Gratuity Calculation Guide – Payroll Simplified

Do all employers come under the ambit of the act?

All entities and departments that fall under the below-mentioned are covered

• Central Government
• State Government
• Defence
• Local governing bodies

In the private sector, organisations with ten or more employees are covered under the act and are liable to pay Gratuity. The law will attract once the employee count crosses ten or more at any point in time during the preceding 12 months. After that, even if the number of employees falls below 10, the organisation will still be covered by the act’s regulations.

Do all employees come under the purview of the act?

Once the act covers an organisation, all employees working for the organisation are also covered. There is no differentiation in terms of class of employees or based on salary limits per se.

However, the employee has to render a minimum of five continuous years of service to the organisation. This condition is relaxed in situations of demise, disablement, or incapacitation of an employee to render services.

In other words, a person is eligible to receive Gratuity only if he has completed a minimum of five years of service with an organisation. However, it can be paid before the completion of five years upon death, disablement, etc.

Here, five years of continuous service means:

For organisations involving work underground (mines etc.): 1 year is considered 190 working days.

Other organisations: 1 year is considered as 240 working days.

Five years of continuous service includes:

• Interruptions caused by strike, lockout, accident, layoff
• Termination of service not on the part of an employee.

Calculation of Gratuity

The calculation of Gratuity is based on two factors:

• Years of service rendered in the organisation
• Employees last drawn salary

The calculation also differs for:

• Employees covered under the act
• Employees not covered under the act

Calculation of gratuity for employees covered under the act:

Gratuity = (15 x Last drawn salary x Number of completed years of service) / 26

Here,

· The last drawn salary is made up of basic pay and dearness allowance. Any other component of income will not be included in the salary calculation.

· Completed years of service include any year where an employee has served for more than 6 months. That is,

· 10 years 5 months considered as = 10 years

· 10 years 6 months considered as = 11 years

· 10 years 11 months considered as = 11 years

Example: Employee1 works for an organisation for 6 years and 9 months, and the last drawn salary is Rs.50,000. Gratuity payable will be:

(15 x 50,000 x 7) / 26 = Rs.2,01,923.

Calculation of gratuity for employees Not covered under the act:

Gratuity = (15 x Average salary for the last 10 months x Number of years of service) / 30

Here,

· The last drawn salary is made up of basic pay, dearness allowance and turnover based commission. Any other component of income will not be included in the salary calculation.

• Number of years of service mean only completed years. That is,

· 10 years 5 months considered as = 10 years

· 10 years 6 months considered as = 10 years

· 10 years 11 months considered as = 10 years

Example: Employee2 works for an organisation for 6 years and 9 months, and the average salary drawn for the last 10 months is Rs.50,000. Gratuity payable will be:

(15 x 50,000 x 6) / 30 = Rs.1,50,000.

Taxation of Gratuity

Section 10(10) of the Income Tax Act,1961 provides exemptions with respect to Gratuity:

A. Received during employment, that is, while still in employment: Fully taxable for both Government employees and Non- Government employees.

B. Received at the time of retirement or after retirement:

1. Retirement gratuity received under the Pension Code Regulations applicable to members of the Defense Service is fully exempt from tax.

2. Employees of Central Government/ Members of Civil Services/ local authority employees: Any death-cum-retirement gratuity is fully exempt from tax under section 10(10)(i).

3. Other Employees:

• Employees covered by the Payment of Gratuity Act, 1972:

Taxable Gratuity= Gratuity received - Amount exempt u/s 10(10).

Amount exempt u/s 10(10) = Least of the following:

i) 15/26 x Salary p.m x No. of years of completed service.

ii) Actual amount received

iii) Threshold Rs.20 lakh.

• Employees Not covered by the Payment of Gratuity Act, 1972:

Taxable Gratuity= Gratuity received - Amount exempt u/s 10(10).

Amount exempt u/s 10(10) = Least of the following:

i) 1/2 x Average Salary p.m x No. of years of completed service.

ii) Actual amount received

iii) Threshold Rs.20 lakh.

When is Gratuity payable?

In terms of tenure, an employee is eligible for Gratuity upon rendering a minimum of five continuous years of service to the organisation. However, an employee is also eligible to avail Gratuity upon –

• Death
• Retirement
• Resignation
• Voluntary Retirement Scheme

· Disablement due to an accident or disease

• Lay off due to retrenchment

· Incapacitation of an employee to be able to render services

· Termination for a fault not on the part of the employee

Also,

· An eligible employee for Gratuity can submit an application within 30 days from the date it becomes payable.

· Claim for a gratuity cannot be said invalid, merely because the claimant did not apply within the stipulated time.

· The employer will have to specify the gratuity amount, within 15 days from the date he receives the application.

· The gratuity amount must be paid within 30 days of the employer receiving the application form.

· If the payment is not made within the said time, Gratuity will then be payable along with simple interest.

Forfeiture of Gratuity

Employers can forfeit to pay Gratuity payable of an employee who has been terminated for the following reasons –

• Committing an offence involving moral turpitude
• Riotous or disorderly conduct or any other violent act
• Where the termination was for a fault on the part of the employee

Additional Pointers

• Gratuity received during the period of service is fully taxable.

· Where Gratuity is received from 2 or more employers in the same year, then the aggregate amount of Gratuity exempt from tax cannot exceed Rs.20,00,000.

· Where Gratuity is received in any earlier year from a former employer and again received from another employer in a later year, the limit of Rs.20,00,000 will be reduced by the amount of Gratuity exempt earlier.

The exemption in respect of gratuities would be available even if the Gratuity is received by the widow, children or dependents of a deceased employee.

• There is no set percentage stipulated by law for the amount of Gratuity an employee is supposed to receive. The employer can use a formula-based approach for the calculation or even choose to pay an amount higher than that.
• Gratuity amount due to the eligible employee is payable even if the employer is bankrupt.