Gratuity In Salary: Formula, Calculation, Taxability and Rules
What is Gratuity in Salary – Under the payment of the Gratuity Act 1972, gratuity can be defined as a monetary benefit that the employer designates to the employees. However, before 1972, it was not law binding for the employers to pay gratuity to their employees. The employer disburses the amount to his employees at the time of retirement. This amount can be stated as a benefit plan where the employee makes no contributions. Gratuity in salary can also be considered a token of appreciation or thank you to an employee for rendering incessant service to the organisation.
How Does a Gratuity in Salary Work?
An employer could consider paying their employees the gratuity amount either from their account or avail themselves of the option of a general gratuity insurance plan with a service provider. Then the company is entitled to pay an annual contribution to the opted service provider. In return, the insurance company must adhere to the policy rules and regulations while paying the gratuity amount to the employee.
Formula for Calculating Gratuity in Salary
Gratuity is calculated using the last drawn salary (Plus DA) and working tenure. Following the 1972 Payment of Gratuity Act, gratuity must not be greater than 20 Lakhs.
Gratuity = B* N*15/26 or 30 where,
- N denotes the number of years of service in a company
- B denotes the last drawn basic salary plus DA
How is Gratuity in Salary Calculated?
The Payment of Gratuity Act 1972 has further bifurcated non-government employees into the following categories:
- Case 1: Employees covered under the act
Gratuity calculation formula: (15 * last drawn salary * tenure of working / 26) - Case 2: Employees not covered under the act
Gratuity calculation formula: (15* last drawn salary * tenure of working / 30)
Gratuity Calculation in Case of Death of an Employee
In case of a fatal event with an employee, such as death, the benefits of gratuity are calculated per the tenure of employee service.
| Years of service | Gratuity Amount |
| <1 year | 2 * basic salary |
| >= 1 year but <5 years | 6 * basic salary |
| >=5 years but < 11 years | 12 * basic salary |
| >=11 years but < 20 years | 20 * basic salary |
| >=20 years or more | For each completed six-month term, you will be paid half of your base wage. But is limited to a maximum of 33 times the base pay. |
Few Significant Points About Gratuity in Salary
Mentioning a few instances where the employee will be eligible to receive gratuity are as follows:
- Firstly, an employee resigns after the completion of five years of service within the same organisation or single employer;
- Secondly, an employee should qualify for superannuation;
- Thirdly an employee suffers some sort of disability either due to illness or accident, and worst-case passes away
- Another noteworthy aspect related to gratuity in salary is that the employer has the right to reject payment of gratuity to the employee owing to any misbehaviour or misconduct.
- Lastly, in case of an employee’s demise, the gratuity amount is paid to either the nominee or the heir of the employee.
Taxability on Gratuity
According to the 1961 Income Tax Act, if an employee receives gratuity during his tenure, then it is fully taxable as income in his hands. On the other hand, if gratuity is received in case of an employee’s resignation or death and some other cases, then tax exemption is applicable under section 10(10) of the Act.
As prescribed in the 1972 Payment of Gratuity Act, certain organisations are entitled to gratuity, viz.
- Factory, mine, plantation, port, oilfield, and the railway company
- Shops, educational institutions, or establishments having ten employees or more on any day while the preceding twelve months
The taxation process for gratuity completely depends upon the employee who is about to receive the gratuity amount. Keeping this in mind, a few standard cases have been outlined for the calculation of tax on gratuity.
Case 1: Government Employee Getting Gratuity Amount
If any employee under the state government, central government, or local authority is eligible to receive the gratuity amount, then the entire amount is exempted from Income Tax.
Case 2: An Employee Receiving Gratuity Amount from an Employer who is Covered by Payment of Gratuity Act
The following exemptions are considered in this scenario, where the employer is covered under the Gratuity Act.
- 15 days salary as per the last drawn salary of the individual
Case 3: An Employee Receiving Gratuity Amount from an Employer who is not covered by the Payment of Gratuity Act
In the case above, the least of the following three amounts, viz.
- Rs.10 lakh (or)
- Gratuity received by employee actually (or)
- Half a month’s salary for each service year that the employee has finished with the employer,
is exempted from tax.
Tax Exemption on Gratuity
Under the section 10(10) of the Act following limits are applicable:
Case 1: Employees falling under the Payment of Gratuity Act, 1972
Tax exemption on gratuity will be done in case of any death and retirement to the extent of least of the following:
- INR 20,00,000
- Gratuity amount received
- Either salary (**) of 15 days for every completed year of service or part thereof in excess of 6 months based on last drawn salary.
The formula for the same is given below:
Basic Salary (Plus DA) last drawn *15/26 * Working Tenure
Case 2: Employees not falling under the Payment of Gratuity Act, 1972
The limit for tax exemption for such employees is the least of the following:
- 20,00,000
- Gratuity amount received
- The formula: 1/2 * (Salary drawn in the last ten months)/10 Working Tenure
(Note: Kindly ignore the months in a fraction)
Gratuity Rules
1. Gratuity Forfeiture
As per the 1972 Payment of Gratuity Act, an employer can forfeit the employee’s gratuity payment, either partially or wholly, despite completing five or more service years in a company. However, this applies only when the employee has been terminated due to delinquency or wrongdoing wherein they try to harm other individuals during their employment physically.
2. Timeline for Gratuity payment
The timeline for gratuity payment comprises three steps which include:
- Initiation: The employee must send an application to the employer regarding the gratuity he/she owns with the company.
- Acknowledgement and calculation: The company owing the gratuity will estimate the amount on receiving the application. It also provides a notice to the employee and the controlling authority mentioning the amount.
- Disbursal: After the acknowledgement is sent within 30 days, the employee must pay the gratuity amount.
3. Latest Advancements regarding Gratuity
One comforting aspect for employees in the private sector is that the ceiling has increased from Rs.10 lakh to Rs.20 lakh for gratuity tax-free. Post the 7th Pay Commission implementation. The same was done for the central government employees.
Considering the COVID-19 outbreak across the nation, which upended the lives of many, the Union Government has suggested numerous security measures for workforce safety. In addition, it has been announced that the government plans to offer the payment of gratuity after one year of service, which applies to a firm’s fixed-term employees.
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Final Word
Gratuity is a monetary benefit paid to the employee by an employer. A closer look at the concepts of gratuity and taxation rules helps employees better understand the eligibility criteria and other areas of concern.
FAQs
Ans: No, an employee is not eligible to get gratuity earlier than five years of service. The employee must complete five consecutive years in the company without any gaps. The employee has to qualify the prerequisites mentioned in the article above to claim for gratuity following the end of his employment term with the organisation.
Ans: The employee provident fund comprises contributions from both employer and employee. It is not the case with gratuity, where the employer pays the entire amount.
As per the Payment of Gratuity Act, 1972, a specific percentage of the salary is calculated, which is then deposited in a gratuity account payable later.
Ans: According to the amendments made in the 7th Pay commission, the upper limit for gratuity is now up to 20 lakhs for a government employee. In contrast, for non-government employees, the gratuity limit is Rs. 10 lakhs.
