After 5 years of working in the company an employee becomes eligible for Gratuity. This article explains what is Gratuity? How many years of service is considered to be eligible for Gratuity? How is Gratuity amount calculated? What is tax and Tax exemption on Gratuity? Difference between Gratuity and Pension.
What is Gratuity?
Gratuity is a lump sum payment made by employer to the employee based on the duration of his total service when the employee leaves the job . The reason for leaving the job can be either by resignation, death, retirement or termination, etc. The amount you get as gratuity depends on the number of years you have served and the last drawn monthly salary. Roughly, you get half a month’s Basic and Dearness Allowance(DA) for every completed year of service.
How many years of service is considered to be eligible for Gratuity?
Gratuity is payable only if an employee has been with the employer for five years or more. But this rule is waived if an employee dies or is disabled. In such cases, even if the tenure is less than 5 years gratuity is paid to the nominees or to the employee. After 5 years of service if you serve more than six months in the last year of employment, it is considered as a full year of service for calculation of gratuity amount. As per the judgement of the Supreme Court an employee is eligible for gratuity if he has completed 4 years of continuous service and 240 days continuous working in 5th year. (Ref lawyersclubIndia ). Since the gratuity is a statutory service condition,the Act provides for the punishment of the employer who fails to pay it to an employee.
To calculate number of years of employment, employee’s date of joining and date of leaving is considered and date of resignation is not taken into consideration.
Probation period is included while calculating eligibility for gratuity.
If you have worked for MNC and join the parent company as permanent employee in foreign location, you will no longer be employee of company registered in India and hence if you have completed 5 years in India office you will be eligible for gratuity.
If the company changes its name but management remains the same , there is no resignation from one company and joining of new company then years in both the companies will be counted.
When will the employee not get Gratuity even after completing minimum 5 years of service? The employer can forfeit gratuity even if employee has completed 5 years when the employee is fired for Disorderly or riotous conduct or any other act of violence or moral offence during the course of his employment. A proper enquiry should be held and employee should have been found guilty and termination letter should mention that. Other than that even on being fired an employee is eligible for Gratuity.
How is Gratuity amount calculated?
Formula to calculate gratuity amount for a government employee/non government employee covered under the act is given below. Your employer can choose to pay you more but the maximum amount of gratuity according to the Act cannot exceed Rs. 10 lakh. Amount paid more than the formula is something voluntary and not mandated according to law(called ex-gratia)
Gratuity amount = (Number of years of service rounded off) * (Last drawn monthly Basic and DA) *15/26.
Ex: if an employee has served 20 years and in last year he drew monthly Basic and DA of Rs. 40,000 , he would get gratuity of Rs. 4,61,538 calculated as (20 * 40,000 *15/26). As mentioned earlier, If employee have served more than 5 years and in last year of employment he served more than 6 months then for gratuity calculation it is considered as a full year of service. For instance, if his tenure is 20 years and 7 months, the years of service for gratuity calculation will be rounded off to 21. But if he has served 20 years and 5 or 6 months, then the number of years of service will be considered as 20.
For an employee not covered under the Gratuity Act
Gratuity amount = (Whole Number of completed years of service) * (Last drawn monthly Basic and DA) *15/30
Ex: if an employee has served in an organisation not covered under the act for 20 years and 7 months, then in calculation 7 months are ignored and only 20 years are used for calculation. If in last year he drew monthly Basic and DA of Rs. 40,000 , he would get gratuity of Rs. 4,00,000 calculated as (20 * 40,000 *15/26).
How do companies plan to pay Gratuity amount?
Some organisations set up a gratuity fund as a part of their financial planning. Some companies take the Gratuity schemes of insurance companies like LIC’s, Group Gratuity(Cash Accumulation) Scheme where the employer pays premium and gets tax rebate on the premium.
What about Tax on the Gratuity amount?
The gratuity received by an employee is NOT taxable if it is received on his retirement, his becoming incapacitated prior to retirementor if such gratuity is received by his widow, children or dependants on his death. So if one doesn’t retire and is below the retirement age then Gratuity is not tax free. Gratuity is taxed under the head Income from Salaries. Gratuity received by the legal heir is taxable under the head Income from Other Sources. Some portion of gratuity received is exempt from tax as per Section 10(10) of the Income Tax Act which is explained below.
For a government employee the entire gratuity amount is exempt from tax.
For a non government employee covered under the Act or not covered by Act, he would get tax deduction for an amount which is the minimum of the following. Note that the ceiling of Rs. 10 lakh applies to the sum of all the gratuity received from one or more employers in the same or different years. Before May 24,,2010 limit was 3.5 lakh.
Actual gratuity received
15 days Basic and DA for each completed year of service (according to calculations in the example above)
Rs. 10 lakh
For example after 20 years of service the employer paid gratuity of Rs. 5,00,000, gratuity amount by calculation is 4,61,538 to employee. Minimum of 5 lakh, 4,61,538 and 10 lakh is 4,61,538. The employee,non government will enjoy tax deduction on Rs 4,61,538 and Rs 38,462(5 lak h – 4,61,538) will be subject to tax.
What is difference between Gratuity and Pension?
Gratuity is an one time payment made to employees who have completed a 5 years of service in an organisation. Gratuity is the amount an employee may receive in gratitude for his services. Technically it is same as a TIP(TO INSURE PROMPTNESS), given to a waiter, taxi driver, or hairdresser . Pension is the monthly payment made to retiring employees. Though most retiring employees get gratuity, pension is given only by some organisations, mostly government ones.
Is Gratuity part of CTC (Cost of Company)?
It’s a company discretion whether they want to make Gratuity part in employee’s CTC or not. The argument of not including Gratuity in CTC is that employee become eligible for gratuity only after completion of 5 years so how come company can make it part of employee CTC. What if employee leave the company before completing 5 years? But employer sees Gratuity as liability to pay in completion of 5 years employee and also in case of death and disablement irrespective of completion of 5 years. So most of employers include Gratuity in CTC because they believe Cost to the Company (CTC) is cash out go today + cash outgo in the future, which means, Basic + perquisites + Company’s contribution to your PF + today’s valuation of the gratuity element, especially when employer has taken insurance policy to cover gratuity liability. Our article Salary, Net Salary, Gross Salary, Cost to Company: What is the difference discusses CTC in detail.