Gratuity in Quora

Gratuity

Gratuity is a part of salary that is received by an employee from his/her employer in gratitude for the services offered by the employee in the company. A person is eligible for gratuity only if he has completed minimum of five years of service with an organisation. However, it can be paid before the completion of five years at the death of an employee or if he has become disabled due to accident or disease.

An employer may give gratuity out of his own funds or may approach a life insurer to get a group gratuity plan. In case the employer chooses a life insurer, he has to make annual contributions as decided by the insurer. The employee can also make contributions to his gratuity fund. The gratuity will be paid by the insurer based upon the terms of the group gratuity scheme.

The amount of payable gratuity completely depends upon two factors:

1. Last drawn basic salary (basic pay, dearness allowance, and commission based on sales)
2. Tenure of service

The computations of gratuity differs for both government organisations and private organisations. In other words, gratuity calculations differ for both government employees and non-government employees. As per the Payment of Gratuity Act, 1972 – non-government employees are categorised in two groups.

1. Employees covered under the Act
2. Employees NOT covered under the Act

Gratuity Calculation for Government Employees with example

Formula: Last drawn basic salary x Year of service x 15/26

This formula is based on the 15 days of last drawn basic salary. While considering the year of service, if an employee has completed more than 6 months of a particular year, the full year is considered for the computation and vice-versa i.e. less than 6 months is completed for a particular, those months aren’t considered as a whole year. Briefly, the tenure in service is rounded off to the nearest full year.

Let’s understand this with the help of example given below.

Example: Rucha’s last drawn basic pay is Rs 75,000 per month. She was employed with Zoya Corporation for 20 years and 8 months.

Here, her gratuity amount would be computed as:

75,000 x 21 years x 15/26 = Rs 9,08,654 i.e. 9.09 lakhs

Gratuity is one of the least understood components of salary. Everything about Gratuity and the tax implications for you.

Gratuity is a part of salary that is received by an employee from his/her employer in gratitude for the services offered by the employee in the company. Gratuity is a defined benefit plan and is one of the many retirement benefits offered by the employer to the employee upon leaving his job. An employee may leave his job for various reasons, such as - retirement/superannuation, for a better job elsewhere, on being retrenched or by way of voluntary retirement.

Eligibility
As per Sec 10 (10) of Income Tax Act, gratuity is paid when an employee completes 5 or more years of full time service with the employer (minimum 240 days a year).

How does it work?
An employer may offer gratuity out of his own funds or may approach a life insurer in order to purchase a group gratuity plan. In case the employer chooses a life insurer, he has to pay annual contributions as decided by the insurer. The employee is also free to make contributions to his gratuity fund. The gratuity will be paid by the insurer based upon the terms of the group gratuity scheme.

Tax treatment of gratuity
The gratuity so received by the employee is taxable under the head ‘Income from salary’. In case gratuity is received by the nominee/legal heirs of the employee, the same is taxable in their hands under the head ‘Income from other sources’. This tax treatment varies for different categories of individual assesses. We shall discuss the tax treatment of gratuity for each assesses in detail.

For the purpose of calculation of exempt gratuity, employees may be divided into 3 categories –

• Government employees and
• Non-government employees covered under the Payment of Gratuity Act, 1972
• Non-government employees not covered under the Payment of Gratuity Act, 1972

In case of government employees – they are fully exempt from receipt of gratuity.
In case of non-government employees covered under the Payment of Gratuity Act, 1972 – Maximum exemption from tax is least of the 3 below:

1. Actual gratuity received;
2. Rs 10,00,000;
3. 15 days’ salary for each completed year of service or part thereof

Note:

• Here, salary = basic + DA + commission (if it’s a fixed % of sales turnover).
• ‘Completed year of service or part thereof’ means: full time service of > 6 months is considered as 1 completed year of service; < 6 months is ignored.
• Here, number of days in a month is considered as 26. Therefore, 15 days’ salary is arrived as = salary * 15/26
• In case of non-government employees not covered under the Payment of Gratuity Act, 1972 – Maximum exemption from tax is least of the 3 below:

1. Actual gratuity received;
2. Rs 10,00,000;
3. Half-month’s average salary for each completed year of service (no part thereof)

Note:

• Here, salary = basic + DA + commission (if it’s a fixed % of sales turnover).
• Completed year of service (no part thereof) means: full time service of > 1 year is considered as 1 completed year of service. < 1 year is ignored.
• Average salary =10 months’ salary (immediately preceding the month of leaving the job)/10

Illustration
Let’s understand the above math clearly with an example:
Varun had been working with an IT company since past 10 years, 7 months. He is retiring on 15th April, 2010. His current Basic = Rs 40,000 pm, DA = Rs 5,000 pm. He is going to receive a gratuity amount of Rs 3 lakhs on retirement. Note: Varun’s basic and DA have been the same since past 1 year.

