Know all about Gratuity eligibility criteria

With this article, we try to simplify the rules surrounding Gratuity, with special focus on streamlining its eligibility criteria.

Mar 31, 2020 11:03 IST India Infoline News Service

Gratuity is a benefit that an employee receives for his services to a company or organization. It is a kind of 'gratitude' amount that the company gives its employee. It is usually paid at the time of retirement but it can be paid before provided certain conditions are met. While the concept seems pretty simple, in reality, understanding Gratuity in totality with the required guidelines attached to its eligibility, makes the process a bit complicated. With this article, we try to simplify the rules surrounding Gratuity, with special focus on streamlining its eligibility criteria.

Gratuity - Understanding the basics
Gratuity is defined as a sum of money that is paid to the employee over and above the decided salary at the time of his retirement. It is paid by the employer in gratitude for the services rendered by the employee in the company if he has worked at least 5 years for that company. Prior to 1972, there was no law that it was mandatory for the employer to pay employees gratuity at the time of retirement. In the year 1972, the Government of India enacted the Payment of Gratuity Act, which made it mandatory for the employers to pay his employees the gratuity at the time of quitting subject to the conditions that certain conditions are met. In order to understand the eligibility criteria of gratuity, it is important to first understand the applicability of the Payment of Gratuity Act, 1972.

The Payment of Gratuity Act, 1972 applies to the following:
  • All the factories, oilfield, mine, railway, port and plantation
  • Shop or establishment in which 10 or more persons are employed on any day during the preceding 12 months
  • Any other establishment or class of establishment in which 10 or more employees are employed on any day during the preceding 12 months, as notified by the central government

It is important to note here that once the provisions of the Payment of Gratuity Act apply to the establishment i.e. 10 or more number of employees are employed, it will continue to apply even if the number of employees falls below 10.

Gratuity eligibility
If the establishment is covered within the Payment of Gratuity Act, then, the employee of such establishment is eligible for gratuity only after the employee has rendered a continuous service of not less than 5 years.

Following are the instances for eligibility to receive gratuity:
  • The employer is paid gratuity in salary when he completes five years of service with the employer or more
  • The employer is also paid gratuity in case of resignation or retirement or if the person is laid off by the company
  • In case of an employee's death or disablement, there is no minimum gratuity eligibility period and the employee can be given the gratuity amount immediately

Calculating gratuity 
As per the Payment of Gratuity Act, 1972, there is no fixed percentage for gratuity calculation. However, employers can use a formula to calculate their employees' gratuity or they can even choose to pay a higher amount than that. As per the Gratuity Act, private sector employees are divided under two categories:
  • Employees covered under the Gratuity Act
  • Employees not covered under the Gratuity Act
Gratuity for employees covered under the Gratuity Act:
Gratuity = Salary last drawn × Number of completed years of service × 15÷26
Where,
  • Salary last drawn = Basic salary + dearness allowance
  • Number of completed years of service = total number of years for which service provided (period above 6 months should be considered as 1 year)
  • 15 days = Number of days employee has worked
  • 26 days = Total number of working days in a month.
Things to be noted
  • The average monthly salary is to be computed on the basis of the salary of the last 10 months immediately preceding the month (not the day) of retirement.
  • The ratio 15/26 represents 15 days out of 26 working days in a month.
  • According to this formula, the time period of over 6 months or more is considered as one year. Which means that if an employee has worked for 7 years 8 months in a company, the working tenure will be considered 8 years. However, if an employee has worked for 4 years 3 months, the tenure will be considered as 4 years.
Gratuity for employees NOT covered under the Gratuity Act:
Gratuity = Salary last drawn × 15÷30 × Number of years of service
Where,
  • Salary last drawn = Basic salary + dearness allowance
  • Number of completed years of service = total number of years for which service provided (period above 6 months should be considered as 1 year)
  • 15 days = Number of days employee has worked
  • 30 days = Total number of days in a month.
Things to be noted
  • There is no law that restricts an employer from paying gratuity to his employees even if the organization is not covered under the Act.
  • In this case, the main difference is that only completed years of service are counted in the number of years of service of an employee. So, if an employee has worked for 7 years 8 months in a company, the working tenure will be considered 7 years. If an employee has worked for 4 years 3 months, the tenure will be considered as 4 years.
Gratuity in case of accident/death:
In case of death of an employee, the gratuity benefits are calculated on the basis of the tenure of service of the employee. The amount is, however, subject to a maximum of Rs20 lakh. The following table shows the rates at which the gratuity will be payable in case of death of an employee:
Tenure of service Amount payable towards gratuity
Less than a year 2 x basis salary
1 year or more but < 5 years 6 x basic salary
5 years or more but < 11 years 12 x basic salary
11 years or more but < 20 years 20 x basic salary
equal to or > 20 years Half of the basic salary for each completed 6-monthly period. However, it is subject to a maximum of 33 times of the basic salary.

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