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.
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.
Let’ take a look at some of the most important points about gratuity payment by an employer to an employee.
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.
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.
The payment if gratuity is done in three simple steps. This includes:
Following are the eligibility criteria to receive gratuity:
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
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.
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
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.|
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:
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.
In case of this, the following are the three amounts exempted from tax.
Helpful Resources: Income Tax Calculator