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Gratuity

Out of various different components of the gross income of an employee, Gratuity is one. It is basically an advantage that is payable as per the Payment Gratuity Act that was passed in the year 1972.

What is Gratuity?

It is an amount that is paid by an employer to his/her employee in return of the services given by him/her to the company. However, the benefit of gratuity is offered to those employees who have been associated with the company for a minimum of five years. In this way, gratuity can be perceived as a gesture of gratitude by a company towards its employees against the services.

Rules of Gratuity

Mentioned below are the gratuity rules:

Gratuity Payment Timeline

The basic three steps that are involved in the payment of gratuity are:

Initial

An authorized person has to send an application to the employer regarding the gratuity payment.

Acknowledgment & Calculation

As soon as the company that owns gratuity receives an application, starts calculating the gratuity. With this, the company also provides notice for the same to the Gratuity seeking employee and the controlling authority with the specification of gratuity amount.

Disbursal

The employer, after sending the acknowledgment gets the time period of 30 days for paying the amount of gratuity to the employee.

Forfeiture of Gratuity

As per Payment Gratuity Act 1972, an employer may forfeit the gratuity payment of the employees, either partially or wholly despite he/she has completed five or more years in the service of the company. However, the only time where this situation occurs is the termination of the employee because of undisciplined conduct in which he/she has tried to physically harm the individuals during employment.

Tax Exemption on Gratuity Payment for the Year 2016 – 17

The gratuity law as per the policy changes made in the budget year of 2016 are:

  • As per the Article 10 (10) I of the Online Income Tax, the gratuity payment received by a government employee except for the statutory corporation, is completely exempt of tax.
  • As per Income Tax Act’s Article 10 (10) ii, the death or/ and retirement gratuity receivable by an individual who is covered under the Gratuity Act 1972 is considered as the minimum amount of the below mentioned that is exempted from the tax:
    • (*15/26) X Salary last drew**X Number of service years completed or its some part in excess of six months.
    • 10 Lakhs
    • The actual received gratuity amount.

Where - * 7 days if one is an employee of some seasonal establishment.

** The amount of salary to the complete salary got by an individual considering the Dearness Allowance and excluding the other benefits such as bonus, HRA, commission, and other perquisites.  

  • As per the Income Tax Act’s Article 10 (10) iii, all the exemption for gratuity payment received by an employee who does not get coverage under Gratuity Act 1974 are:
    • Salary of half month * X Service years completed

Where *Average Salary = Average Salary of last ten months immediately after the month of retirement.

Eligibility for Gratuity Payment

To get the gratuity payment, an individual needs to fulfill the below criteria:

  • An individual should qualify for superannuation
  • An individual must have retired from his/her job.
  • An individual has resigned from the services of the company after remaining employed with it for at least five years.
  • In case of the death of the individual, or if one has become disabled due to some accident or sickness.

What is the Working of Gratuity Payment?

An employer can provide the gratuity to his/her employees from his/her own pocket or can buy a group gratuity plan from an insurance provider. For group plans, the employer needs to pay the annual contribution to the insurance provider. Moreover, an employee also can contribute to the gratuity amount. The gratuity that is paid by the insurance provider is as per the of the group insurance plan.

The formula to Calculate Gratuity

The components and the formula to calculate gratuity is given below. The amount of gratuity also depends upon the years for which an individual has served a company and his/her last drawn income.

If, N = Years (number) x that one serves in a company

B = Last drawn salary (basic) with DA

So the

Gratuity = N*B*15 / 26

Gratuity Calculation Example

To understand the calculation of gratuity, let us take an example. For example, Sumit is a software engineer and is working for an IT firm. In his 20 years of employment with the same organization, Sumit has had previous month’s basic salary plus DA salary as Rs.25, 000. In this case, the gratuity amount that Sumit will get is:

Gratuity amount for Sumit = 20*25, 000*15 / 26 = Rs. 2, 88,461.54

However, an employer may pay more gratuity to his/her employees, however, the amount of gratuity cannot exceed than Rs. 10 Lakhs as per the Gratuity Act. Any amount that is more than Rs.10 Lakh is considered as ex-gratia and is voluntarily given and is not enforced as per the law.

