What is Gratuity? Meaning, Eligibility & Calculation in India

The dictionary meaning of the term ‘ gratuity’ is a sum of money given voluntarily as a token of appreciation or goodwill for services rendered.Basically, it is extra money given above regular dues and the amount of gratuity is at the discretion of the giver. It depends on multiple factors such as the quality of service received, industry norms, and personal preference. What is gratuity under employment rules? Here, it is an amount that a company pays employees when they leave the organisation as a token of appreciation for their services.Gratuity payment is a component of one’s gross salary. It is not a regular payment; but a lump sum amount paid when the employee leaves. The gratuity in salary is calculated using an employee's basic salary and varies, depending on a company's policies and duration of service.

The Payment of Gratuity Act, 1972 governs the gratuity that is payable to employees who work in factories, oilfields, mines, ports, railway companies, plantations, shops or other establishments.An establishment should have at least 10 or more employees on any given day during a timeframe of 12 months if it is to be regulated by the Act. Even if the number of employees becomes less, gratuity is still going to have to be paid by the company.As per the Act, to be entitled to gratuity an employee must have worked with the employer for a minimum of five years with no gaps. So, if the employee quits before five years, gratuity is not paid.
However, as per current gratuity rules, an employee is eligible for gratuity on completion of 240 days of service in the fifth year of employment. The tenure is treated as five years.The five-year rule targets to inspire employees to work for a longer period with the company, which is good for the employer and the employee. The rule ensures employees who contribute significantly to the company's growth are recognised and rewarded.The five-year rule is not applicable in case of an employee's death or disability and the employee's nominee receives gratuity.The nominee can be a family member, or any other person nominated by the employee.
Interns and contractual workers are not eligible for gratuity. That is because they are not permanent employees of the company, and their employment is typically for a fixed duration or a project.Also read: Are You Eligible for Gratutity With Less Than 5 Years Spent in A Company?

Employers have the option to pay the gratuity amount from their own funds, or they can opt for group gratuity insurance coverage. The second option is a widespread practice, especially for larger organisations, where the gratuity payment is a considerable expense.In a gratuity insurance plan, the company pays annual contributions to an insurance company, which invests the contribution amounts in various instruments. The returns generated are used to fund the gratuity amount payable to the employees.

Gratuity in salary

In the beginning, we touched upon gratuity as a salary component; the question is, ‘ What is gratuity in salary?’ Gratuity meaning in salary, is this: it is part of the employer's salary obligation towards employees and is considered as a form of appreciation for services provided.The employer is governed by the rules and regulations of the Gratuity Act while paying gratuity to employees. The Act specifies the eligibility criteria, the calculation of gratuity in salarypayable, along with the payment terms. Employers regulated by the Act must abide by these guidelines when they calculate and pay the gratuityamount to the employee. Contribution to gratuity is made entirely by the employer.When a company opts for a general gratuity insurance plan with a service provider, employers can manage the payment process easily, while employees gain security and are guaranteed of gratuity payment when they leave the firm.Also Read: Know Your Gratuity – When and How Much? Eligibility criteria for gratuity The eligibility criteria for an employee to receive the gratuity amount from an employer are:

• The employee should have completed at least five years of service with a single employer before resigning
• The employee must be eligible for superannuation
• The employee should have retired from work
• The employee should have suffered a disability or passed away due to an accident or illness

It is important for both employers and employees to understand the eligibility criteria and the gratuity amount calculation, as it is a significant retirement benefit. The Payment of Gratuity Act 1972 does not state a fixed percentage to be paid to employees. The Gratuity formula is used to calculate the gratuity amount to be paid to employees.Calculation of gratuity falls under two categories namely, employees covered under the Gratuity Act and those who are not. To calculate the gratuity payable to an employee, the employee's last drawn salary and the number of years of service completed are required. Gratuity payable will be 15 days wages per year, calculated based on the last drawn salary.

- Calculation of Gratuity for employees covered under the Gratuity Act

For employees covered by the Act, the gratuity calculation formula is:Last drawn salary/ 26 x 15 x Number of years of serviceLast drawn salary implies - the basic salary of the employee plus dearness allowance. The average of the basic salary drawn by the employee for the past ten months is considered for computing the gratuity amount.
Here 26 refers to 30 days in a month minus four Sundays.For employees covered by the Act, rounding off ‘the number of years’ in the gratuity formula is done as follows: six months and more is moved to one year, but not below six months.Let us consider two scenarios here:One, where an employee worked with a company for eight years and six months. Here the number of years for gratuity calculation becomes nine.Two, when an employee worked for eight years and four months. Now, the number of years has become eight.Let us consider this, if an employee's last drawn salary (basic plus dearness allowance) is ₹25,000 and the years of service completed is 10, then the gratuity amount will be 25,000/26 x 15 x 10 = ₹1,44,230.

- Calculation of Gratuity for the Employees not Covered under the Gratuity Act

For employees not falling under the cover of the Gratuity Act , the formula to calculate gratuityis: Last drawn salary/30 x 15 x Number of years of serviceHere the number of days that the employee worked in a month is considered as 30. The difference for employees not governed under the act is that the employee is paid for the actual number of years of completed service.

In case of an unforeseen death of an employee, the gratuity amount goes to their rightful nominee. It is calculated based on the employee’s tenure and has a maximum limit of ₹20 lakh. The following table gives the gratuity amount payable by the employer in case of an employee’s demise.

