job after a specified period. Here in this blog, we’ll explore the essential aspects of gratuity, from eligibility and calculation methods to tax implications and practical examples.
What is Gratuity?
Gratuity is a monetary benefit provided to employees as per the Payment of Gratuity Act, 1972. It is offered by employers as a gesture of gratitude for an employee’s service tenure with the organization. The gratuity amount is generally disbursed at the time of retirement, resignation, or in unfortunate events like death or disability.
Eligibility Criteria for Gratuity
Employees become eligible for gratuity if they meet the following conditions:
· They must have completed at least 5 continuous years of service in the organization.
· They qualify if they resign, retire, or face a disability due to an accident or illness.
· In the case of death or disability, gratuity is payable to the nominee or heir of the employee, even if they haven’t completed five years of service.
How is Gratuity Calculated?
Gratuity is calculated differently for employees covered under the Payment of Gratuity Act, 1972, and those who aren’t. Generally, organizations with at least 10 employees are covered under the Gratuity Act, 1972. Here’s how to calculate it for both categories:
For Employees Covered under the Payment of Gratuity Act
Gratuity = Last Drawn Salary X 15/26 X Number of Completed Years of Service
· Last Drawn Salary includes basic salary and dearness allowance.
· 15/26 represents 15 days of salary for each year of service (26 working days per month).
For example, if an employee’s last drawn salary is ₹40,000 and they have completed 10 years and three months of service:
Gratuity = 10 X 40,000 X 15/26 = ₹2,30,769
In the above example, the year of experience is 10 years. This is because the employee worked for less than six months in the year. Similarly, in a scenario where years of experience exceed 6 months in a year, then 11 years would be considered for computation.
For Employees Not Covered under the Act:
Gratuity = Last Drawn Salary X 1/2 X Number of Years of Service
· The gratuity calculation here is based on half a month’s salary for each year of service that has been completed.
Note:
The above-mentioned categories apply to both private and government employees.
The gratuity formula sets the minimum gratuity that an employer is legally required to pay. However, the maximum gratuity amount is currently capped at ₹20 lakhs as per government regulations.
Tax Implications on Gratuity
Gratuity can be a tax-free benefit, depending on the employee’s category and the amount.
Gratuity paid to government employees (state or central) is entirely tax-free.
Private sector employees may qualify for exemptions, depending on whether they are covered under the Payment of Gratuity Act or not.
Tax Exemption Calculation (Non-government employees Covered under Gratuity Act):
Exempted amount is the least of:
· Actual gratuity received.
· Rs 20 lakh.
· Last drawn salary X years of employment X 15/26 (the eligible gratuity).
Tax Exemption Calculation (Non-government employees Not Covered under Gratuity Act):
Exemption is the least of:
· Actual gratuity received.
· Rs 20 lakh.
· Average of the last 10 months’ salary X years of employment X 1/2 (the eligible gratuity).
Let us take an example. Suppose Mr. Ravi retired on 15.06.2022 after completion of 26 years and 8 months of service and received gratuity of Rs. 15,00,000. At that time his salary was Rs. 50,000. He is a private sector employee covered by the Gratuity Act. The tax exemption will be least of the following:
Gratuity received = Rs. 15,00,000
Threshold limit = Rs. 20,00,000
Eligible Gratuity = 15*last drawn salary*tenure of working/26 = 15*50,000*27/26 = Rs. 7,78,846
How to Claim Gratuity
The process to claim gratuity varies depending on the organization’s policies and the employee’s circumstances:
1. Application to Employer: An employee must submit a gratuity application in Form I when they leave or retire.
2. Employer Verification: The employer verifies the application details and calculates gratuity.
3. Disbursement: The employer is legally required to release the gratuity amount within 30 days from the date of the employee’s departure.
Conclusion
Gratuity is an essential aspect of financial planning for every long-term employee, offering a sense of security and reward for dedicated service. By understanding how gratuity is calculated, the tax exemptions, and the claiming process, employees can better plan their finances for the future.
FAQs
Q1: Can gratuity be forfeited?
Yes, gratuity can be partially or fully forfeited if the employee has been terminated for misconduct, such as theft or violent acts.
Q2: Can gratuity be claimed multiple times?
No, gratuity is only provided once for a particular service period. If an employee changes jobs, they will qualify for a new gratuity period if they meet the criteria again.
Q3: What happens if the employer does not pay gratuity on time?
Employers who delay gratuity payments are liable to pay interest on the amount.
Q4: Which class of employers are required to pay gratuity to their employees?
Under the Payment of Gratuity Act, 1972, any organization with 10 or more employees is required to pay gratuity. Once an organization becomes eligible under the Act, it must continue to pay gratuity to eligible employees even if its employee count drops below 10.
Q5: What is the maximum exemption that can be claimed for gratuity for non-government employees?
For non-government employees, gratuity is exempt from tax up to a maximum limit of ₹20 lakhs.