Lets consider 2 situations here – (a) Varun’s employer is covered under Payment of Gratuity Act, 1972; and (b) Varun’s employer is not covered under Payment of Gratuity Act, 1972. • Salary = Basic + DA = Rs 40,000 pm + Rs 5,000 pm = Rs 45,000 pm
• Average salary = 10 months’ salary (immediately preceding the month of leaving the job)/10 = (Rs 45,000 pm * 10)/10 = Rs 45,000 pm. Therefore, half-month’s average salary is = Rs 45,000/2

Important points to remember
• Generally, only government employers give DA to their employees. Above example is only for illustrative purpose.
• The salary of the employee may differ over a period of time on account of change in basic, DA and/or other factors.
• In case gratuity is received from more than one employer during the previous year, maximum exemption allowed is up to Rs 10,00,000.
• Where employee has already claimed gratuity exemption in any previous year (s), the maximum exemption amount allowed for the current previous year i.e. Rs 10,00,000 will be reduced by the amount of deduction already claimed in the previous years.
• In case of an employee who is employed in a seasonal establishment ( not employed throughout the year), the gratuity exemption shall be for seven days wages for each season.

An employee is eligible for payment of gratuity if [ section 2 ]:-

He/she rendered the continuous service for five or more than five years on the termination of his employment :-

• On his superannuation; or
• On his resignation or retirement; or
• On his disablement due to disease/accident or death. (continuous service of five years is not applicable in this case)

Here meaning of an employee [ section 2(e) ]:-

• Any person (not apprentice)
• Employed on salary or wages
• Employed in any factory, establishment, mine, plantation, oilfield, port, shop or Railway Company.
• To do any work (i.e., manual supervisory, non technical, technical, unskilled, semiskilled, skilled, managerial, officer or clerical)
• Whether the terms of employment are implied or expressed.
• Whether or not he is employed in an administrative or managerial capacity.

Here meaning of Superannuation [ section 2(r) ]:-

• The attainment by the worker/employee of such age
• As defined in service conditions and contract.
• As the age on attainment of which the worker/employee shall vacate the service/employment.

Gratuity shall be paid to :-

• The Employee
• Employee’s Nominee (if deceased employee had made a nomination)
• Employee’s Legal heir (if deceased employee had not made any nomination)
• If case of minor legal heir or nominee, the amount of gratuity shall be deposited with controlling authority. Controlling authority deposit/invest the gratuity amount in a financial institution or bank for benefit of minor, as may be prescribed, until such minor attains majority.

How to calculate : Monthly Salaried Employee

Gratuity = Last drawn wages × 15/26 × Completed years of Service (including a part of year in excess of six months)

Note:

Wages = Last Drawn

Month = Period of 26 Days

15 days wages = Last drawn wages × 15/26

However, not everyone receives the same gratuity amount. There are certain gratuity calculation rules which need to be followed to calculate an individual's gratuity.

Recently, the government has formulated the following gratuity calculation rules, based on which the amount is calculated. It is:

Gratuity Calculation= [(Basic Pay + D.A) x15 days x No. of years of service]/26

Gratuity is calculated based on:

• 15 days of wages last drawn by the employee.
• The basic monthly salary is divided by 26, as a whole.
• It is then multiplied by 15.
• If there is an excess period of six months in the individual's service, then it is counted as a year whole.

According to the Government Act, the maximum payable amount for gratuity to an individual is Rs. 20 Lacs. The particular amount is also exempted from any taxation, as per the Income Tax Act. However, the employee is not eligible to enjoy the tax exemption when he/she is in her service term.

What is Gratuity ?

Gratuity is a sum of money paid by an employer to an employee for services rendered in the company. However, gratuity is paid only to employees who complete 5 or more years with the company.

Eligibility Criteria for receive Gratuity :

Following are the few points when you will be eligible to receive gratuity.

1. An employee should be eligible for superannuation.
2. An employee retires.
3. An employee resigns after working for 5 years with a single employer.
4. An employee passes away or suffers disability due to illness or accident.

Gratuity is the collectible amount for an employee, paid as a gratitude by the organization. An individual who has worked in an organization for a minimum period of 5 years is eligible for gratuity. Gratuity calculation is based on his/her average salary, dearness allowance and number of years he / she worked in the organization.

Gratuity Calculation= [ (Basic Pay + D.A) x 15 days x No. of years of service ] / 26

Gratuity is a monetary payment given to an employee who has spent 5 or more years in the same firm. The payment is a kind of bonus which one gets as a recognition. The payment is made only when an employee leaves the co. It is calculated as below

last drawn basic salary * (15/26) * no of years completed

Basically you get ~ 15 days of last drawn monthly basic salary for the each completed years.

