When an employee leaves an organization after completing an uninterrupted service for five years or more, they are liable to receive a gratuity for the services rendered by them. However, the 5-year clause does not hold when the employee in question dies, suffers disablement, or has to discontinue his/her service due to any specific disease(s).
Gratuity is a “gratitude” amount that an employer pays their employees upon their resignation or retirement for services rendered to the employer in question. Regardless, an employer can choose to pay gratuity even when an employee is not retiring or has not completed five years of service, provided such circumstances meet particular conditions.
The Payment of Gratuity Act, 1972 (amended 2018), governs gratuity payment in India. The act functions as a reference point for payment of gratuity. However, the amount in and of itself is at the discretion of the employer.
That is to say, it is mandatory to pay gratuity when an employee is retiring or resigning after completing five years of uninterrupted service. However, there is no stipulated percentage that an employer is bound to follow when calculating the gratuity amount.
The criteria that dictate and mandate the payment of gratuity are as follows –
Moreover, individuals must note that a contractual employee is not eligible by law to receive gratuity even after completion of 5 years of service. Nevertheless, employers can choose to pay gratuity to their contractual employees.
According to the Payment of Gratuity Act, 1972, an employee is considered to be in continuous or uninterrupted service when –
As mentioned previously, there is no fixed gratuity percent that employers are legally bound to follow when calculating it. However, for the sake of convenience, employers can refer to specific formulas mentioned in the Payment of Gratuity Act, 1972, when calculating this amount.
According to the act, non-governmental establishments are bifurcated into two categories –
Organisations that employ a minimum of 10 individuals in the 12 months preceding such date of gratuity calculation are covered under the act. These organisations must pay gratuity to its employees. Furthermore, once an organisation comes under the act’s jurisdiction, it remains so even when the number of its employees goes below 10.
1. Calculation of gratuity amount for employers covered under the act
As per the Gratuity Act, 1972, the formula for calculation of gratuity for employers covered under the law goes as follows –
In this case, the last drawn salary includes the basic pay plus dearness allowance and any commission earned from sales. Furthermore, the average monthly salary considered for calculation shall be the mean of the 10 months’ salary immediately preceding the month of calculation.
The formula is expressed as follows –
Gratuity = (15 x last drawn salary x completed years of service) / 26
Example: Gopal has been employed in Company ABC for 11 years and 7 months. The organisation employs more than 200 individuals. His last drawn salary (basic pay + dearness allowance) was Rs.65000.
In that case, Gopal’s gratuity amount would be –
Gratuity = Rs. [(15 x 65000 x 12) / 26]
Or, Gratuity = Rs.450,000
In the case of Gopal, Company ABC considered 12 years of service for calculation because he had worked for 7 months, i.e. more than 6 months of service, in his last year. In case Gopal worked for 11 years and 5 months, then 11 years would have been considered for gratuity calculation.
2. Calculation of gratuity amount for employers not covered under the act
Employers who are not covered under the Gratuity Act, 1972, can also choose to pay gratuity to their employees. In that case, the formula for calculation of gratuity goes as follows –
Even in this case, the last drawn salary includes basic pay plus dearness allowance and any commission earned from sales.
The formula is written as follows –
Gratuity = (15 x last drawn salary x completed years of service) / 30
Example: Rahul worked in Shop A for 15 years and 8 months. The shop had an employee count of 8. Rahul’s last drawn salary including his sales commissions amounted to Rs.30,000. Therefore, his gratuity from Shop A would be –
Gratuity = Rs. [(15 x 30000 x 15) / 30]
Or, Gratuity = Rs.225,000
In the case of Rahul, Shop A took 15 years of service despite him working for an additional 8 months. That is because, in case of establishments not covered under the law, only the number of completed years of service is taken into account.
3. Calculation of gratuity amount for deceased employees
As mentioned previously, employees who pass away are eligible to receive gratuity from their employers irrespective of how many years of service they have completed. Nevertheless, as per the Gratuity Act, 1972, the gratuity calculation is based on the number of years of service.
The following table illustrates the gratuity eligibility based on years of service for deceased employees, as per the act.
|Qualifying years of service||Gratuity payment|
|Less than a year of service||2 x basic pay|
|More than or equal to one year but less than 5 years of service||6 x basic pay|
|More than or equal to 5 years but less than 11 years of service||12 x basic pay|
|More than or equal to 11 years but less than 20 years of service||20 x basic pay|
|More than or equal to 20 years of service||Half of the salary for every 6 months of service up to a maximum of 33 x emoluments|
Example: Anoushka worked in Company XYZ for 22 years and 6 months before passing away due to a heart condition. Her salary was Rs.70,000 per month. Therefore, her gratuity would be –
Gratuity = Rs. [(70000/2) x 45] = Rs.15,75,000
4. Calculation of gratuity amount for retired employees
According to the pensioner website of the government, retirement gratuity is calculated based on one-fourth of a month’s last drawn salary for every 6 months’ service. It is subject to a maximum of 16 x basic pay limited to Rs.20 lakh.
For the Financial Year 2020 – 21, a government employee’s gratuity would be fully exempt from taxation, irrespective of the amount.
Non-government employees would enjoy tax exemption on gratuity up to a maximum of Rs.20 lakh in a lifetime.
One should also note that employees can be denied gratuity on the terms of termination pertaining to disorderly conduct or any offense involving degeneracy.