Gratuity Rules in India

Gratuity in India is a statutory benefit provided to employees as a gesture of appreciation for their long and dedicated service to an organization. Governed by the Payment of Gratuity Act, of 1972, these rules outline the conditions under which employees become eligible for gratuity, the calculation method, and the obligations of employers to facilitate timely payouts. Let us look into the details of the gratuity rules in this article.

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What is Gratuity?

Gratuity is an amount paid by an employer to their employee in return for the services offered by them to the company. This benefit is granted to employees with at least five years of company tenure. Essentially, gratuity reflects a company's gratitude towards its long-serving employees. The rules for gratuity are outlined in the Payment of Gratuity Act of 1972.

IMPORTANT:

The Payment of Gratuity Act of 1972 is applicable to all the central and state government departments, defence, and local governing bodies. Private organizations may be included if they meet specific conditions.

Gratuity Rules on Eligibility Criteria

  1. Eligibility Based on Employment:

    Employees can receive gratuity not only upon retirement but also in situations like—

    • Superannuation

    • Resignation

    • Death or disablement

    • Retrenchment

    • Voluntary retirement

    • Termination

  2. Eligibility for Businesses and Institutions:

    • Gratuity is mandatory for organizations with 10 or more employees in the past 12 months.

    • For non-underground work, a year is 240 working days; for roles in mines, it is 190 days.

  3. Eligibility for Employees:

    • To qualify for gratuity, an employee must serve continuously for 5 years.

    • The 5-year count includes breaks from strikes, lockouts, accidents, leaves, layoffs, unauthorized absence, and non-employee-initiated termination.

Exception to 5-Year Gratuity Rule:

Generally, an employee is eligible for gratuity only after completing five years of continuous service with an establishment. However, there are two exceptions to this rule:

  1. Termination Due to Death or Disablement:

    If an employee's service ends due to death or disablement, they are eligible for gratuity, irrespective of completing five years.

  2. 4 Years 240 Days Rule:

    In specific situations, an employee can qualify for gratuity with just four years and seven months of continuous service. The Payment of Gratuity Act, 1972, considers 240 days of service in the fifth year as equivalent to completing five years of continuous service.

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Rule for Gratuity Calculation

Gratuity is determined by considering an individual's final salary and years of service. The calculation method varies based on whether the organization falls under the Payment of Gratuity Act, 1972.

  1. Gratuity Calculation for Employees Covered by the Act:

    Organizations with at least 10 employees in the past 12 months fall under this act. The formula for their gratuity calculation is:

    Gratuity Formula = (15 x Last Drawn Salary x Number of Working Years) / 26

    Where,

    • Last Drawn Salary = Basic Salary + Dearness Allowance (DA)

    • One Working Year = An year in which the employee worked for 6 months or more

    Illustration of Gratuity Calculation for Employees Covered u/ Gratuity Act:

    Let us consider an example of Mr. X:

    • Working Period of Mr. X = 11 years and 8 months

    • No. of working years = 12 years

    • Last drawn salary = Rs. 75,000

    Total Gratuity = Rs. 5,19,230

  2. Gratuity Calculation for Employees Not Covered by the Act:

    For those not covered by the act, the formula is:

    Gratuity Formula = (15 x Last Drawn Salary in Last 10 Months x Number of Working Years) x 30

    Where,

    • Last Drawn Salary = Basic Salary + DA + Commissions

    • One Working Year = On completion of each year of work

    Illustration of Gratuity Calculation for Employees Not Covered u/ Gratuity Act:

    Let us consider an example of Mr. Y:

    • Working Period of Mr. Y = 14 years and 7 months

    • No. of working years = 14 years

    • Last drawn salary in last 10 months = Rs. 75,000

    Total Gratuity = Rs. 5,25,000

Income Tax Implications on Gratuity Policy

Income tax implications vary as per the following criteria:

Criteria Tax Implication on Gratuity
Organisations Covered under the Act
  • Not applicable up to the least of the following:
  • Rs. 20 Lakh
  • Actual gratuity received
  • (15 x last drawn salary x number of completed years of service) / 26
Organisations Not Covered under the Act
  • Not applicable up to the least of the following:
  • Actual gratuity received
  • Rs. 10 Lakh
  • (15 x average salary for the last 10 months x number of years employed) x 30
Central/State Government, Defence, and Local Government Authorities Not applicable for income tax
Tax Exemption for Widow or Legal Heir
  • If an employee passes away, the gratuity paid to their widow or legal heir is tax-exempt. 
  • Similarly, any ex-gratia payment due to injury is also tax-free.

Key Points to Consider about Gratuity

Mentioned below are some of the most significant points of gratuity:

  1. Gratuity Limit:

    • According to the Payment of Gratuity Act 1972, an employer may pay more gratuity to their employees, still the gratuity amount cannot exceed Rs. 20 lakhs. 

    • Any amount that is more than Rs.20 Lakh is considered ex-gratia and is voluntarily given and is not enforced as per the law.