Using existing tools to calculate gratuity can be very useful, take for example, Adity Birla Capital’s Gratuity Calculator available here . There are quite a few advantages this helpful tool can provide, aside from the most basic fact that it helps users accurately calculate gratuity in seconds. All you need to do is enter your current monthly salary (Basic + DA) and the number of years you have been employed with the company. Hit enter and you will have your answer.The tool helps you avoid any potential errors that could come up in manual calculations and always gets you the right amount. It’s fast, it’s easy and extremely simple to use. It doesn’t cost a thing to use this tool either.

The employer has room to give the employee a higher gratuity than that calculated by the formula. Initially, the Gratuity Act stipulated that the tax-free gratuity amount cannot exceed ₹ 10 lakh.
That was amended as per the recommendation of the Seventh Pay Commission and increased to ₹20 lakh for the entire working life for employees covered under the Payment of Gratuity Act.In the interim budget of 2019, the finance minister announced an increase in the tax-free Gratuity limit to ₹ 30 lakh.

The salary "exclusive of tax and gratuity" indicates the standalone salary amount and does not include taxes or gratuity.Here, tax refers to the income tax employees pay on their earnings, and gratuity is the amount employers give as appreciation. Taxes or gratuities are calculated separately and may be deducted from the salary.

The taxation rules on gratuity vary for different types of employees. For government employees, the gratuity amount is entirely exempt from income tax. However, for private sector employees covered under the Gratuity Act , a limit is set for tax exemption on the gratuity amount.The actual amount received by the employee and that calculated using the above formula are considered for tax exemption. The lower of the two values is applicable for tax exemption.Consider this example, let us suppose an employee received a gratuity of ₹9 lakh. But let’s assume the gratuity calculated according to the formula is just ₹7 lakh. In this case, the tax exemption becomes applicable for ₹7 lakh. The balance amount, which is ₹2 lakh, will be taxable as per the existing income tax slabs.It is advisable to consider consult a tax expert. That way you will have all the relevant and the most accurate information regarding taxation of your gratuity.

Gratuity nomination is an essential aspect of India's Payment of Gratuity Act 1972 . As per the Act, if an employee completes one year of service in an organisation, they must file a nomination for gratuity payment in the unfortunate event of their demise. That is done by filling out and submitting a Gratuity Form . It ensures that the payment is received by the rightful person after the death of the employee.The employee must fill and submit nominee details in Form F. They are allowed to appoint more than one nominee.It is important to give the required information accurately and verify for any errors or discrepancies. This will avoid complications at the time of payment.In case of any changes in the information or nomination, the employee can give written notice to the employer and fill out Form H.In the absence of a nominee, the gratuity amount will be paid to the legal heir of the employee. Therefore, it is essential to nominate a beneficiary to avoid legal hassles in future.Reviewing the nomination details periodically and making changes, if required, is also advisable. That will ensure the payment goes to the intended beneficiary.

The gratuity amount is payable to employees when they leave a firm, be it due to retirement, resignation, or layoff. The payout process comprises three steps:

• The employee or any authorised person should apply to the employer concerned about the gratuity
• As a next step, the firm must compute the sum and inform the governing authority and the employee of the calculated amount
• The company has 30 days to pay gratuity to the recipient

If an employer is unable to pay the gratuity amount within the allotted time, then the beneficiary can get a simple interest on the amount.The gratuity amount should be paid only in cash. The payment can be made via Demand Draft (DD) or Cheque only when the employee, nominee, or legal heir specifically requests.

It is possible that your gratuity amount is not given within the timeframe of 30-days. What should you do if then? You must file a written complaint with the Controlling Authority.The Indian Penal Code considers non-payment of gratuity as an punishable offence. The employer can be imprisoned for three months or more and/or must pay a fine of ₹10,000-20,000.

The amount of gratuity paid to an employee depends on number of years of their service and the taxation rules that differs for government employees and private sector employees.This benefit that rewards employees for their services is typically paid for during retirement or when certain other conditions are met. These other conditions include resignation, layoffs, disability, or demise. However, it calls for a minimum of five years of service to the employer.In case of the employee's demise, their nominee or dependent is entitled to receive the gratuity amount.Under the tax rules, this payment falls under the head of "income from other sources" for the receiver.

Yes, an employer can reject to pay gratuity to an employee if they were asked to leave their job because of any kind of misconduct like violent behaviour within the premises of the company, or any illegal activity.
In such cases, the employer is within their rights to forfeit the entire gratuity amount or partial amount to the scope of damage/loss sustained. Decoding the Eligibility Criteria for Gratuity: Analysing Section 4(2) of the Payment of Gratuity Act The Payment of Gratuity Act 1972 states that to be eligible for gratuity benefits employees must have served a firm for five complete years.According to Section 4(2) of the Payment of Gratuity Act, more than six months of service becomes one year for calculation of gratuity.Using this, when an employee has worked with a firm for more than four years and six months, the number of years of service becomes five complete years to determine eligibility for gratuity.

In summary, gratuity is a financial benefit employers give to their employees in appreciation of their service on meeting some eligibility criteria.It is a significant terminal benefit provided by the employer to foster employee stability, commitment, and loyalty during their tenure.This token of appreciation acknowledges an employee's service, providing a lump sum payment that serves as both retirement savings and social security.It is solely the employer's cost and cannot be included in the employee's CTC (Cost to Company).