Moreover, anything that is more than six months is rounded off to the next number whereas anything that is below six months of the previous year of the employment is adjusted to the lower number of the previous month. In this way, anyone who has served his/her job for 6 years and 7 months would be entitled to get the gratuity of 7 years. On the other hand, a job held for 6 years and 4 months will get the gratuity of 6 years.

Some Points about Gratuity

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

  • An employee can get the gratuity of a maximum of Rs.10, 00, 000. In this case, the tax exemption will be calculated as per the points listed under taxation.
  • In the situation of the death of an employee, the heir or nominee of the employee gets the gratuity.
  • The employer always has the right to reject the gratuity payment, in case of the termination of an individual due to some misconduct.

Gratuity Taxation Process

The taxation for gratuity payment depends on the employee who is getting the gratuity payment. There are three cases that arise in this situation:

Government Employee Getting the Gratuity Payment

If an employee is central or state government or local authority's servant and getting the gratuity from his/her employer, then he/she gets a full exemption on the income tax.

Any Other Salaried Individual Getting Gratuity Payment from the Employer Who is not Covered with the Payment Gratuity Act

In this case, the minimum of the below amounts are exempted from the tax:

  • 10, 00,000
  • Actual gratuity got by an employee
  • Salary of half month of every service year that the employee has finished with the employer.

Any Other Salaried Person Getting the Gratuity Amount from the Employer Who is Covered by the Payment Gratuity Act

The following gratuity amount is exempted from the salary of an employee in this case:

  • Salary of 15 days according to the last drawn salary of an individual.

Gratuity FAQs

Question 1: Specify the kind of employees covered in the Gratuity Act of the year 1972?

Answer: The Gratuity Payment Act 1972 applies to the employees of factories, oilfields, mines, ports, plantations, railway companies, and other establishments. All type of government jobs also come under this category. This act is applicable in all the Indian states except the Jammu and Kashmir.

Question 2: I am working on a contract with a company. Will I be able to get a gratuity, if I retire or resign after five years?

Answer: Generally, full-time employees or employees working full time are eligible to get gratuity. However, if one is working as a contractor, then the gratuity payment must come from your contractor, not the company.

Question 3: Will I be eligible to get the benefits of gratuity, if I resign from my job after four and a half years?

Answer: No, one has to serve at least five years to get the gratuity payment from the employer. As per the Madras High Court, one can avail the benefits of gratuity, if he/she completes 240 days after the service of the fifth year. One can get the idea about the gratuity rules by talking to the HR of the company. However, if someone dies while he/she is in service of a company, then his/her legal heir receives the benefit of gratuity even though he/she has not completed five service years in the company. In addition to this, the amount paid to the nominee is non-taxable.

Question 4: What is the difference in gratuity calculation of employees who are not covered in the Gratuity act?

Answer: An employer can provide the benefits of gratuity to his/her employees even if they are not covered in the Gratuity Act. The following formula is applied for calculation of gratuity in this case: Gratuity = Average salary (Basic + DA) *1/2 *Number of service years.

Question 5: Does the gratuity amount has any cap?

Answer: One cannot receive more than Rs.10 Lakhs as gratuity payment despite the number of years he/she has spent with the company. This limit on gratuity is as well applicable to the gratuity amount that one gets from different employers. If the organization wants to pay you more, then they can give it as a bonus or ex-gratia.

Question 6: How many days an employer takes to remit the gratuity payment?

Answer: Ideally, an employer should remit gratuity amount with the full and final settlement of the employee. As per the government laws, it is mandatory for employers to pay the amount of gratuity within 30 days. However, if there is a delay in the payment of the gratuity, then the employer has to pay simple interest on this amount from the due date till the date of payment.

Helpful Resources: How To Calculate Income Tax

Written By: PolicyBazaar - Updated: 28 October 2020
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