This benefit, payable under the Payment of Gratuity Act 1972, is provided by an employer to his/her employee in return of the services rendered by the latter.

Gratuity calculation formula

1. The gratuity calculation formula for individuals covered under the Act mentioned above is - Last drawn salary x 15/26 x years of service.
2. For individuals who are not covered under the Act, the gratuity formula is - Last drawn salary x 15/30 x years of service.

This gratuity amount, so received, can be invested in safer investment options like fixed deposits. With FDs, there are added advantages, such as higher and guaranteed returns, multiple options of periodic payouts, etc.

Gratuity rules and regulations

There are various rules and regulations associated with the gratuity amount that include factors such as –

• Applicability – This amount is paid by an employer solely, and to be eligible for gratuity, an employee must do a minimum of 5 years of service at the existing organisation.

This amount is paid to an employee, in cases of –

1. Retires.
2. Resignations.
3. Superannuation.
4. Rendered disabled due to illness or accident.
5. Death.

• Tax exemptions – Considering the gratuity calculation for private company[1], if the amount does not exceed 15 days of salary for each year of service (as per the last drawn salary slip), the amount is exempted from taxation.

Acknowledging and familiarising one with these details of gratuity payment in India ensures that he/she has a better idea about their future financial plans.

Under the gratuity act 1972, every establishment with more than 10 employees has to provide gratuity to its employees. Once a person works for more than 5 years in an organisation, he/she becomes eligible to receive gratuity.

It is the sum paid to an employee when he/she retires or leave an organisation. The limit on gratuity that can be given to a person is 10 lakhs.

Gratuity amount = (no of years of employment * last drawn salary * 15)/26

Government employees don’t have to pay any tax on gratuity.

Gratuity is given by the employer to an employee for the services rendered by him. It is usually paid at the time of retirement but it can be paid before provided certain conditions are met.

As per Sec 10 (10) of Income Tax Act, gratuity is paid when an employee completes 5 or more years of full time service with the employer(minimum 240 days a year). However, it can be paid before the completion of five years at the death of an employee or if he has become disabled due to accident or disease.

There is no set percentage stipulated by law for the amount of gratuity an employee is supposed to get - an employer can use a formula-based approach or even pay higher than that.

Gratuity payable depends on two factors: Last drawn salary and years of service. To calculate how much gratuity is payable, the Payment of Gratuity Act, 1972 has divided non-government employees into two categories:

a) Employees covered under the Act
b) Employees not covered under the Act

An employee will be covered under the Act if the organisation employees at least 10 persons on a single day in a preceding 12 months. And once an organisation comes under the purview of the gratuity Act, then it will always remain covered even if the number of employees is falls below 10.

The gratuity is paid to an employee on the termination of his employment after he has served for five continuous years. In case of death of the employee, five continuous years of services is not mandatory.

Gratuity Calculation

The Gratuity amount is calculated differently for monthly-rated, piece-rated and seasonal employee. Here are some key points considered for gratuity calculation:

• The wage considered for calculation is the last drawn salary.
• Allowances other than Basic and DA are not considered for gratuity calculation.

Gratuity calculation for monthly rated employees

15 days of wages (Basic + DA) of each year of completed service is considered for calculation. The per-day wage of the employee is calculated by dividing the monthly wage by 26.

Service rendered by the employee for more than six months is considered as one year.

For calculating the per day wage of the employee, the monthly wage (last drawn Basic + Dearness Allowance) is divided by 26 and the result is multiplied by 15 x the number of years of service; i.e.

Gratuity = (Basic + DA) x 15/26 x number of years.

Example: If an employee had joined a job on 01-08-2005 and retired or got his job terminated on 30-04-2019, with last drawn basic Salary of Rs 20,000 and DA of Rs 12000, his Gratuity will be:

(Rs 20,000+Rs 12000)x 15/26 x 14 = Rs 258,461.5

Note: Here the employee has completed 14 years of service. The seven months of his first year (August 2005 to March 2006) is to be counted as one year as it is more than six months of service.

Gratuity calculation for piece rated employee:

In case of such employees, month wage to be considered for gratuity calculation is the average of the total wages he has received for a period of three months immediately preceding the job termination. The rest of the calculation is the same as the monthly rated employees.

Gratuity calculation for seasonal employees

In the case of seasonal employees, 7 days wages for each season of service completed by the employee is considered for calculation. Rest of the formula is same as monthly-rated employees.

For example: If a seasonal employee retires after working from 2005 to 2015, working one season each year, with Rs 10000 Basic and Rs 6000 DA, his gratuity will be

7/26 x (Rs 10000+6000) x 11 = Rs 47,384.6

Note: Here the employee has worked for one season every year. Hence, the total season is 11.