Gratuity

In many situations, when an employee has given significant time to the employer and they together achieved something great for the company - this person is often rewarded with gratuity. One must remember that while it's typical for people to receive gratuity at their retirement time, sometimes they can also get it in the years of active employment.

This article gives information about what gratuity is, its associated benefits and laws connected to it. We also talk about who can get gratuity, how it is calculated and if one needs to pay tax on the amount received.

What is gratuity?

Gratuity means the payment an employer gives to an employee as appreciation for their work and time. Usually, it is handed out when there is a long period of honorable service by the worker which goes beyond just normal paychecks. Many times, gratuity represents a part or fraction of all salary/wage that has been earned over complete employment length up until now by this same individual.

What are the benefits associated with gratuity?

Since gratuity is additional payment an employee receives in appreciation of their service, there are numerous benefits associated with the same. The first and foremost benefit being that it is a formal recognition of the employee’s hard work.

Another benefit is that it can help boost the company’s team morale and motivate them. This in turn helps reduce the total staff turnover and helps the company retain employees.

What are the laws related to gratuity?

The payment of gratuity is a custom in many lands, and the laws for this payment are not the same everywhere. In United States, it is not mandatory for bosses to give gratuity to their workers. But if they choose so, there are particular conditions that must be fulfilled by these US companies.

The gratuity concept started in India after the Act of 'Payment of Gratuity' was passed by Parliament during 1972. Another important point to note is that this act covers all factories, mines, railways, oilfields and plantations along with ports too. Shops or establishments employing around ten or more people for a year prior are also subjected to this rule. Companies that are not covered under this act are not mandated to pay gratuity and can choose to disburse it at their own accord.

What is the eligibility criteria for gratuity?

The Payment of Gratuity Act, Section four states that organisations have to mandatorily pay gratuity to all terminated employees who have worked continuously for 5 years. Accepted reasons for termination include:-

1. Employee’s superannuation
2. Resignation or retirement
3. Due to death
4. Due to disablement owing from accident or illness

How to calculate gratuity?

Generally, employees use an external gratuity calculator for calculating gratuity. We will list the process here so that you can do it yourself.

Note - the formula for calculating gratuity is dependent on the act and varies based on it.

Calculating gratuity for employees covered under the Payment of Gratuity Act 1972

Gratuity = Last Drawn Salary Number of Completed Years of Service 15 26
Where, Last Drawn Salary = Basic Salary + Dearness Allowance
Calculating gratuity for employees not covered under the Payment of Gratuity Act 1972
Gratuity = Average Salary of Last 10 Months Number of Completed Years of Service 1 2

Is gratuity taxable?

Now, the last question - is gratuity taxable? According to the Section 10 (10) of the Income Tax Act, gratuity is tax-free for government employees and those employed by local authorities.

However, gratuity is taxable for non-government employees with a few thresholds applicable. For them, the lowest of either of these following amounts would be tax-free:-

1. The actual gratuity received
2. Last Drawn Salary * 15/26 * Completed Years of Service
3. Maximum amount of INR 20,00,000