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Gratuity is a retirement benefit that is tax-free subject to certain rules. However, people often get confused about the various aspects of it. So in this article, we will discuss the meaning, eligibility criteria, rules, and calculation of gratuity.

What is gratuity?

• Gratuity is essentially a lump sum payment that the employer gives to the employee.
• The employer gives it at the time of retirement or leaving the job.
• The employer gives gratuity as a mark of recognition of the employee’s service.
• It is a defined benefit plan.
• The gratuity amount depends on the tenure of service, and the last drawn salary.

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What is the eligibility criteria for receiving gratuity?

• An employee is eligible to receive gratuity only if he or she has completed a minimum of 5 years of continuous service.
• 6 or more months are counted as 1 year.
• Hence, you are eligible to receive gratuity if you have completed 4 years and 7 months of service.
• The term ‘continuous service’ allows for certain interruptions.
• For example – interruptions due to leave, illness, accident, strike, layoff or lock-out.
• So an interruption which isn’t caused because of the fault of the employee isn’t considered a break in service.

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Gratuity Rules

It is important to understand the following gratuity rules in India:

Number of Employees

• Every employer employing more than 10 employees has to give the gratuity to its employees.
• The number of employees is calculated by taking the average of the last 12 months.
• Gratuity rules apply to both government as well as private-sector employees.

After Termination of Employment

• The employer gives gratuity only after termination of employment.
• The termination may be because of retirement or leaving the job.

In Case of Death or Disablement

• The minimum 5-year rule is not applicable in the case of death or disablement.
• In such a case, the gratuity amount is given to the nominee or legal heir.

Protected against Liabilities

• A court cannot attach the gratuity amount in case of a decree against the employee.
• This applies to civil as well as criminal courts.

Forfeiture of Gratuity

• If the employee makes a loss to the company, then the employer can forfeit gratuity.
• The forfeiture of the gratuity amount would be to compensate the loss.
• However, in such a case, the employer must terminate the services of the employee because of the loss.

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Is gratuity taxable?

In general, gratuity is tax-free. But there are certain rules regarding it.

Gratuity Tax Rules:

Tax-free Amount

• The gratuity amount is non-taxable if it is given according to the prescribed formula.
• However, there is a limit of Rs.10,00,000 for tax exemption for private sector employees.
• If the gratuity amount is over the limit, the employee has to pay tax on the excess.

Tax on Excess Gratuity

• An employer can give gratuity that is more the amount of the prescribed formula.
• The excess amount is taxable.

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Calculation of Gratuity Amount according to Formula

There is a fixed formula for calculating gratuity.

• As per the formula, the employer must give 15 days’ salary for every completed year as the gratuity.
• Every month is considered to have only 26 days.
• Hence the gratuity amount per year is 15/26 of one month’s salary.
• In percentage, the gratuity amount per year is 57.69% of monthly salary.

To calculate the net gratuity amount, use the following formula:

Salary Calculation

• Salary (for gratuity calculation) includes basic salary, dearness allowance, and commission.
• The last drawn salary is taken into account for gratuity calculation.
• For daily wage earners, the average of last 3 months’ daily wage is considered as one day’s salary.

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Hopefully, this article has helped you understand the basics of gratuity. If you have any questions, please comment below.

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