Gratuity – Check Gratuity Calculation and Meaning
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. It can be understood as a form of tip paid by the employer to the employee for services offered in the company
How does Gratuity Payment Work?
An employer may offer a gratuity to his/her employees from his/her own pocket or may take a group gratuity plan with an insurance provider. Annual contributions are then paid by the employer to the insurance provider for this. The employee too can contribute to his/her gratuity amount. The gratuity paid by the insurance company is based on the clauses in the group insurance scheme.
Payment of Gratuity Act, 1972:
The payment of Gratuity Act was passed in the year 1972 and covers employees engaged in mines, factories, oil fields, plantations, companies, ports and other such establishments which have more than ten employees. The gratuity amount, unlike provident fund, is totally paid by the employer without any contribution from the employee.
Eligibility Criteria for Gratuity Payment:
Following are the few instances when you will be eligible to receive a gratuity.
- An employee should be eligible for superannuation
- An employee retires
- An employee resigns after working for 5 years with a single employer
- An employee passes away or suffers disability due to illness or accident
The formula for Calculation of Gratuity Amount:
Listed below are the components that go into the calculation of gratuity amount. The amount is also dependent upon the number of years served in the company and the last drawn salary.
If,
N = number of years of service in a company
B = last drawn basic salary plus DA
then,
Gratuity = N*B*15/26
Taxation Process of Gratuity:
The taxation process for gratuity depends upon the employee who is receiving the gratuity amount. Two standard cases arise for the calculation of tax on gratuity:
- Government Employee Receiving Gratuity Amount:
In case any employee under the state government, central government or local authority receives gratuity amount than the amount is fully exempt from Income Tax.
- Any Other Salaried Individual Receiving Gratuity Amount from an Employer who is Covered by Payment of Gratuity Act:
In case of gratuity received by any employee whose employer is covered under the Gratuity Act, the following amount is exempt from tax.
- 15 days salary as per the last drawn salary of the individual
- Any Other Salaried Individual Receiving Gratuity Amount from an Employer who is not Covered by Payment of Gratuity Act:
In such a case the least of the following three amounts are exempt from tax.
- Rs.10,00,000
- Gratuity actually received by the employee
- Half month’s salary for every year of service that the employee has completed with the employer
Gratuity Rules
Forfeiture of Gratuity
According to the Payment of Gratuity Act of 1972, an employer holds the right to forfeit their gratuity payment, either wholly or partially despite the employee having completed 5 and more years of service in a company. The only situation where this works is when the employee has been terminated due to disorderly conduct wherein he/she tries to physically harm individuals during the course of his/her employment.
Timeline for Gratuity payment
There are three steps involved regarding gratuity payment. These include:
- Initiation: An individual or a person authorized must send in an application to an employer regarding the gratuity he/she is owed by a company.
- Acknowledgment and calculation: As soon as the application is received, the company which owes gratuity will calculate the amount and also provides a notice of the same to the individual and the controlling authority with the amount specified.
- Disbursal: The employer, having sent the acknowledgment, has a time period of 30 days to pay the gratuity amount to the individual.
Tax exemptions on gratuity for Assessment Year 2016-17
Based on the policy changes made during the 2016 budget, here’s what gratuity laws look like:
- According to Article 10 (10) I of the Income Tax Act, any gratuity received by government employees, apart from statutory corporations, is fully exempt of tax.
- According to Article 10 (10) ii of the Income Tax Act, death, and retirement gratuity receivable by an employee covered under Gratuity Act 1972 is the least amount of the following that is exempt from tax:
- (*15/26) X Last drawn salary** X completed year of service or part thereof in excess of 6 months.
- Rs.10 lakhs.
- Gratuity amount that is actually received.
* 7 days in case an individual is an employee of a seasonal establishment.
** Salary amounts to the total salary received by an employee including Dearness Allowance and excluding any other benefits like bonus, HRA, commission, and any other such perquisites.
- According to Article 10 (10) iii of the Income Tax Act, exemption for gratuity amount received by individuals who are not covered under the Gratuity Act of 1974 are as follows:
- Half month’s Average Salary* X Completed years of service
- Rs. 10,00,000 3. Gratuity actually received.
*Average salary = Average Salary of last 10 months immediately preceding the month of retirement ** Salary = Basic Pay + Dearness Allowance (to the extent it forms part of retirement benefits)+ turnover based commission
Few Significant Points about Gratuity:
Following are some of the most prominent points about payment of gratuity by an employer to an employee.
- An employee can receive a gratuity amount higher than Rs.10,00,000 from his/her employer, the exemption for tax in this case will be calculated as per the points listed above under taxation.
- The employer has the right to reject payment of gratuity to an employee if he/she has been asked to leave his/her job owing to any misconduct.
- In case of death of the employee, the nominee or heir of the employee is paid the gratuity amount. The taxation for this is calculated for the receiver under the head – income from other sources.
