Gratuity – Meaning, Gratuity Act, Eligibility, Calculation & Taxation Rules

Gratuity is a benefit which is payable under the Payment of Gratuity Act, 1972. It is a financial component offered by the employer to an employee in recognition of his or her services rendered to the organisation.

The employer may either pay their employees the gratuity amount from their own account or may opt for a general gratuity insurance plan with a service provider. The company then pays an annual contribution to the service provider, and in return, the insurance company can pay the gratuity amount to the employee, by following the policy rules and regulations.

The gratuity amount is totally paid by the employer without any contribution from the employee.

The Payment of Gratuity Act came into force in 1972. The act covers all employees working in mines, companies, ports, plantations, and other such organisations that have more than 10 employees. Unlike the provident fund, the gratuity amount is fully paid by the employer without any contribution from the employee. 

About Payment of Gratuity Act 1972
Gratuity Act	For government and non-government employees
Minimum years of service	5 years
Minimum number of employees	10
Gratuity payable	After Retirement / Resignation/ Death
Tax exemption on gratuity	Rs. 20 lakh
Last drawn salary means	Basic Salary, Dearness Allowance, and Commission received on Sales

Gratuity Rules

1. Forfeiture of Gratuity – An employer has the right to forfeit the gratuity payment, either partially or completely, even if the employee has completed 5 years of service. But this situation can only work if the employee has been terminated because of misconduct.

2. Timeline for Payment of Gratuity- The 3 important points regarding payment of gratuity are given below:

• Initiation: The employee has to send an application to the employer regarding the gratuity amount to be received from the organisation.
• Calculation and Acknowledgement: Once the employer receives the application, the company calculates the amount of gratuity that is payable and sends an acknowledgement to the concerned employee and the controlling authority, mentioning the specific amount.
• Disbursal: The employer has a period of 30 days to pay the gratuity amount after sending the acknowledgement.

You are eligible for gratuity only if you fulfil any of the following eligibility criteria:

• You should be eligible for superannuation (meaning attainment of the maximum age of service as fixed by the organisation)
• You should have retired from service
• You should have resigned after continuous employment of 5 years with the organisation
• Upon your death or disablement, the amount is paid to the nominee

The gratuity amount depends on the number of service years in the same company and the last drawn salary. The formula for calculating gratuity is-

Gratuity= n x b x 15 / 26

Here,

n= The service tenure completed by an individual in a company

b= Last drawn basic salary + dearness allowance by an individual

No set percentage is provided by law for calculating the actual gratuity amount that an employee gets after retirement or resignation. 

Important Points To Note:

• According to the Gratuity Act, the gratuity amount can never be more than Rs. 20 lakh. Any excess amount is known as ex gratia
• If the last remaining months in the last year of one’s employment are more than 6 months, then it is rounded up to the next number. For example, if your service tenure is 15 years 8 months, then you would get the gratuity based on 16 years.

To calculate how much gratuity is payable, the Payment of Gratuity Act has divided non-government employees into two categories-

1. Employees covered under this act

For employees who are covered under the act, the gratuity amount is calculated using the following formula-

15 x last drawn salary x tenure of working / 26

Let’s understand this with the help of an example:

For example, the last drawn salary (Basic + DA) of A is Rs. 50,000 per month and his employment with ABC company was for 26 years. In this case, the gratuity will be: Gratuity Amount= 15 x last drawn salary x tenure of working / 26 Gratuity Amount of A= (15 x 50,000 x 26) / 26= Rs. 7. 5 lakh

2. Employees who are not covered under this act

For employees who are not covered under the act, the gratuity amount is calculated using the following formula-

15 x last drawn salary x tenure of working / 30

Let’s understand this with the help of an example:

For example, B is working with a firm that does not come under the Payment of Gratuity Act but the basic salary that he drew was Rs. 40,000 per month, and he has been in the company for 25 years. In this case, the gratuity will be: Gratuity Amount= 15 x last drawn salary x tenure of working / 30 Gratuity Amount of A= (15 x 40,000 x 25) / 30= Rs. 5 lakh

In case of the demise of an employee, the gratuity amount is calculated based on the terms of service of that employee. However, the amount is subject to a maximum of Rs. 20 lakh. Given below is the tabular description of the rates at which gratuity will be paid to the beneficiary or the family member in case of the death of an employee. 

Term of Service	Amount Payable Towards Gratuity
Less than 1 year	2 x Basic Salary
1 year or more but less than 5 years	6 x Basic Salary
5 years or more but less than 11 years	12 x Basic Salary
11 years or more but less than 20 years	20 x Basic Salary
20 years or more	Half of the Basic Salary for each completed 6-month period. However, it is subject to a maximum of 33 times of Basic Salary

The tax levied on gratuity amount depends on the type of employee who has to receive the gratuity-

• The amount of gratuity received by any government employee (whether central / state / local authority) is exempted from income tax
• For any other eligible private sector employee whose employer is covered under the Payment of Gratuity Act, the least of the following three amounts will be exempted from income tax:

1. Rs. 20 lakh
2. The actual amount of gratuity received
3. The eligible gratuity

I am a contract employee in a company. Will I get gratuity if I resign or retire after 5 years?

If you are on the company roll and are considered an employee of the company, then you will receive gratuity. However, if you are under a contract that is separate from the company, then the gratuity should come from the contractor and not the company.

How many days will it take for the employer to remit the gratuity amount?

Usually, gratuity is released along with or just before/after your full and final settlement is done. The government mandates that employers pay the amount within 30 days. If there is any delay in payment, the employer has to pay simple interest on the amount from the due date until the date when the payment is made.

Is the notice period considered for gratuity?

Gratuity is calculated from the day you have joined an organisation till the last working day, including your notice period, as you get salary for that time as well.

Can I get gratuity if I resign?

As per the Gratuity Act, gratuity is payable only after the completion of 5 years of your service. If you resign before 5 years of service, then you are not eligible to get gratuity.