What is Gratuity?

Legal Basis

Payment of Gratuity Act, 1972

The Payment of Gratuity Act of 1972 is the central legislation that governs gratuity payments in India.

• Date of Enactment: Enacted by Parliament on August 21, 1972, effective September 16, 1972.
• Purpose: Mandates payment of gratuity as a mandatory benefit, ensuring employees receive a lump-sum payment for long-term service, distinct from discretionary rewards.

Applicability

• Applies to all factories, mines, oilfields, plantations, ports, railways and shops or establishments employing 10 or more persons on any day in the preceding 12 months.
• Organisations remain applicable even if employee numbers fall below 10 after initial coverage.
• Eligible employees include permanent, temporary, and contract workers (via principal employer), subject to eligibility criteria. Exemptions may apply to certain charitable trusts.

Eligibility Criteria

Minimum Service Requirement

• The employees should have served for at least 5 years in continuous service with the same employer to be eligible for gratuity.
• "Continuous service" would include maternity leave, accident, sanctioned leave, layoff, strike, lock-out, or work stoppage beyond the employee's control.

Exceptions

• The 5-year requirement is exempted in the event of death or disablement from accident or disease; gratuity is paid regardless of the length of service in such an event.
• On death, gratuity is payable to the nominee or, in the absence of a nomination, to legal heirs.

Special Case

Certain judicial pronouncements (e.g., Madras High Court) have held gratuity to be admissible after 4 years and 240 days' service, even though the Act does not prescribe.

How is Gratuity Calculated?

Standard Formula (in case of employees included under the Act):

Gratuity = Last Drawn Salary×15×Number of Completed Years of Service/26

• Last Drawn Salary: Basic pay plus dearness allowance.
• Number of Completed Years: All years of service, with any amount over 6 months in the last year rounded to a full year; less than 6 months is not counted.
• Partial Years (Rounding Rule): For instance, 7 years and 7 months is taken as 8 years and 7 years and 5 months is rounded to 7 years.

Calculation Example:

• Last drawn salary: ₹40,000
• Service: 7 years and 7 months (rounded to 8 years)
• Gratuity: (40,000×15×8)/26=₹1,84,615

For organisations not covered under the Act:

Employers can voluntarily pay gratuity, usually based on a policy formula (e.g., dividing by 30 rather than 26), which is not required by law.

Tax Implications

Tax Exemption Limit:

Under Section 10(10) of the Income Tax Act, 1961, gratuity received by private sector employees is exempt from tax up to ₹20 lakh, applicable cumulatively across all occupations. The exemption for statutory gratuity (per the Payment of Gratuity Act, 1972) is the least of:

The exemption is the minimum of:

• Actual gratuity received,
• ₹20 lakhs
• Amount calculated per the Act’s formula (Last Drawn Salary × 15 × Years of Service / 26).

Government Employees/ Non-Government Employees:

• Government Employees (Central/State/Local): Gratuity is fully exempt from tax, regardless of amount, for both non-statutory and statutory benefits.
• Non-Government Employees: Amounts above ₹20 lakh are taxable as per the employee’s income tax slab (e.g., 30% for high earners). For example, a ₹25 lakh gratuity would see ₹5 lakh taxed.

When is Gratuity to be Paid?

Gratuity becomes payable under the following circumstances:

• Retirement/Superannuation: Upon reaching the retirement age as per company policy.
• Resignation: After completing at least 5 years of continuous service.
• Death: Paid to the nominee or legal heirs, regardless of service duration.
• Disablement: Due to accident or disease, whether work-related (e.g., workplace injury) or non-work-related (e.g., car accident, chronic illness), provided it renders the employee unfit for work, regardless of service duration.
• Termination: Includes layoffs, retrenchment, or closure after 5 years of service, even if due to misconduct, provided eligibility criteria are met.

Legal Deadline for Payment:

Payment must be made within 30 days of the end of employment. Delays incur simple interest at 10% per annum, as specified by the Payment of Gratuity Act, 1972, from the due date until payment is completed.

Gratuity Nomination Process

Importance of Filing a Nomination:

Nominating ensures that, in the event of an employee’s death, the gratuity is paid directly to the designated recipient(s), reducing disputes among heirs and streamlining the payment process.

How and When to Nominate:

• Employees may submit a nomination using Form F to the HR department upon joining or at any time thereafter.
• Nominations can designate one or more family members (e.g., spouse, children). If no family exists, any individual may be nominated, but this must be updated upon acquiring a family (e.g., after marriage or divorce).
• Employees must submit updated nominations in writing to HR upon changes in family status, such as marriage, divorce, or the death of a nominee.

Employer's Responsibility

Statutory Obligation:

• Employers covered by the Payment of Gratuity Act, 1972, must pay gratuity to eligible employees (those meeting service criteria) using the Act’s formula (Last Drawn Salary × 15 × Years of Service / 26) within 30 days of the due date. 
• Non-payment attracts penalties, including a fine up to ₹10,000 or imprisonment for up to 6 months.

Dealing with Liability:

Employers can manage gratuity liability through:

• Group Gratuity Insurance: Policies (e.g., LIC schemes) ensure funding for timely payments and may provide tax deductions under Section 37 of the Income Tax Act, 1961.
• Trust Funds: Establishing a gratuity trust fund allows employers to set aside funds, ensuring compliance and financial planning.