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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.

How does Gratuity Payment Work?

In some cases, the employer pays his employees from their own pockets, while on the other hand, they tie up with insurance providers for group gratuity plans. Additionally, it is possible for an employee to contribute to his gratuity amount. The gratuity that the insurance company pays depends on the clauses attached to the group insurance scheme.

Payment of Gratuity Act, 1972: This act was passed in the year 1972 to cover employees that were engaged in factories, mines, oil fields, plantations, ports, companies and establishments with over ten employees. As per the act, the gratuity amount due is to be paid wholly by the employer and does not require contribution by the employee.

Eligibility Criteria for Receiving Gratuity

Gratuity can be received by the employee on the following criteria:

  • The employee has to be eligible for superannuation
  • The employee should have retired
  • The employee must have resigned after completing 5 years with the same employer
  • The employee dies or suffers with a disability caused due to an illness or accident

Calculation of Gratuity

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.

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

Taxation Process of Gratuity

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.

FAQs

What is the maximum cap of receiving the gratuity?

INR 10 lakhs is the maximum cap of receiving gratuity. The company cannot pay you an amount higher than that as gratuity even if you have completed more number of years in the company. This maximum cap defines the highest limit that is payable to you by different employers throughout your work-span. If a company still decides to pay you an additional sum of money, they can do so in the form of bonus or ex-gratia.

Can I nominate somebody to get my gratuity if I die?

Yes, you can nominate somebody to get your gratuity if you die. You will have to fill Form F upon joining the company in order to do so.

How long does it take for an employer to pay the gratuity amount?

Gratuity is generally released during or soon after or before settling the full and final of the employee. As per the Government mandate, the employer has to pay this amount in a time span of 30 days. If this payment is delayed, the employer will end up paying an interest on the gratuity amount right from the due date to the time that the payment is done.

I haven’t completed 5 years of service. It has been 4.5 years. Can I still get my gratuity?

No, you need to complete at least 5 full years in the same company to qualify. As per the Madras High Court ruling, if you have completed 240 days of service in the 5th year of work, you might be able to avail gratuity. Please get in touch with your company’s HR for the same.

I work under a contract in my current company. If I retire or resign after 5 years, will I still get my gratuity?

You will receive gratuity if you are on the company roll and are considered to be an employee of the company; not otherwise.

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