Gratuity – Eligibility, Calculation and Tax
Gratuity is an amount paid by an employer to his/her employee in exchange for the services provided by the employee to the employer. This is governed by the Payment of Gratuity Act, 1972, and is paid only to the employees who have completed at least 5 years in the organisation. In a way, it can also be seen as a gratitude from the employee in exchange for his/her work in the organisation. Let us understand Gratuity in detail below.
Gratuity came into effect with the passing of Payment of Gratuity Act, 1972. All the organisations with a minimum of 10 employees are covered under this act.
Eligibility for Gratuity
In order to be eligible to get the gratuity amount, the following criteria must be met:
- The employee should be eligible for Superannuation (Superannuation is a retirement benefit offered to the employee by his employer)
- The employee should have completed 5 years of continuous service in the same organisation.
- In case of death of the employee, Gratuity is paid to his heir even before the completion of 5 years.
An employee is said to have completed an year if he has worked for atleast 240 days in the financial year. For example, if an employee has completed 4 years and 8 months, he would be eligible for gratuity even though he has not completed 5 years in the organisation (since 8 months means 240 days).
Gratuity claim can be rejected by the employer even when an employee is eligible for the same in case the employment has been terminated due to some violent act.
Calculation of Gratuity Amount
Gratuity is calculated based on the last drawn salary (basic + DA) of the employee. It is paid as 15 days salary for every year for which the employee worked in the organisation. Below is the formula used for calculation of Gratuity amount.
Gratuity amount = number of years of service * last drawn salary (basic + DA) * 15 / 26
The amount which an employer can pay to his/her employee has an upper limit of Rs 20L. If the employer wishes to pay more to the employee (as per the above formula), the extra amount should be paid as an incentive and should not be included in the Gratuity.
Tax on Gratuity
The amount up to Gratuity received is fully exempted from tax. However, if the amount received by the employee is more than 20L, the extra amount is paid as an ex-gratia amount and will be fully taxable as per the slab of the employee.
Example of Gratuity Calculation
Dumbledore, a private sector Employee is retiring at an age of 60 years after successfully completing 35 years of service. His last drawn Salary (basic + DA) was Rs 1.2L. His total Gratuity amount as per the above formula will be: 35 * 1,20,000 * 15 / 26 = Rs 24,23,076. Out of this amount, 20L will be paid to him as gratuity and will be fully tax free. However, Dumbledore would have to pay income tax on the remaining Rs 4,23,076 depending on his tax slab in the financial year.
Gratuity is a good incentive which can help you have a decent sum all at once which you can use for bigger expenditures, or you can invest it to generate a passive income. However, you will receive gratuity only when you complete 5 years in the organisation. Some points to take care related to gratuity:
- Some organisations, to show increased CTC, include gratuity in your CTC and deduct it from your salary every month. This is a loss for you since if you leave the organisation before completing 5 years, you never get that amount back. Always ask your tentative computation sheet from the HR when negotiating salary.
- If you are switching to a new employer and would be eligible for gratuity in coming months, it is a good advice to keep gratuity in mind. Similar evaluation is helpful if you have completed x years and 6/7 months in the organisation. You can defer your last date by 1/2 months and get additional 15 days of salary as gratuity.
- When leaving the organisation, gratuity must be paid along with the full and final settlement. If not, you can submit an application post which, if the amount is not paid to you within 15 days, the employer will have to pay an additional interest on the due amount.
- If your payslip contains ‘No. of days’ which contains only the working days for the month (most of the companies mention this as the actual number of the days in that month), then 8 months would be less than 240 days and in this case, 4 years 9 months would not make one eligible for Gratuity.
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Hi! I’m Gaurav, a Software Engineer by profession and a credit card enthusiast by heart. I love earning reward points and cashbacks from credit cards and giving ‘gyaan’ on credit cards and personal finance.