What is Gratuity: Meaning, Formula, Eligibility & Calculation 

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Gratuity, in simple terms, is the amount your employer pays you for working with them for five years or more. This extra sum is considered an additional benefit and is seen as a reward for your loyalty and service.

In this blog, we will address the questions that we, as common men, often have in mind when joining any organisation, such as: What is gratuity, and how is gratuity actually calculated?

A gratuity is more like a special monetary reward given to employees who’ve worked full-time at a company for over five years. This practice is ruled by The Payment of Gratuity Act, 1972. It’s a way for your employer to acknowledge your long-term commitment and support your financial well-being when you retire.

Gratuity Meaning as per Gratuity Act of 1972

The Gratuity Act of 1972 lays out the rules for giving extra pay, called gratuity, to employees in places like factories, mines, shops, and more. The act was passed by the Parliament of India on 21st August 1972 and came into force on 16th September 1973.

For a workplace to follow this law, it needs to have at least 10 employees on any given day in a year. Even if the number of employees later drops, the company still has to pay a gratuity.

As per the Gratuity Act, to get gratuity, you must work with the same employer for at least five years without any significant breaks. If you leave before five years, you won’t get a gratuity. But there’s a catch. According to the latest rules, you can get a gratuity if you complete 240 days of work in your fifth year, treating it like you worked for five years.

This five-year rule is there to encourage employees to stick around longer, which is good for both the employer and the employee. It ensures that those who really help the company grow get recognised and rewarded.

Please Note: This rule doesn’t apply if an employee passes away or becomes disabled. In those cases, the person nominated by the employee (like a family member) gets the gratuity. Also, interns and temporary workers don’t qualify for gratuity since their jobs are usually for a fixed time or project.

What Is Gratuity in Salary, and How Does It Work?

Gratuity in salary refers to a crucial part of an employer’s responsibility towards employees, representing an acknowledgement of their services.

Key Points

  • Employers adhere to the Gratuity Act’s rules and regulations when disbursing gratuity to employees. 
  • The Act outlines eligibility criteria, the calculation of gratuity in salary, and payment terms. The entire contribution to gratuity comes from the employer.
  • The gratuity amount is paid upon the employee’s separation from the company after a minimum of 5 years of continuous full-time service.
  • The gratuity term spans from the employee’s starting date at the organisation to their final working day, including the served notice period. The employer bears the gratuity amount, which is part of the employee’s overall CTC (cost to the company).

Gratuity Contribution by Employer

Employers can either pay the gratuity amount from their company’s funds or opt for an insurance provider offering a general gratuity insurance plan. The entire gratuity amount is covered by the employer and is not deducted from the salary of the employee’.

As per regulations under the Gratuity Act, employers must disclose the gratuity contribution in the CTC, ensuring it is an additional component of the employee’s salary. This prevents the company from deducting any contribution from the employee towards this amount.

While there’s no specific set percentage for gratuity contribution, regulations suggest a standard gratuity of at least 50% of the employee’s basic salary, excluding other CTC components like allowances.

How Gratuity Works

Employers have the choice to pay the gratuity amount from their funds or opt for group gratuity insurance coverage. The latter is a common practice, particularly for larger organisations, where gratuity payments constitute a significant expense.

In a gratuity insurance plan, the company makes annual contributions to an insurance provider, which invests these amounts in various instruments. The generated returns fund the gratuity amounts payable to employees.

Eligibility Criteria for Gratuity

Gratuity becomes accessible to employees when specific conditions are fulfilled, demonstrating a recognition of dedication and commitment:

  1. Dedication to Service: Serve consistently for a continuous period of 5 years within the same organisation, displaying a commitment that makes one eligible for gratuity upon resignation or retirement.
  2. Minimum Team Size: The organisation should have a minimum of 10 employees, ensuring a collective environment for gratuity eligibility.
  3. Approaching Retirement: Eligibility for superannuation is a prerequisite, signifying the journey toward retirement and offering an additional benefit for future plans.
  4. Dealing with unforeseen circumstances: In the unfortunate event of disability or death, even before completing 5 years, the employee or their nominee remains eligible for full gratuity, providing essential support during challenging times.
  5. Gratuity Act or Company Policy: Some organisations, regardless of having fewer than 10 employees, adhere to the Gratuity Act of 1972. For those not covered, the option to offer gratuity remains guided by the organisation’s internal policies.

Gratuity Calculation

Understanding how gratuity is calculated is crucial for both employers and employees, given its significance as a retirement benefit.

  • Gratuity calculation is categorised into two sections: one for employees under the Gratuity Act and another for those not covered. 
  • The last drawn salary and the completed years of service are essential to compute gratuity. The gratuity payable is 15 days’ wages per year, derived from the average of the last 10 months’ salary.

For Organizations Covered by the Gratuity Act of 1972

If your workplace follows the Gratuity Act, and you’ve worked for more than 5 years, your gratuity amount is calculated as per the following gratuity formula:

Gratuity=(15×Last Drawn Salary×Years of Service) / 26)

Let’s take an example: 

Mr. A worked at XYZ Company for 11 years and 7 months, with a last-drawn salary of

INR 55,000.

