Gratuity Rules

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Introduction

Gratuity Rules is a financial reward offered by employers to employees as a sign of appreciation for their dedicated service over some time. The Payment of Gratuity Act, of 1972, governs gratuity payments in India, mandating certain eligibility criteria and calculation methods to ensure fair distribution.

What is Gratuity?

Gratuity refers to a lump sum payment provided by employers to employees who have completed a specified duration of service. Under the Payment of Gratuity Act, of 1972, the gratuity rules apply to various entities, including private companies, central and state government departments, defense organizations, and local governing bodies. Private organizations can also be covered under this act, provided they meet specific eligibility requirements.

You may also want to know Section 43B

Key Gratuity Rules and Conditions for Eligibility

Here are the essential rules regarding gratuity eligibility and its calculation:

1. Applicability of Gratuity Based on Employee Count

Organizations with a workforce of 10 or more employees on any single day in the previous 12 months are required to pay gratuity. If a company’s employee count subsequently falls below 10, it remains liable to pay gratuity to eligible employees as per the Act’s provisions.

2. Service Tenure Requirement

To qualify for gratuity, an employee must complete five years of continuous service with the employer. However, this requirement is waived in cases of employee death or disability. For service calculation, a single year equates to 240 working days (non-underground work) or 190 days (underground work), and the five years may include breaks caused by factors like strikes, layoffs, or leaves.

3. Gratuity Eligibility on Events Beyond Retirement

Under Indian gratuity rules, employees are eligible for gratuity upon:

Retirement or resignation
Death or disability due to illness or accident
Layoff or voluntary retirement

4. Gratuity Calculation Methods

The gratuity amount depends on the employee’s last drawn salary and years of service, with different formulas applied based on whether the employer falls under the Payment of Gratuity Act.

a. Calculation for Employees Covered Under the Act

The formula for gratuity calculation under the Act is:

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

For instance, if an employee has a last drawn salary of ₹77,000 and has served 13 years, their gratuity will be:

Gratuity=15×77000×13/26=₹5,77,500

b. Calculation for Employees Not Covered Under the Act

The formula for gratuity calculation for employees not covered by the Act is:

Gratuity=15×Average Salary (last 10 months)×Years of Service/30

For example, if an employee with an average last 10-month salary of ₹92,350 served 15 years, their gratuity would be:

Gratuity=15×92350×15/30=₹6,92,625

You may also want to know Section 194C – TDS on Payment to Contractor

5. Situations Where Gratuity Can Be Forfeited

An employer has the right to forfeit an employee’s gratuity if the employee was terminated due to:

Misconduct involving moral turpitude
Destruction of employer property
Riotous behavior or violent actions

6. Gratuity Obligation During Bankruptcy

Even if an organization declares bankruptcy, it is still liable to pay gratuity to eligible employees, and no court order can override this.

7. Tax Exemption on Gratuity Payment

Gratuity up to ₹20 lakh is tax-exempt for employees in organizations covered under the Payment of Gratuity Act. Previously, this limit was ₹10 lakh but was raised to ₹20 lakh in 2021.

8. Tax Applicability Differences for Covered and Non-Covered Employees

Covered employees can enjoy tax exemption on the least of:

Actual gratuity amount received
₹20 lakh threshold
15 days’ pay for every completed year of service

Non-covered employees are also eligible for tax exemptions but may have different calculations based on their salary structures and organization-specific rules.

9. Cumulative Tax Exemption Limit of ₹20 Lakh

The ₹20 lakh tax exemption on gratuity is cumulative. For example, if an employee receives ₹17 lakh in gratuity from one employer and then ₹5 lakh from another, only ₹20 lakh is tax-free; the remaining ₹2 lakh is taxable.

10. Tax-Free Gratuity to Legal Heirs

If an employee passes away, the gratuity paid to the widow or legal heir is entirely exempt from tax. Any additional ex-gratia payment made due to injuries is also tax-free.

Conclusion

Gratuity is a crucial component of employee benefits in India, offering financial security after retirement or in times of need. By understanding the rules outlined in the Payment of Gratuity Act, employees can ensure they maximize their benefits and employers can maintain compliance.