Gratuity and Its Features as per Payment of Gratuity Act 1972

Have you ever taken a closer look at your salary slip If yes, you must have observed that It has many components such as HRA, D.A. (for government employees only), etc. We have already discussed about HRA in our previous article House Rent Allowances or HRA and its calculation.

In this article we will try to understand Gratuity.

Gratuity and Its Features as per Payment of Gratuity Act 1972

What is Gratuity

A Gratuity is an amount which is given by an employer (organisation) to his employee for providing his services to the organization continuously for a period of 4 or 5 years. An employee can receive Gratuity amount in cash, cheque or in the form of demand draft.

Conditions To Get Gratuity: There are 2 conditions that are prerequisite to get Gratuity benefit. These 2 conditions have been discussed below:

1- Your company or organization must have atleast 10 people on payroll which means minimum 10 people must be receiving salaries from your company. Remember that people working on contract basis are not eligible for Gratuity benefit.

2- You must have completed atleast 5 years with your company. However, there is a relaxation for this 5-years rule; if employees dies or becomes disable to perform his job even within 1st year of his services he is entitled to get this Gratuity benefit given that first condition is met.

Payment of Gratuity Act 1972- Rules and Regulations

As per law, an employer is required to arrange payment of Gratuity amount within 30 days from the date it becomes payable meaning an employee retires or his employment gets terminated ( in the event of death or disability due to accident). In the event of death Gratuity amount is paid to nominee.

If the employer doesnt pay gratuity in specified period then the employer is needed to pay simple interest on Gratuity amount to be paid at the rate in coherence guidelines laid out by central govt.

Gratuity received by Central and State Government Employees are fully (max limit 20 lakh) exempted from Income Tax. Gratuity received by private sector employees are exempted from Income Tax for upto Rs.20 lakhs.

Note: Gratuity Act 1972 follows the rule of Once covered always, always covered which means an organization will come under the effect of this act if it has atleast 10 employees on any single day in last 12 months. It also means if a company once comes under this act it will always remain covered even if the employees count falls down to less than 10.

You May Also Refer : House Rent Allowances or HRA and its calculation

How Do We Calculate Gratuity

Gratuity payable to an employee depends on 2 factors .i.e 1-Last drawn salary and 2- No. of years of service.

Payment of Gratuity Act, 1972 has divided non-government employees into two categories:

A) Employees covered under the Act: An employee is said to be covered under this act if the organization he works for has atleast 10 people on payroll ( not on contract) on any single day in last 12 months.

Formula: Formula to calculate Gratuity is based on last drawn salary for 15 days in each completed year of service, mathmatically we can represent it as:

(15 X last drawn salary X tenure of working) 26

Here last drawn salary means basic salary, and commission received on sales (if any) and D.A.

Lets understand this with a simple example: Suppose Viveks last drawn salary (including D.A.) is Rs 40,000 per month and he has worked with ABC Ltd. for 11 years and 7 months. In this case, using the formula above, gratuity will be calculated as: (15 X 40,000 X 12)/26 = Rs. 2.76 lakh approx.

In the above example, we have taken 12 years as service instead 11 years and 7 months because we rounded-off the years, we do so as per law. Had it been 11 years and 5 months, we would have taken it 11 years only.

B) For employees not covered under the Act: Employees who are not covered under this Act, their Gratuity amount is calculated using the below formula.

(15 X last drawn salary X tenure of working) divided by 30

In the above mentioned example, if Viveks organisation is not covered under the Act, then his gratuity will be calculated as:

(15 X 40,000 X 12) /30 = 2.40 lakh

Tax Benefits of Gratuity

Any gratuity amount received by an employee be it govt or private employee During his service is taxable. However, when gratuity is received by the employee at the time of his retirement, death or superannuation then tax exemption rules for government employees differs from private employees.

You May Also Refer : Tax Free Gratuity Limit increased to Rs 20 Lakhs [Read Notification]

Lets have a look at the below situations

A. Any Gratuity received by, defense employees and employees in local authority , Central and State Government employees During death or retirement is completely tax-free.

B. Private Sector employees who are covered under the Payment of Gratuity Act 1972 is exempted up to the least of the following-

1. Actual Gratuity received

2. Rs 20 Lakh

3. Last drawn salary*15/26*Number of years of service

C. Private sector employees who are NOT covered under the Payment of Gratuity Act 1972 is exempted up to the least of the following-

1. Rs 20 Lakh

2. Actual Gratuity received

3. Average salary * (1/2*Number of years of service)

List of forms used for Gratuity Treatment

Form I-Application for the payment of Gratuity

Form J-Application for the payment of Gratuity for nominee

Form K-Application for the payment of Gratuity for legal heirs .

Form F-Nomination Form

Form G-To make a fresh nomination Form

H-Modification of the nominee

Form L-Issued by the employer to the employee stating amount and date of payment.

Form M-Issued by employer stating reasons for rejection.

I have tried to cover as much information as much I could in this article, hope this proves helpful for you to have understanding of Gratuity.

This Article has been Authored by Mr Satish Gupta. The Author of this article can be contacted at [email protected]