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 Service?
According to the Payment of Gratuity Act, 1972, an employee is considered to be in continuous or uninterrupted service when –
- An employee has uninterruptedly rendered their services for that period. This uninterrupted definition includes services that have been discontinued due to several conditions. These include, sickness, leave, accident, absence sans leave – provided the establishment does not mark such absence as a break from employment – furloughing, lock-out, strike, and cessation of work that does not stem from any fault of the employee in question.
- If an employee does not fulfill the “continuous service” criterion as per the clause mentioned above for any period of 1 year or 6 months, then –
- Such an employee is considered to be in continuous employment for 1 year provided –
- He/she has worked for a minimum of 191 days if such an employee works underground in mines or is employed in an organization with less than 6-day working weeks.
- In any other case, he/she has worked for a minimum of 240 days.
- Such an employee is considered to be in continuous employment for 6 months provided –
- He/she has worked for a minimum of 95 days, in case the employee in question works underground in mines or works in an establishment that has less than 6-day working weeks.
- He/she worked for a minimum of 120 days, in any other case.
- If an employee belonging to a seasonal organization does not fulfill the “continuous service” criterion as per the first clause for 1 year or 6 months, then –
- Such employees must work for a minimum of 75% of the days in which such an establishment was functional, to be deemed to be in “continuous service”.
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 –
- Establishments covered under the act.
- 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.
|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.
How is Gratuity Taxed?
- Government employees
For the Financial Year 2020 – 21, 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.