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The Payment of Gratuity Act, 1972 is an act that makes the payment of gratuity mandatory for employers to their employees. Employees working in mines, oilfields, railways, factories, ports, and shops or establishments are covered under this Act and stand to benefit from its provisions.

The Act was passed by the Parliament of India on 21st August 1972, while it came in force on 16th September 1972.

What is Gratuity?

Gratuity is a lump sum amount that an employer pays to his or her employees as a form of gratitude for the services rendered by the latter.

Employers can pay this gratuity in the following ways –

  • From their own account.
  • Via a group gratuity insurance plan.

These insurance policies cover employers in case of a sudden liability for gratuity payment. Additionally, employers also earn interest and tax benefits on the amount paid as gratuity.

Who is Liable to Pay Gratuity?

An organization with a workforce of 10 individuals and above is liable to pay gratuity under the Payment of Gratuity Act 1972. Such an organization that has come under the purview of this Act must still pay gratuity even if the employee strength goes below 10.

Who is Eligible for a Gratuity? 

An employee, contractual worker, or temporary individual has to work for at least 5 continuous years to be eligible for gratuity. This also includes service that is interrupted due to leave, accident, sickness, lockout, strike, layoff, termination of work not caused by the employee, and absence from duty without leave.

As per the Act, for the calculation of these 5 years, 1 year means 240 working days for those working in any institution that does not involve work underground. For those working below the ground, in mines and other such conditions, it is 190 working days.

For example –

If an individual has worked for 4 years and 9 months, it will be considered as 5 years, and he/she will be eligible for gratuity. On the other hand, if he/she has worked for 4 years and 3 months, it will be considered as 4 years only.

It should be noted here that the 5 years of continuous service is not applicable in case of demise or disablement of an employee.

What are the Clauses for Nomination?

Employees can nominate another person to receive gratuity on their behalf, under circumstances of the former’s death, within 30 days of completing 1 year of service with an organisation.

Few clauses for nomination are –

  • For employees with a family – Employees having a family can nominate one or more of its members. Nominations made to any other person will be void.
  • For employees without a family – Employees will be able to nominate a 3rd person if they do not have a family. However, such nomination will become void once they have a family.

If the nominated person expires, the employee can nominate another individual in such cases.

When is Gratuity Paid?

As per the Payment of Gratuity Act 1972 rules, gratuity is paid under the following situations when an employee –

  • Retires.
  • Opts for VRS.
  • Expires.
  • Become disabled due to an accident or a disease.
  • Resigns.
  • Is terminated or laid off due to retrenchment.

How is Gratuity Calculated?

The calculation of gratuity is based on the employee’s last drawn salary and years or service. There are two formulas for this calculation based on the following two categories –

  • Employees covered under the Act 

When an organisation employs at least 10 individuals in a single day in the preceding 12 months, it is covered under the Act.

The formula for calculation of gratuity in this case is –

Gratuity = (15 x last drawn salary [basic + DA] x number of completed years of service) / 26

Any year, where an employee works for more than 6 months, will be counted as a completed year of service. Contrarily, if he/she works for less than 6 months in a particular year, then that year is to be excluded from gratuity calculation.

For example –

If an employee has worked for 10 and 7 months, the completed years of service will be 11 years. On the other hand, if he/she has worked for 10 years and 3 months, the completed years of service will be 10 years only.

Consider the following example for gratuity calculation –

Mr Ganguly has worked with Wayne Iron & Steel for 30 years and 8 months, which becomes 31 years. His last drawn salary was Rs.85,000.

By putting these numbers into the formula – 

Gratuity = (15 x 85,000 x 31) / 26.

Therefore, gratuity = Rs.15,20,192.

  • Employees not covered under the Act 

Organisations that are not under the purview of the Payment of Gratuity Act 1972 can still pay gratuity to their employees.

In such a case, the formula is –

Gratuity = [15 x average salary for the last 10 months (basic + DA + commission) x number of years employed] x 30

Here, the number of years employed are only taken into account based on completion, unlike the former.

For example –

If an individual has been employed for 10 years and 7 months, it will be considered as 10 years only.

Consider the following example for gratuity calculation –

Mrs. Talwar has been employed with Initech Electronics for 26 years and 6 months, which is counted as 26 years. Her average salary in the last 10 months was Rs.65,425.

By putting these numbers into the formula – 

Gratuity = (15 x 65,425 x 26) / 30

Therefore, gratuity = Rs.8,50,525.

Employees can easily and quickly calculate their gratuity by using an online gratuity calculator. Those not covered under the Act only have to know their average salary for the last 10 months.

What are the Income Tax Implications on Gratuity?

As per the Gratuity Act, tax implications on gratuity is as follows –

Type Tax applicability 
Central/state government, defence, and local bodiesEntire amount received will not attract any tax.
Employees covered under the ActThe amount which is the least of the following is exempt from taxation:

  • Actual gratuity received
  • Rs.20 Lakh
  • (15 x last drawn salary x number of completed years of service) / 26
Employees not covered under the ActThe amount which is the least of the following is exempt from taxation:

  • Actual gratuity received
  • Rs.10 Lakh
  • (15 x average salary for the last 10 months x number of years employed) x 30

It should be noted here that the Rs.20 Lakh denotes the cumulative gratuity received from all employers in one year or different years.

For example –

Mr. Khan received a gratuity of Rs.15 Lakh after leaving his company. He then joined another organisation from where he earned a gratuity of Rs.10 Lakh after retirement.

Hence, the total gratuity that he received was Rs.25 Lakh. So, Mr. Khan will be liable for income tax on Rs.5 Lakh (Rs.25 Lakh – Rs.20 Lakh).

Gratuity paid to a widow or legal heir of an employee upon his demines in the line of duty will be exempt from taxation. Additionally, any gratuity paid as a form of ex-gratia payment to an employee or his legal heir or widow owing to an injury caused in the line of duty will also not attract any tax.

What are the Conditions for Termination of Gratuity? 

As per the Payment of Gratuity Act 1972 rules, an employee can be denied gratuity if he or she has been terminated for the following reasons –

  • Committing an offense involving moral turpitude.
  • Riotous or disorderly conduct or any other violent act.

It should be noted that an organisation cannot refuse payment of gratuity to an employee on account of bankruptcy. No court decree will be able to withhold this action.

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