Gratuity is a lump sum amount that employers pay their employees as a sign of gratitude for the services provided.
The gratuity rules are mandated under the Payment of Gratuity Act, 1972. The act was passed by the Parliament on 21st August 1972 and came into force on 16th September the same year.
All central and state government departments, defence, and local governing bodies are covered under this act. Private organisations can come under its purview subject to fulfilment of certain conditions.
Rules pertaining to the applicability of gratuity are mentioned below –
Organisations with a workforce of 10 employees on a single day in the preceding 12 months are liable to pay gratuity. If the number of employees of the same organisation reduces to under 10, it will still have to pay the gratuity, as per regulations of the Act.
To meet the gratuity eligibility criteria, an employee has to render his/her services for 5 continuous years. However, this condition is not taken into consideration in situations of demise or disablement of an employee.
For the calculation of the 5 years, a single year is assessed as 240 working days for employees working in organisations that do not involve work underground. For those working in mines and other such fields, a year is assessed as 190 days.
The 5 years of continuous service also include interruptions caused by strike, lockout, accident, leaves, layoff, absence from duty without leave, and termination of service not on the part of an employee.
As per the gratuity rules in India, an employee will be eligible to avail gratuity upon–
Gratuity is calculated based on an individual’s last drawn salary and years of service. The formula for calculation differs from the applicability of the Payment of Gratuity Act, 1972.
a. Gratuity calculation for employees covered under the act
As mentioned before, organisations with 10 employees in a single day in the preceding 12 months are covered under this act.
For the calculation of gratuity of employees in such organisations, the gratuity calculation formula is –
Gratuity Formula = (15 x Last Drawn Salary x Number of Completed Years of Service) / 26
For instance, if Mr. B works for an organisation for 12 years and 8 months, his completed years of service will be taken as 13 years as per the gratuity rules. However, if he had worked for 12 years and 3 months, it would be considered as 12 years.
Now, let us assume that Mr. B’s last drawn salary was Rs.77,000. If he worked for 13 years, his gratuity will be –
(15 x 77,000 x 13) / 26 = Rs.5,77,500.
b. Gratuity calculation for employees not covered under the act
For calculation of gratuity of employees not covered under the act, the formula is –
(15 x average salary for the last 10 months x number of years employed) x 30
For instance, if Mr. C has been employed at an organisation for 15 years and 8 months, his number of years employed will be considered as 15 years.
Now, let’s assume that Mr. C’s average salary for the last 10 months was Rs.92,350. Then, his gratuity will be –
(15 x 92,350 x 15) /30 = Rs.6,92,625.
As per the gratuity rules, employers can forfeit to pay a gratuity of the employee who has been terminated for the following reasons –
An organisation is liable to pay gratuity to its employees even if it declares bankruptcy. No court decree or order can restrict an employer against it.
A gratuity of up to Rs.20 Lakh paid by organisations covered under the Payment of Gratuity Act, 1972, other than central and state government departments, defence, and local governing bodies, is exempt from tax as per the gratuity rules 2021. Earlier, this threshold was set to Rs.10 Lakh.
|Gratuity tax implications
Covered under the act
Not applicable up to least of the following:
|Not covered under the act
|Not applicable up to least of the following:
|Central/state government, defence, and local government authorities
For instance, Mr. D received a gratuity of Rs.17 Lakh after leaving an organisation. After that, he joined another company that paid him a gratuity of Rs.5 Lakh. The cumulative gratuity he received was Rs .23 Lakh.
Hence, Mr. D will be liable to pay income tax on Rs. 3 Lakh (Rs. 23 Lakh – Rs. 20 Lakh).
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Upon an employee’s demise, the gratuity that is paid to his widow or legal heir will be exempt from tax. Any ex-gratia payment made to an employee or his legal heir on account of an injury caused will also be tax-free.
It is crucial for individuals to be aware of these new gratuity rules to ensure that they can maximise their benefits from this aspect attached to their employment terms.