What is gratuity? How to calculate gratuity?

The Central Government amended the Payment of Gratuity Act of 1972 under the 7th Central Pay Commission roll out in 2017. Under the amendment, the ceiling on tax free gratuity was doubled to Rs20 lakhs from Rs10 lakhs earlier.

Jul 19, 2019 09:07 IST India Infoline News Service

Most people are not aware of the element of gratuity in their salary irrespective of being a government employee or working in private sector. Under the Payment of Gratuity Act of 1972, you are eligible to receive gratuity if you have rendered continuous services for a minimum of five years. This Act is applicable to employees of factories, railways, oilfields, ports, mines, plantations and any establishment that has 10 or more employees.

It is not compulsory for establishments or organisations to pay gratuity if they do not fall under the Gratuity Act. If such an employer, still chooses to pay gratuity, the amount paid is tax free. However, the calculation is slightly different in such cases. We shall explore the calculation in detail, later in the article.

Rules of gratuity payment
Unlike the Employee Provident Fund (EPF), where you have to make a contribution from your salary, you are not required to make a contribution to be eligible for gratuity. Your employer may pay the gratuity component as a retirement benefit or as a social security from its own funds. Alternatively, it may enter into an agreement with a life insurer for a group gratuity plan.

In case you suffer from a disability or expire while employed with the organisation, your employer will have to offer the gratuity amount to your nominee or legal heir. In such cases, the number of years in service will not be taken into consideration. In case your nominee is a minor, he or she is still eligible to receive the gratuity. However, the funds are deposited in his or her name in a term deposit by the Assistant Labour Commissioner in any nationalised bank. Your nominee becomes eligible to withdraw the funds once he or she turns 18.

Forfeiture of gratuity
The gratuity of an employee can also be forfeited under the following circumstances:
  • The service of the employee was terminated due to anti-social activity/violence, disorderly conduct.
  • The service of the employee is terminated following an offence that involved moral turpitude during his employment.
However, there must be a termination order provided by the employer on such grounds clearly stating the reason for the forfeiture of gratuity. In the absence of a termination order, an employee’s gratuity cannot be forfeited.

Calculation of gratuity
There is no set percentage for the amount of gratuity that you may be eligible for. Your employer may use a formula based approach or may even choose to pay a higher amount. There are two main components that go into the calculation of gratuity, i.e. the last drawn salary and years of service. To calculate how much gratuity is payable, non-government employees are classified under two categories:
  • Employees covered under the Gratuity Act
  • Employees not covered under the Gratuity Act
Employees covered under the Gratuity Act
For employees that fall under the Gratuity Act, the formula used for calculation of gratuity is as follows:

Number of years in service x Last drawn salary (inclusive of basic salary, dearness allowance and commission received on sales) of 15 days = Number of years x 15/26 x monthly salary.

Let us understand this with an example:
Suppose Mr Ashok Banerjee has worked in a steel plant for 21 years where his last drawn salary was Rs60,000/month. Thus using the formula as explained above, his gratuity would be calculated as follows.
(15 x 60,000 x 21) /26 = Rs 7.26 lakhs

Employees not covered under Gratuity Act
As mentioned earlier, an employer who does not fall under the Gratuity Act can also choose to pay gratuity to his employees. The calculation however differs in such cases.

The formula will be as follows:
15 x last drawn salary x tenure of working /30

To understand this with the above example, if Mr Ashok were to be employed with a company that does not fall under the Gratuity Act, his gratuity would be calculated as follows:
(15x 60,000 x 21) /30= Rs 6.30 lakhs

Increase in ceiling
The Central Government amended the Payment of Gratuity Act of 1972 under the 7th Central Pay Commission roll out in 2017. Under the amendment, the ceiling on tax free gratuity was doubled to Rs20 lakhs from Rs10 lakhs earlier. This puts Central Government employees at par with private and unorganised sector employees.

Further, the Government is also considering increasing the gratuity component of all employees who fall under the Payment of Gratuity Act 1972. This is in consideration of the fact that inflation and wages have increased considerably over the last four decades. The Government is keen on the amendment as the main aim of gratuity is to provide a social security to individuals post their retirement.

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