Gratuity: Meaning, Calculation, Applicability and Taxation

In this comprehensive guide, we will provide you with a fundamental understanding of gratuity, covering its meaning, applicability, calculation, taxation rules, penalties, forfeiture, and common FAQs.

Meaning of Gratuity

• Gratuity is the amount paid by an employer to the employee for the services rendered by him/her during the period of employment.
• Gratuity is mandatory under Payment of Gratuity Act,1972.
• This is given to employees on there superannuation, retirement or resignation and death or disablement.

Applicability of Gratuity

• Gratuity is only applicable to employees who have completed continuous service of five years. Continuous service means it should be an uninterrupted service.
• Gratuity is only applicable to companies which has 10 or more employees on one day in previous 12 months. The applicability of gratuity will remain even if subsequently the number of employees fall below ten.
• Gratuity is fully paid by the employer. No part of the gratuity comes from an employee’s salary.

Calculation of gratuity

• The Gratuity amount is 15 days of salary for each year of service years (rounded years), where daily salary is calculated considering 26 days in a month.
• Gratuity=(Monthly basic salary*15*completed years of service)/26
• According to this formula, the time period of over six months or more is considered as one year
• Monthly basic salary is the addition of basic pay and dearness allowance.
• As per the new rules proposed of gratuity, organizations must ensure that 50% of employees’ CTC (cost to company) is basic pay and the remaining 50% comprises employee allowances, house rent, and overtime. This is a proposed rule and not implemented yet.

Payment of Gratuity

• The gratuity payable under the Act shall be paid in cash or in Demand Draft or bank cheque to the eligible employee, nominee or legal heir.
• Companies have two options which is funded gratuity or unfunded gratuity. Funded gratuity is also known as Approved Gratuity Trust.

Taxation rules of Gratuity

• The gratuity received by all the government employees, employees of municipalities and defense forces is fully exempt without any upper monetary limit.
• For other employees the gratuity to the extent of minimum payable under the Payment of Gratuity Act, 1972 is tax-free.
• In absolute terms, gratuity received in aggregate upto 20 lakhs is exempt during your lifetime and gratuity received beyond the limits becomes taxable for other category of employee.
• For calculating gratuity exemption, only the basic salary and dearness allowance is to be considered.

Penalties

• For non-payment of gratuity, there is a sentence of minimum 6 months and it can go up to 2 years.
• For making false statement or false representation to avoid payment of gratuity, there could be a six-month imprisonment or fine up to 10000 rupees and in some cases both.

Forfeiture

• Gratuity shall be partially paid or not paid in case of termination of service of member. This could happen if the person has done any act of violence.
• In case the person has done any damage or destruction of property belonging to employer his/her gratuity upto the amount of the damage shall be forfeited.

FAQs

Q.1 What is the maximum gratuity payable to employee?

Ans. The maximum gratuity amount payable to an employee is 20 lakhs.

Q.2 If the employee died during 1^st to 4^th year before completion of 5^th year, then what would be the benefit for employee’s nominee?

Ans. The employee’s nominee will get the gratuity payment from the Employer.

Q.3 If the employee resigned during 1^st to 4^th year before completion of 5^th year, then what would be the benefit for employee?

Ans. The employee will not get any Gratuity Payment from the Employer.

Q.4 Example of gratuity calculation.

Ans. For example, if you are in a company for 10 years and 10 months and your last drawn salary is 50,000 then the  calculation of the gratuity amount done is as follows:-

Gratuity amount:- (15*50000*11)/26 = 3,17,308

Q.5 In case an employee worked in a ABC company for 3 years, then switched the company and then came back and worked for 3 years again. So would this employee be subject to payment of gratuity?

Ans. As this employee didn’t do a continuous service of five years, so we can say that he/she is not eligible for gratuity payment.