  2. Rounding off Tenure:

    • If the tenure in previous employment is over 6 months, it is rounded up to the nearest figure. 

    • For instance, if the service period is 14 years and 7 months, gratuity is calculated for 15 years. 

    • Conversely, if the tenure is 14 years and 3 months, the calculation is based on 14 years.

  3. Death of Employee:

    In case of an employee's demise, the heir or nominee follows gratuity rules for the entitlement.

  4. Employer's Right to Reject:

    Employers can reject gratuity payments in cases of individual termination due to misconduct.

  5. Forfeiture Conditions:

    Gratuity can be forfeited for specific reasons, as outlined in the gratuity rules, particularly in cases of employee termination.

  6. Gratuity Obligation in Bankruptcy:

    Even during bankruptcy, organizations must fulfill their gratuity obligations. No court order has the authority to exempt employers from this responsibility.

Frequently Asked Questions

  • What are gratuity new rules for 2023?

    There have been no major changes to the Payment of Gratuity Act, 1972, in 2023. The key points to remember about the gratuity rules in 2023:
    • Eligibility: Employees who have completed five years of continuous service with an establishment are eligible for gratuity.

    • Calculation: Gratuity is calculated as follows:

      • For employees covered under the Gratuity Act: Gratuity = (15/26) × (Last drawn salary) × (Total period of service)

      • For employees not covered under the Gratuity Act: Gratuity = (15/26) × (Average salary for the last 3 months) × (Total period of service)

    • Maximum limit: The maximum amount of gratuity that can be paid to an employee is ₹20 lakhs. Any amount in excess of this limit will be treated as ex-gratia payment and will be taxable.

    • Payment: Gratuity must be paid to the employee within 30 days of the date of employment termination or retirement.

  • Is 4 years and 7 months eligible for gratuity?

    Generally, an employee is eligible for gratuity only after completing five years of continuous service with an establishment. However, there are two exceptions to this rule:
    • Termination due to death or disablement: If an employee's employment is terminated due to death or disablement, they are eligible for gratuity even if they have not completed five years of continuous service.

    • 4 years 240 days rule: The Payment of Gratuity Act, 1972, states that an employee is considered to have completed five years of continuous service if they have completed at least 240 days of service in their fifth year.

  • What is the latest rule of gratuity?

    The most recent change to the Gratuity Act was made in 2014. This amendment made the following changes:
    • It increased the maximum amount of gratuity that can be paid to an employee from Rs. 10 lakhs to Rs. 20 lakhs.

    • It made it mandatory for all establishments to maintain a separate Gratuity Fund.

    • It introduced a new provision that allows employees to commute a portion of their gratuity in lieu of a lump sum payment.

  • What happens if gratuity is not paid within 30 days?

    If an employer fails to pay gratuity to an employee within 30 days of the date of employment termination or retirement, the employer is liable to pay simple interest on the amount of gratuity payable. The rate of interest is notified by the Central Government from time to time for repayment of long-term deposits.
  • Is it mandatory for an individual to serve five years of continuous service for gratuity?

    Yes, an individual must serve five years of nonstop service to avail of the gratuity benefit.
  • How much time does the employer take to release the gratuity amount?

    The employer must pay the full gratuity amount within 30 days of the 'gratuity payment' application.
  • Who can receive gratuity benefits?

    To receive gratuity benefits, one must fulfill the below eligibility criteria:
    • One must be eligible for superannuation.
    • One should have retired from service.
    • One should have performed continuous employment for five years with the company.
    • In case of death, the gratuity is paid to the nominee.
  • How much is the tax on gratuity?

    The tax on gratuity depends on the type of employee.
    • Tax on gratuity for government employees: Exempt
    • Tax on gratuity for employees whose employer is covered under the Payment of Gratuity Act (the least of the following three is exempt):
      • Rs. 20 lakhs
      • The actual amount of gratuity received
      • The eligible gratuity
    • Tax on gratuity for employees whose employer is not covered under the Payment of Gratuity Act (the least of the following three is exempt):
      • Rs, 20 lakhs
      • Half month's average salary x completed years of service
      • The actual amount of gratuity received
  • How to nominate someone to receive my gratuity in case of my death?

    To nominate one or more for receiving gratuity amount, one needs to fill in Form F when joining a company.
  • Can gratuity be paid before retirement?

    As per the Gratuity Rules in India, gratuity is paid after retirement, but one can avail of gratuity under certain conditions.
  • Will contractual employees receive gratuity on completing 5 years in service?

    Currently, contractual workers are not covered under the gratuity benefit as per the gratuity rules.
  • Does the gratuity amount have any cap?

    One cannot receive more than Rs.20 Lakhs as gratuity benefits despite the number of years they have spent with the company. This limit on gratuity is well applicable to the gratuity benefit amount that one gets from different employers. If the organization wants to pay you more, they can give it as a bonus or ex-gratia.
  • Is gratuity payable if the company has less than 10 employees?

    As per the Gratuity Rules in India, companies having a workforce of 10 or more employees on a single day in the previous 12 months are subject to pay gratuity benefits.

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