What is Gratuity?

Understand what gratuity is and how to calculate it.
Gratuity
4 min
24-April-2024

Gratuity is the amount that an employer pays to the employees in recognition of their long service and contribution to the company. The payment is made in a lump sum, typically when the employee resigns after completing five years of service, retires, dies, or becomes disabled. Gratuity is governed by the Payment of Gratuity Act of 1972.

Also read: Gratuity calculation

Eligibility criteria

  • Must be eligible for the organisational pension programme or superannuation.
  • Completion of five years of continuous service with the same employer.
  • Death while in service (gratuity paid to nominee).
  • Permanent disability due to illness or accident (gratuity paid to employee).

Formula for calculating gratuity

The calculation can be done using the following formula:
(N * B * 15) / 26
Where:
N = Number of years served in the company
B = Last withdrawn basic salary + Dearness Allowance (DA), if applicable
Also readInvest gratuity funds in FD

How to calculate gratuity

Let us understand how to calculate gratuity. Assume an employee has worked with a company for 25 years and earned a basic salary + dearness allowance of Rs. 40,000 per month. The amount earned will be as follows:

Gratuity = 25 x 40,000 x 15/26

= Rs. 5,76,923

Points to note: It is important to note two key points:

  • According to the Gratuity Act, the gratuity sum cannot be more than Rs. 20 lakh. If it does, it will be regarded as ‘ex gratia’.
  • The number of months you worked in the last year will be rounded to the nearest figure. For instance, if your service tenure is 15 years and 8 months, you will receive a gratuity for 16 years. Conversely, if the tenure is 15 years and 5 months, you will receive a gratuity for 15 years.

Calculation of gratuity for employees who are not covered under the Gratuity Act

If an employer is not covered under the Gratuity Act, they must pay gratuity. For this, the calculation is based on their half-month salary for every year that has been completed. The salary includes basic salary, dearness allowance, and commission (sales-based).

The following formula is considered for employees of an employer who is not covered under the Act:

Eligible Amount = (15 * Last drawn salary amount * period of service) / 30

For instance, if you have worked in a company for 10 years and 8 months and your salary is Rs. 50,000, the calculation will be as follows:

Eligible Amount: (15 * 50,000 * 11) / 30 = Rs. 2.75 lakh

The employee's tenure is considered as one year for calculation purposes. If the number of months worked in the most recent year is less than six months, the previous total for completed years is taken into account.

However, the year is regarded as a full year for calculation purposes if the number of months completed in the most recent year of service is more than six months.

Calculation of gratuity in case of death of an employee

In case of an employee’s demise, the eligible amount is calculated based on the tenure of service of the employee. However, the amount is subject to a maximum of Rs. 20 lakhs The table below shows the rates at which the amount would be payable in case of an employee’s death:

Tenure of service

Eligible amount payable

20 years or more

Half of the basic salary for every six-month duration completed.

This, however, is subject to a maximum of 33 times the basic salary.

11 years or more but under 20 years

20 * the basic salary

5 years or more but under 11 years

12 * the basic salary

1 year or more but under 5 years

6 * the basic salary

Less than 1 year

2 * the basic salary


How is gratuity taxed?

The taxation procedure depends on the employee receiving the eligible amount. The standard cases for the calculation of gratuity taxable are as follows:

  • Government employee receiving the amount: In case an employee under the central government, state government, or local authority earns gratuity, the amount is fully tax exempt.
  • Any other salaried employee receiving the amount from an employer who is covered under the Payment of Gratuity Act: For employees receiving the eligible amount from an employer who is covered under the Gratuity Act, 15 days of salary is exempt from tax as per the last drawn salary of the employee.
  • Any other salaried employee receiving the eligible amount from an employer who is not covered under the Payment of Gratuity Act: In this case, the least of the following amounts is exempt from tax.
  • Rs. 20 lakh
  • Eligible amount actually received by the employee

Gratuity rules

  • To qualify, an employee must have completed at least five years of continuous service with the company.
  • Any company with a workforce of 10 or more employees must pay the amount, even if the employee count falls below 10.
  • In case of an employee's demise, the eligible amount is paid to the legal heir or nominee and is exempt from taxation. Employees who suffer from disablement due to an illness or accident are still entitled to gratuity.
  • An employer remains obligated to pay gratuity even amid bankruptcy. However, in the case of a job termination resulting from misconduct, theft, fraud, or assault, the employee loses the right to claim the amount from the company.
  • The eligible amount is typically based on basic salary + DA. After 5 years of service, every 6 months counts as a year. For instance, 8.6 years would round up to 9 years, while 8.4 years would round down to 8 years.

Conclusion

The gratuity benefit is provided to employees for providing their services to a company for 5 years or more. It is the right of every employee and cannot be denied as long as they fall under the eligible criteria. It is a safe and secure way to create a corpus, and you can invest the surplus amount for your future.

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Frequently asked questions

What is a gratuity in salary?

Gratuity in salary is the amount paid by an employer to their employee in return for the services provided to the company. Gratuity applies only to those employees who have worked with the company for five or more years. It is covered under the Payment of Gratuity Act of 1972.

Will I get gratuity for 4.8 years?

Gratuity is typically extended to employees who have completed at least 5 years of service in the same company. However, the Gratuity Act has a provision that enables employees to avail of gratuity even if their tenure is 4.8 years or less.

Is gratuity tax free?

Gratuity claimed by government employees is completely tax-free. However, gratuity for non-government employees is only partly exempt from income tax.

Disclaimer

As regards deposit taking activity of Bajaj Finance Ltd (BFL), the viewers may refer to the advertisement in the Indian Express (Mumbai Edition) and Loksatta (Pune Edition) furnished in the application form for soliciting public deposits or refer https://www.bajajfinserv.in/fixed-deposit-archives
The company is having a valid Certificate of Registration dated March 5, 1998 issued by the Reserve Bank of India under section 45 IA of the Reserve Bank of India Act, 1934. However, the RBI does not accept any responsibility or guarantee about the present position as to the financial soundness of the company or for the correctness of any of the statements or representations made or opinions expressed by the company and for repayment of deposits/discharge of the liabilities by the company.

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