Everything You Need to Know about Gratuity

Gratuity is a component of salary, which is offered by the employer to its employee for their services offered to the organization. It is administered by the Payment of Gratuity Act 1972. As per Section 10(10A) of Income Tax Act, gratuity is offered to an employee after he/she completes tenure of minimum 5 years full-time service with the organization.

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An employer can pay gratuity to its employees either from his/her pocket or can take a group gratuity plan from an insurance company. In the case of a group gratuity plan, yearly contributions are paid by the employer to the insurance company. The employees can also contribute to their own gratuity amount. In order to help you know more about gratuity, further in this article we have discussed it in detail.

Few Important Points about Gratuity

Let’ take a look at some of the most important points about gratuity payment by an employer to an employee.

  • An employee can get a gratuity amount more than Rs.10, 00,000 from his/her employer. The tax exemption, in this case, will be computed according to the points listed under taxation.
  • In the interim budget of 2019, the current Finance Minister of India Mr.Piyush Goyal has announced that the prevailing tax-exempted gratuity limit has increased to Rs.30 Lakhs.
  • The employer has all the right to reject the gratuity payment to the employee in case the employee has been asked to leave the job because of any misconduct.
  • In case of demise of the employee, the beneficiary or family member of the employee gets the gratuity amount. The income tax for this is calculated for the receiver, under the head of income from other sources.

Gratuity Act 1972:

The Payment of Gratuity Act was introduced in the year 1972. All the employees with a workforce of 10 or more who works in factories, mines, plantations, oil fields, port, companies and other such establishment are eligible to get gratuity from their employers. Unlike, provident fund the amount of gratuity is entirely paid by the employer without any contribution to the employee.

Gratuity Rules

Gratuity Forfeiture

As per the Payment of Gratuity Act 1972, the employer has all the rights to fine the gratuity payment of the employee either partially or wholly in spite of the employee having completed 5 or more years of service in the organization. Gratuity forfeiture is applicable in case the employee has been asked to leave the job because of any misconduct.

Timeline for Payment of Gratuity

The payment if gratuity is done in three simple steps. This includes:

  • Initiation- The authorized person or an individual needs to send an application to the employer regarding the gratuity he/she owns by the company.
  • Computation and Acknowledgement- As soon as the application is received by the employer, the organization which owns the gratuity will compute the amount and also provide an acknowledgement of the same to the concerned employee and the controlling authority along with the specific amount. The employer can make use of gratuity calculator to determine the amount of gratuity.
  • Disbursal- After sending the acknowledgement, the employer has a time period of 30 days to make the payment of gratuity to the individual.

Eligibility of Gratuity

Following are the eligibility criteria to receive gratuity:

  • The employee should be eligible for superannuation.
  • When the employee gets retired.
  • In case the employee resigns after working for 5 years or more in an organization.
  • In case the employee dies due to illness or accident or suffers a disability.

Gratuity Formula

Let’s take a look at the components that go in the computation of gratuity amount. The gratuity amount also depends on the number of service years in the same company and the last drawn salary.

Gratuity= Number of Service years in a company* Last Drawn Basic Salary+ Dearness Allowance*15/26

How to Calculate Gratuity

Let’s take an example.

Rajesh is a software engineer who worked in an IT company for 20 years and had Rs.25,000 as his last drawn salary (Basic +DA amount) then the gratuity amount of Rajesh will be.

Gratuity Amount of Rajesh= 20*25,000*15/26= Rs.2, 88,416.54

Even though the employer can choose to make more gratuity payment to the employee in the form of a tip, the amount of gratuity payment should not exceed Rs.10 Lakh as restricted by the Gratuity Act. 

Computation of Gratuity for Employee Who Does Not Come Under the Act of Gratuity

In the case of gratuity payable to the employee, the employer is not restricted by the law even if the company is not covered under the gratuity act. The amount of gratuity payable to the employee is computed based on the half month’s salary for each complete service year. Salary, in this case, is computed including the commission on sales, basic pay and dearness allowance.

Let’s take a look at the formula which is considered for the computation of the amount of gratuity for employees who are not covered under the gratuity act.

Gratuity Amount= (15*Last Drawn Salary Amount* Period of Service)/30

Gratuity Computation in Case of Demise of an Employee

In case of the demise of an employee, the gratuity amount is computed based on the term of service of the employee. However, the amount is subject to a maximum of Rs. 20 Lakhs. Below is the tabular description of rates at which the gratuity will be paid to the beneficiary or the family member in case of demise of the employee.

Term of Service Amount Payable Towards Gratuity
Less Than Year 2* Basic Salary
1 year or more but less than 5 years 6* Basic Salary
5 years or more but less than 11 years 12* Basic Salary
11 years or more but less than 20 years 20* Basic Salary
20 years or more  Half of the BS for each completed six month period. However, it is subject to a maximum of 33 times of basic salary.

Taxation on Gratuity

The process of taxation of gratuity depends on the employee who is receiving the amount of gratuity. Two standard cases applicable to the computation of tax on gratuity are:

Government Employee Receiving Gratuity Benefit

Any government employee who comes under the central government, state government or local authorities is eligible to receive gratuity amount that is totally e

xempted from Income Tax.

Any Salaried Individual Other than Government Employee Who Receives Gratuity from an Employer who is Covered by Payment of Gratuity Act

In case of any salaried individual other than a government employee who receives gratuity from an employer who is covered by payment of gratuity act, the following amount is tax exempted.

  • 15 days salary as per the last drawn salary of the individual.
  • Any Other Salaried Individual Receiving Gratuity for Employee Who Does Not Come Under the Act of Gratuity

In case of this, the following are the three amounts exempted from tax.

  • 10,00,000
  • Gratuity actually received by the employee.
  • Half a month’s salary for every year of service that the employee has completed with the organization.

Helpful Resources: Income Tax Calculator

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*Tax benefit is subject to changes in tax laws. Standard T&C Apply
^The tax benefits under Section 80C allow a deduction of up to ₹1.5 lakhs from the taxable income per year and 10(10D) tax benefits are for investments made up to ₹2.5 Lakhs/ year for policies bought after 1 Feb 2021. Tax benefits and savings are subject to changes in tax laws.
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