Gratuity: Eligibility Criteria, Income Tax Exemption Limit & Calculation

‘Gratuity’ in simple term is a reward given by the employer to his employee at the time of his retirement / resignation / termination / death.

Present article contains the answer to the basic gratuity related questions like what is the eligibility criteria of gratuity, what is the gratuity calculation formula and what is the gratuity exemption limit under the income tax.

A. What Is the Eligibility Criteria of Gratuity?

In order to understand the eligibility criteria of gratuity, it is important to first understand the applicability of the Payment of Gratuity Act, 1972.

The Payment of Gratuity Act, 1972 applies to the following –

• All the factories, oilfield, mine, railway, port and plantation;
• Shop or establishment in which 10 or more person are employed on any day during the preceding 12 months;
• Any other establishment or class of establishment in which 10 or more employees are employed on any day during the preceding 12 months, as notified by the central government.

It is important to note here that once the provisions of the Payment of Gratuity Act applies to the establishment i.e. 10 or more number of employees are employed, it will continue to apply even if the number of employees falls below 10.

Now if the establishment is covered within the Payment of Gratuity Act, then, the employee of such establishment are eligible for gratuity only after the employee has rendered a continuous service of not less than 5 years. However, the completion of continuous service is not necessary in case of termination of employment on account of death / disablement of the employee.

Gratuity shall be payable to the employee on termination of his employment and such termination can be on account of superannuation of the employee or on his retirement / resignation or on his death / disablement due to accident or disease.

However, it is important to be mentioned here that, even if the establishment is not covered within the above mentioned criteria of the Payment of Gratuity Act, 1972, the employer on his own accord can pay gratuity and there is no restriction on the employer for such payment.

Concluding thereby that if the establishment is covered within the scope of the Payment of Gratuity Act, 1972, then, the employee would be eligible for gratuity if he has rendered service for a continuous period of not less than 5 year, however, if the establishment is not covered within the scope of the Payment of Gratuity Act, 1972, the employer can pay gratuity on his own accord.

B. What Is Gratuity Calculation Formula?

The Gratuity calculation formula is different for the employees who are covered under the Payment of Gratuity Act and for the employees who are not covered under the Payment of Gratuity Act. Let us understand both the formula –

a. Gratuity Calculation For Employees Who Are Covered Under The Payment Of Gratuity Act, 1972

Gratuity = Salary last drawn × Number of completed years of service × 15÷26

Salary last drawn = Basic salary + dearness allowance

Number of completed years of service = total number of years for which service provided (period above 6 months should be considered as 1 year)

15 days = Number of days employee has worked

26 days = Total number of working days in a month.

b. Gratuity Calculation For Employees Who Are Not Covered Under The Gratuity Act, 1972

Gratuity = Last 10 months average salary × Number of completed years of service × ½

C. What Is Gratuity Exemption Limit Under Income Tax?

Gratuity exemption limit is provided under section 10 (10) of the Income Tax Act, 1961. Below table provides the details of different exemption limit for gratuity which is being received by different categories of employees –

The ceiling limit of gratuity amount has been increased from time to time based on the overall economic conditions, the employer’s capacity to pay and salary of the employees.

D. Recent Changes in maximum exemption limit of gratuity

Below table points out the change in maximum exemption limit of gratuity for the employees who are covered under the Payment of Gratuity Act, 1972 and the employees who are not covered under the Payment of Gratuity Act, 1972 –