Gratuity: All You Wanted to Know

Gratuity forms a part of an individual’s salary. It is one of the components that make up the gross salary of an individual. In other words, it is a sum of money that is paid to an employee when his employment term ends. It is a form of acknowledgement given to an employee for the services that he has rendered. This benefit is payable under the Payment of Gratuity Act, 1972. Although it is actually payable upon retirement, it can be paid to the employee beforehand, depending on the terms and conditions. The person should have completed at least five years of service in an organization. It can be paid before the five-year mark in case of the death of the employee or some disability or illness.

The Payment of Gratuity Act, 1972, states that an employee is eligible to get gratuity only after he or she has worked with an organization for at least five years. The employee stands to receive the gratuity amount on his or her superannuation, or at the time of retirement or resignation. However, it must be noted that there is an exception where the condition of working for five straight years with a firm does not apply. In the event that an employee becomes disabled or passes away, the law mandates that the employer pay the gratuity to the employee or his or her nominee, regardless of the number of years of continuous service. The law also says that if the nominee is a minor, then the assistant labour commissioner will invest the sum in his or her name into a term deposit with a nationalised bank for the minor's benefit until the time that he or she becomes a major.

There are rules that need to be adhered to during the time of payment. The rules state that when an employee is eligible to get gratuity, the individual needs to apply within a matter of 30 days from the date it becomes payable. Should the date of superannuation or retirement be known, the application can be made before 30 days. An employer, however, is not allowed to turn down an application from the employee after the expiry of 30 days if the delay is due to a valid cause. The rules also suggest that no claim for gratuity shall be regarded as invalid, simply because the individual did not file his or her application during the specified period.

There are a number of components that go into making the gratuity amount. This amount also depends on the time span one has served in the company as well as the salary last drawn.

Let’s take:

N = the number of years served in the company B = the basic last drawn salary + DA Then, Gratuity = N x B x 15/26

An employee who has worked with an organization for 15 years and has INR 30,000 as his last drawn basic + DA amount, then his Gratuity = 1530,00015/26 = INR 2,59,615.38

Points to consider:

• As gratuity is a sort of tip, the employer could choose to pay a higher amount. However, it should not exceed INR 10 lakhs.
• An amount above the cap of INR 10 lakhs is called ex-gratia. It is not imposed by the law and is a voluntary contribution.
• A time span of more than 6 months, of the last year of employment, is rounded off to the next number, while the time below 6 months is not; i.e. if an employee has worked for 7 years 8 months in a company, he is liable to 8 years gratuity, whereas if he has worked for 7 years 4 months, he is liable for 7 years gratuity only.

Gratuity calculator:

The Gratuity Calculator tool in the following link can be used for calculating your gratuity.

Source: www.incometaxindia.gov.in/Pages/tools/Gratuity-calculator.aspx

The process of taxation of gratuity is dependent on the receiver of the gratuity amount. There are 2 main cases for the same:

• When a government employee receives the gratuity amount: If the employee works under the state or central government or local authority and receives gratuity, then his gratuity amount is fully exempt from income tax.

• When a salaried employee receives the gratuity amount from an employer covered by the act: If the employee’s employer is covered under the Gratuity Act, then the amount that is exempt from tax is: 15 days salary as per the employee’s last drawn salary

• When a salaried employee receives the gratuity amount from an employer not covered by the act: Then, the least of the following amounts is exempt from tax: INR 10,00,000 or gratuity received by the employee or half a month’s salary for every year of service which the employee has completed with his employer

Important rules

Forfeiture: The employer can forfeit the payment of gratuity, as per the Payment of Gratuity Act of 1972. This can be partial or whole even if the employee completes 5 or more years of service in the company. This can happen if the employee has to be terminated owing to his disorderly conduct when he physically harms people during his service.

Payment timeline: The three main steps of payment are as below

• Initiation: The employee must send the application to the employer w.r.t. his or her gratuity owed by a company.

• Acknowledgement and calculation: Once the application is received, the company that owes the gratuity calculates the amount and then provides a notice to the employee and controlling authority with the specified amount.

• Disbursal: The employer has a timeframe of 30 days for paying the gratuity amount, after sending the acknowledgement.

Tax exemptions: Certain policy changes made in the 2016 budget have caused the gratuity laws to change a little. Here are the key highlights:

• As per Article 10(10)i of the Income Tax Act, gratuity that is received by government employees, besides statutory corporations, is fully exempt from tax.

• As per Article 10(10)ii of the Income Tax Act, retirement and death gratuity receivable by the employee under the act is the least amount of the below options, which is exempt from tax:

  • (15/26) x Last drawn salary x Completed year of service or part in excess of 6 months (7 days if the employee belongs to a seasonal establishment)

  • INR 10 lakhs

  • Actual gratuity amount received

Note: Last drawn salary = total salary that an employee receives including DA (Dearness Allowance). This excludes benefits such as HRA, bonus, commission etc.

• As per Article 10(10)iii of the Income Tax Act, the exemption of the gratuity amount that is received by employees not covered under the act is as follows:

  • Half month’s average salary X Completed years of service

  • INR 10 lakhs

  • Actual gratuity received

Note: Average salary = average salary of the last 10 months that immediately precede the retirement month

Salary = Basic pay + DA + turnover based commission

Another point to note is that if the employee dies, his nominee or heir gets the gratuity amount. The receiver’s taxation is calculated under the head – income from other sources.

Key highlights about Gratuity :

• While receiving gratuity from an employer, if the amount exceeds INR 10,00,000, then the tax exemption in this case is to be calculated based on the points highlighted under the taxation section above.

• An employer can reject the gratuity payment of an employee if they have been told to leave the organization owing to their misconduct.

• If the employee dies, the gratuity amount is paid to their heir or nominee. However, tax has to be calculated for this too, under the head Income From Other Sources.