Gratuity is a monetary benefit paid out by the organization to its employees as a form of gratitude for the services rendered by them. It is payable based on a certain defined formula and guaranteed if basic conditions are met. In India, the rules pertaining to gratuity are governed under the Payment of Gratuity Act, 1972. It is offered by organizations with more than 10 employees and paid only to those who have completed 5 or more years of full-time service (minimum 240 days a year) with the organization.
Gratuity is one of the several retirement benefits offered to an employee when he or she leaves the job. However, it must be noted that retirement or resignation after 5+ years of employment with an organization is not the only instance where the employer makes the gratuity payment. The employer can pay this benefit earlier if the employee becomes disabled or passes away due to an accident or disease. In case of the employee’s demise, the benefits shall be handed to the nominee or legal heir. The condition stating the time limit of 5 years shall not be applicable for incidents like death or disablement.
For the purpose of calculating the gratuity payable, employees can be classified into those who are covered under the Payment of Gratuity Act, 1972 and those who are not.
Gratuity for employees covered under the Payment of Gratuity Act, 1972
To calculate the gratuity payable to employees covered under the Act, the formula applicable is (15 x salary last drawn x period of employment) divided by 26. The formula factors in the 15 days of last drawn salary for every year of service completed or part of thereof in excess of 6 months. The last drawn salary here can include basic salary, dearness allowance and commission on sales.
To understand this better, consider the following example: Mr. Raj’s last drawn basic pay is Rs. 50,000 per month and he has worked with ABC Ltd. for 20 years and 8 months. In this case, using the formula above, gratuity will be calculated as: (15 x 50,000 x 21)/26 = Rs. 6.05 lakhs.
Gratuity for employees who are not covered under the Payment of Gratuity Act, 1972
To calculate the gratuity payable to employees who are not covered under the Act, the formula applicable is (15 x salary last drawn x period of employment) divided by 30. There is no rule that states that an employer cannot pay gratuity to his or her employees, even if the organization is not covered by the Act. The amount that becomes payable is based on half month's salary for every completed year. The last drawn salary here can include basic salary, dearness allowance and commission on sales.
To understand this better, consider the following example: Mr. Rakesh is working for an organization that is not covered under the Act. His last drawn basic pay is Rs. 60,000 per month and he has worked with XYZ Ltd for 20 years and 9 months. In this case, using the formula above, gratuity will be calculated as: (15 X 60,000 X *20) /30 = Rs. 6 lakhs
The years of service is taken as per each completed year. Therefore, given that Mr. Rakesh worked with the organization for 20 years and 9 months, the tenure taken is 20, not 21.
According to the Government of India’s Pensioners' Portal, retirement gratuity is calculated at the rate of one-fourth of a month's basic pay plus dearness allowance drawn on retirement for every completed six-monthly period of service. The retirement gratuity that is payable for qualifying service of 33+ years is 16 times the basic pay plus DA, with a maximum of Rs. 20 lakhs.
In the event of the death of the employee, a one-time lump sum benefit is payable to the nominee or family member of the deceased. The death gratuity that gets paid out is as under:
| Qualifying Service | Rate |
|---|---|
| Less than a year | 2 times of basic pay |
| One year or more but less than 5 years | 6 times of basic pay |
| 5 years or more but less than 11 years | 12 times of basic pay | 11 years or more but less than 20 years | 20 times of basic pay |
| 20 years or more | Half of emoluments for every completed 6 monthly period of qualifying service subject to a maximum of 33 times of emoluments. |
Source: pensionersportal.gov.in/retire-benefit.asp
Note - The maximum amount of death gratuity payable is Rs. 20,00,000.
The gratuity that an employee receives is taxable under the ‘Income from salary’ head. Should the case be that gratuity is handed to the employee’s nominee or legal heir(s), the same shall be taxed in their hands under ‘Income from other sources’ head. The tax treatment differs depending on the category of individual assessees.
Calculations with regards to exemption of gratuity is covered under section 10(10) of the Income Tax Act, 1961. For the purpose of computing the amount that is exempt from tax, employees may be divided into 3 categories, namely government employees, non-government employees who are covered under the Payment of Gratuity Act, 1972, and non-government employees who are not covered under the Payment of Gratuity Act, 1972. The gratuity that is paid by the government to its employees is fully exempt from tax.
The maximum tax exemption that is allowed to non-government employees covered under the Payment of Gratuity Act, 1972, is least of following three:
Note - *7 days in case of employee of seasonal establishment.
Salary = Last drawn salary including DA but excluding any bonus, commission, HRA, overtime and any other allowance, benefits or perquisite.
The maximum tax exemption that is allowed to non-government employees not covered under the Payment of Gratuity Act, 1972 is least of following three:
Note - *Average salary = Average Salary of last 10 months immediately preceding the month of retirement. Salary = Basic Pay + DA (to the extent it forms part of retirement benefits) + turnover based commission.
Source: incometaxindia.gov.in/Documents/Left%20Menu/Income-from-salary.htm
When is gratuity payable?
Gratuity - one of the several retirement benefits offered to an employee - is payable when the individual leaves the job. It is offered by organizations to those employees who have completed 5 or more years of full-time service (minimum 240 days a year) with the organization. However, it must be noted that, retirement or resignation after 5 years is not the only instance where an organization makes the gratuity payment. The employer can pay this benefit if the employee becomes disabled or passes away due to an accident or ailment. In the event of the employee’s demise, the nominee stands to receive the benefits. The condition stating the time limit of 5 years shall not be applicable for incidents like death or disablement.
How is gratuity amount calculated for employee who are covered under the Payment of Gratuity Act, 1972?
The formula for calculating gratuity for employee who are covered under the Payment of Gratuity Act, 1972, is as follows: (15 x last drawn salary x tenure of working) divided by 26.
How is gratuity amount calculated for employee who are not covered under the Payment of Gratuity Act, 1972?
The formula for calculating gratuity for employee who are not covered under the Payment of Gratuity Act, 1972, is as follows: (15 x last drawn salary x tenure of working) divided by 30.
Is gratuity taxable in the hands of government employees?
No. The gratuity that is paid by the government to its employees is fully exempt from tax.
Is gratuity taxable in the hands of non-government employees?
Yes, gratuity is taxable in the hands of non-government employees. Tax exemption, however, can be claimed on it. The amount of exemption that can be availed will be determined by whether or not the employee is covered under the Payment of Gratuity Act.
How much is the tax exemption allowed to non-government employees covered under the Payment of Gratuity Act?
The maximum tax exemption that is allowed to non-government employees covered under the Payment of Gratuity Act, 1972 is least of following three:
Note - *7 days in case of employee of seasonal establishment.
** Salary = Last drawn salary including DA but excluding any bonus, commission, HRA, overtime and any other allowance, benefits or perquisite.
What is the tax exemption allowed to non-government employees not covered under the Payment of Gratuity Act?
The maximum tax exemption that is allowed to non-government employees not covered under the Payment of Gratuity Act, 1972 is least of following three:
Note - *Average salary = Average Salary of last 10 months immediately preceding the month of retirement. Salary = Basic Pay + DA (to the extent it forms part of retirement benefits) + turnover based commission.
