What is the Rule of Gratuity?

Gratuity is a significant component of employee benefits in India, aimed at providing financial security to employees after years of dedicated service. It serves as a reward for long-term association and loyalty towards an organization. Governed by the Payment of Gratuity Act, 1972, gratuity is a statutory right for employees, ensuring they receive a lump sum amount at the end of their employment. However, many employees and employers often find the rules around gratuity confusing. This comprehensive guide aims to clarify what gratuity is, its calculation, eligibility, tax implications, and much more.

Understanding Gratuity

Gratuity is a lump sum payment made by an employer to an employee as a token of appreciation for continuous service. It is typically given at the time of retirement, resignation, or any other form of termination. The Payment of Gratuity Act, 1972, makes it mandatory for organizations with 10 or more employees to provide gratuity benefits.

Gratuity is not a discretionary benefit; it is a statutory obligation that employers must fulfill. However, there are specific rules governing eligibility, the calculation method, and payment processes.

Eligibility Criteria for Gratuity

For an employee to be eligible to receive gratuity, certain conditions must be met:

1. Continuous Service of Minimum 5 Years:
   • The employee must have completed a minimum of five years of continuous service in the same organization.
   • The only exception to this rule is if the employee dies or becomes disabled due to accident or illness, in which case the gratuity is paid irrespective of the duration of service.
2. Type of Employment:
   • The employee must be working on a full-time basis and can be either permanent or on a contract.
   • Daily wage workers are also eligible, provided they meet the continuous service requirement.
3. Applicability to Organizations:
   • The Payment of Gratuity Act applies to organizations with 10 or more employees, including factories, mines, oilfields, plantations, ports, and shops or establishments.

How is Gratuity Calculated?

Gratuity calculation is straightforward and depends on the employee’s last drawn salary and the years of service. The formula for calculating gratuity is:

Gratuity = (Last Drawn Salary × Years of Service × 15) / 26

• Last Drawn Salary: It includes basic salary and dearness allowance.
• Years of Service: The service period is rounded up to the nearest year. For instance, if an employee has worked for 5 years and 7 months, the service period will be considered as 6 years. If it is less than 5 years and 6 months, it is rounded down to 5 years.
• 15/26 Factor: The number 15 denotes 15 days of salary for each year of service, and 26 represents the number of working days in a month.

Let’s consider an example to understand the calculation better:

Example: If an employee’s last drawn salary (including basic and DA) is ₹50,000 per month, and they have completed 10 years of service, the gratuity would be:

Gratuity = (₹50,000 × 10 × 15) / 26 = ₹2,88,461.53

So, the employee will receive ₹2,88,461 as gratuity.

Payment of Gratuity

1. Timing of Payment:
   • Gratuity should be paid within 30 days from the date it becomes due. If there is a delay, the employer is liable to pay interest as prescribed under the Act.
2. Nomination Process:
   • Employees should nominate a family member as the beneficiary of their gratuity in case of death. This nomination must be made within the first year of employment.
3. Gratuity on Resignation:
   • If an employee resigns after completing 5 years of service, they are entitled to gratuity. However, if an employee is terminated due to misconduct, the employer has the right to forfeit gratuity.
4. Gratuity on Retirement or Death:
   • In the case of retirement, the employee receives the full gratuity amount as per the calculation.
   • If an employee dies during service, the gratuity is paid to the nominee or legal heir, even if the employee did not complete 5 years of service. The amount payable in case of death is higher and calculated based on the number of years the employee might have worked had they continued.

Tax Implications of Gratuity

Gratuity received by employees is subject to certain tax exemptions under the Income Tax Act, 1961. The tax treatment depends on the type of employee:

1. For Government Employees:
   • Gratuity received by government employees is fully tax-exempt.
2. For Non-Government Employees Covered under the Gratuity Act:
   • The maximum exemption limit is ₹20 lakhs. Any gratuity amount exceeding ₹20 lakhs is taxable.
3. For Non-Government Employees Not Covered under the Gratuity Act:
   • The least of the following three amounts is exempt from tax:
     1. Actual gratuity received.
     2. ₹20 lakhs.
     3. Half month’s salary for every completed year of service.

Forfeiture of Gratuity

Gratuity can be partially or wholly forfeited if an employee is terminated due to misconduct or acts of moral turpitude. The employer must justify the forfeiture and provide valid reasons as per the provisions of the Gratuity Act. Examples of such misconduct include theft, violent behavior, or damaging the employer’s property.

Gratuity vs. Provident Fund: What’s the Difference?

It is important not to confuse gratuity with provident fund. While both are post-retirement benefits, they differ significantly:

• Gratuity:
  • Paid by the employer.
  • Requires a minimum of 5 years of service.
  • Tax exemption is limited to ₹20 lakhs.
• Provident Fund:
  • Contributions are made by both employer and employee.
  • No minimum service period for eligibility.
  • Tax-free on withdrawal after 5 years of continuous service.

Importance of Gratuity in Employee Welfare

Gratuity acts as a reward for loyalty and long-term service, making it an important part of employee welfare. It ensures that employees have a financial cushion at the end of their careers or in case of unexpected events such as death or disability. From an employer’s perspective, offering gratuity enhances employee retention and fosters a positive work culture.

Conclusion

Gratuity is a crucial component of employee benefits, providing financial security to employees after years of dedicated service. Understanding the rules of gratuity, eligibility criteria, and tax implications helps both employees and employers make informed decisions. Ensuring timely and accurate payment of gratuity is not just a legal obligation but a gesture of goodwill that promotes a positive employer-employee relationship.

By adhering to the regulations under the Payment of Gratuity Act, employers can foster a positive work environment, while employees can enjoy the financial benefits of their long-term association with the company.