Mr. A’s Gratuity Amount= (15×55,000×12)/ 26 = INR 380,769

For Organizations Not Covered by the Gratuity Act

If your workplace isn’t under the Gratuity Act, the formula for gratuity changes a bit:

Gratuity= (15×Last Drawn Salary×Completed Years of Service) /30

For instance, Mr. B worked at LMN Company for 15 years and 8 months, with a last drawn salary of INR 40,000.

Mr. B’s Gratuity Amount=(15×40,000×16) / 30 = INR 3, 20,000

These examples show how gratuity is calculated based on the rules that apply to your workplace. 

Gratuity Calculation in the Event of Employee Death

In the unfortunate event of an employee’s demise, the gratuity amount goes to the nominee. Calculated based on the employee’s tenure, it has a maximum limit of ₹20 lakh.

The following table outlines the gratuity amount payable by the employer in case of an employee’s death:

Tenure of ServiceGratuity Amount Payable
Less than one yearTwo times the basic salary
More than one year but less than five yearsSix times the basic salary
More than five years but less than 11 years12 times basic salary
More than 11 years but less than 20 years20 times the basic salary
20 years or moreHalf of the basic salary for each completed six-month period, subject to a maximum limit

Tax on Gratuity

The tax rules for gratuity in India depend on the type of employee and the amount of gratuity received. There are two types of employees for the purpose of gratuity taxation: government employees and private employees.

Government Employees

If you are a government employee, you are in luck. The entire gratuity contribution from the employer is exempt from income tax. You do not have to pay any tax on your gratuity amount, irrespective of the amount or the number of times you receive it.

Private Employees

If you are a private employee, you have to follow some rules to claim tax exemption on your gratuity amount. First of all, you have to be covered under the Payment of Gratuity Act, 1972. This act applies to every factory, mine, oilfield, plantation, port, railway company, and shop or establishment employing 10 or more persons.

For private employees covered under the Gratuity Act, the least of the following three amounts is exempt from income tax:

• The eligible gratuity calculated as last salary (basic + DA) * number of years of employment * 15/26

• The actual amount of gratuity received

• Rs. 20 lakh

Read- Mistakes that you must avoid while filing your income tax returns.

Gratuity Benefits

Gratuity benefits stand as a tangible acknowledgement from employers to employees for their dedicated service to the organisation. These benefits come as a monetary reward and are granted during key life events such as retirement, resignation, or in unfortunate situations like disability or death. To be eligible for gratuity benefits, an employee must have completed a minimum of five years of continuous service with the same employer.

Can an Employer Refuse to Pay Gratuity?

Certainly, an employer has the authority to decline the payment of gratuity to an employee under specific circumstances. If an employee is asked to leave their job due to misconduct, such as violent behavior on the company premises or engagement in illegal activities, the employer has the right to withhold the entire gratuity amount or a partial amount based on the extent of damage/ loss incurred.

Criteria for Gratuity Eligibility: Examining Section 4(2) of the Payment of Gratuity Act

As outlined in the Payment of Gratuity Act 1972, employees become eligible for gratuity benefits after completing five full years of service with a company.

As per Section 4(2) of the Payment of Gratuity Act, any service period exceeding six months is considered one year for gratuity calculation purposes.

Applying this provision, if an employee has worked with a company for more than four years and six months, their service duration is considered as five complete years, making them eligible for gratuity.

FAQs| What is Gratuity

What is a gratuity in salary?

A gratuity is a gesture of appreciation in the form of a monetary benefit that employers pay to employees upon retirement, resignation, or death; however, it is subject to applicable rules as per the Gratuity Act.

What does it mean to pay gratuity?

Paying gratuity involves giving a lump sum amount to an employee based on their last salary and years of service. The employer must fulfil this within 30 days of the employee’s departure.

Is there a maximum limit on gratuity payable to an employee?

Yes, there is a limit. Government and private employees covered by the Gratuity Act have a maximum limit of Rs. 20 lakh, while for non-covered private employees, it’s Rs. 10 lakh.

If I resign after 4.5 years of service, can I get a gratuity?

No, eligibility requires completing a continuous service of at least five years with the same employer, so resigning after 4.5 years excludes gratuity.

What is the difference between PF and gratuity?

PF is a monthly savings scheme mandatory for employees earning up to Rs. 15,000, while gratuity is a one-time payment during exit, mandatory for those covered under the Gratuity Act.

Under what conditions do I become eligible for gratuity?

Eligibility arises if you are a government or Gratuity Act-covered private employee, have completed at least five years of continuous service, and have experienced retirement, resignation, termination, death, or disability.

How is gratuity paid in case of the death of an employee?

In the event of an employee’s death, gratuity is paid to the nominee or legal heir. Application must be made within one year of death, and the employer should pay within 30 days of receiving the application.



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