Gratuity

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).

What is Gratuity?

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.

What are the Eligibility Criteria for Payment of Gratuity?

The criteria that dictate and mandate the payment of gratuity are as follows –

• An employee must have completed at least five years of service with an employer at the time of retirement or resignation.
• An employer that employs a minimum of 10 employees in the 12 months preceding gratuity calculation needs to pay this amount.
• An employee who has suffered disablement or is dead before completing five years of uninterrupted service with an employer is liable to receive gratuity.
• An employee who is disabled due to a disease(s) before he/she has rendered uninterrupted service for five years to an employer can receive this amount.

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.

What is Uninterrupted or Continuous Service?

According to the Payment of Gratuity Act, 1972,  an employee is considered to be in uninterrupted or continuous service if they have worked without interruption during a particular period. However, even if there are interruptions, the service will still be considered continuous if the breaks are due to -

• Sickness
• Accident
• Leave (with or without pay, unless specifically marked as “break in service”)
• Lay-off declared by the employer
• Strike or layout
• Temporary closure or cessation of work not caused by the employee

Deemed Continuous Service for Non-seasonal Establishments

At times, an employee may not have uninterrupted service. In such cases, the law still considers them to be in continuous service if they have worked for a minimum number of days:

For 1 year

• 190 days – if employed underground in a mine or in an establishment working less than 6 days a week
• 240 days – in all other cases

For 6 months

• 95 days – if employed underground in a mine or in an establishment working less than 6 days a week
• 120 days – in all other cases

This ensures that even if there are breaks, the employee is not denied gratuity benefits.

What Days Count as ‘Worked’?

While calculating days for continuous service, the following are also counted as days worked:

• Lay-off days as per law
  
  
• Paid leave (earned leave from the previous year)
  
  
• Absence due to temporary disability from a work-related accident
  
  
• Maternity leave (up to 12 weeks) for female employees
  

This provision ensures fairness, especially for employees who cannot attend work due to genuine reasons.

Continuous Service in Seasonal Establishments

In seasonal industries (like agriculture or sugar factories), employees are considered in continuous service if they have worked for at least 75% of the days the establishment was operational during the year or six months.

Why Continuous Service Matters for Gratuity

Under the law, employees become eligible for gratuity after completing 5 years of continuous service with the same employer (except in cases of death or disability, where this condition is waived).

How to Calculate Gratuity Amount?

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 –

1. Establishments covered under the act.
2. Establishments not covered under the act.

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 –

• 15 days of last drawn salary by an employee for each completed year of service rendered by him/her or partly completed with more than 6 months of service. It is further divided by 26.

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 –

• 15 days of last drawn salary by an employee for each fully completed year of service. It is further divided by 30.

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.

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.

How is Gratuity Taxed?

• Government employees

For the Financial Year, a government employee’s gratuity would be fully exempt from taxation, irrespective of the amount.

• Non-government employees

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.