Gratuity is your organisation’s way of acknowledging and rewarding you for your service. If you’re up for gratuity in a few months’ time, here’s how you can check if you’re receiving the right amount.
An employee is paid gratuity by his/her employer for services rendered to a company. However, one is eligible for gratuity only if he/she has completed 5 years in the said organisation. Gratuity can be viewed as an organisation’s way of acknowledging and rewarding an employee for the years services put into the company. Gratuity amount varies across countries and employers.
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How does gratuity payment work?
An organisation can pay gratuity to its employees from its own pocket or may take a group gratuity plan with an insurance provider. The organisation makes annual contributions to the insurance provider for this. Based on the clauses in the group insurance scheme, the insurance company pays the gratuity. The employee too can contribute to his/her gratuity amount.
What does the law say?
Individuals who are employed in mines, factories, oil fields, plantations, companies, ports and other such establishments that have more than 10 employees fall under the purview of the Payment of Gratuity Act that was passed in the year 1972. Unlike the Provident Fund that is partially paid by the employee, gratuity doesn’t involve any contribution from the employee.
Additional reading: When Will You Get Gratuity Payment?
Eligibility criteria for gratuity payment:
One is eligible for gratuity payment if he/she meets one of the following conditions:
- The employee is eligible for superannuation.
- He/she retires.
- The worker resigns after working for 5 years with a single employer.
- The employee passes away or suffers disability due to illness or accident.
How to calculate gratuity?
Interestingly, the Act doesn’t stipulate the amount that an employer can pay to its employee as a gratuity. Often, a formula is used to calculate the amount payable to an employee. The employer, however, can pay an even higher amount than that. Two factors determine the payable gratuity amount: last drawn salary and years of service.
There are two categories of gratuity payment. This is for the purpose of calculating how much gratuity is payable to a non-government employee:
- Employees covered under the Act.
- Employees not covered under the Act.
An employee will fall under the purview of the Act if the organisation employs at least 10 individuals on a single day in the preceding 12 months. But once an organisation comes under the purview of the Gratuity Act, then it will always remain covered even if the employee count falls below 10.
Additional reading: Gratuity Act And Its Impact
Calculation of gratuity for employees covered under the Act
For employees covered under the Act
Following are the elements that go into calculating the total gratuity payable to employees covered under the Act:
A=no. of years of service in a company
B=last drawn basic salary plus Dearness Allowance (DA)
As an illustration, if Arun is a business analyst who’s worked with a consulting company for 20 years and had Rs. 50,000 as his last drawn basic plus DA amount, then,
Gratuity amount for Amit=20*50,000*15/26= Rs. 5, 76, 923.
Here, the last drawn salary means basic salary, dearness allowance, and commission received on sales.
2. For employees not covered under the Act
An organisation can still pay gratuity to it employees even if it doesn’t fall under the purview of the Act. The elements which go into the formula for calculating the gratuity payable for employees not covered under the Act are as follows:
A=no. of years of service in a company
B=last drawn salary plus DA
Considering the example of Arun above, if his organisation didn’t fall under the purview of the Act, then he would receive the following amount as gratuity:
Gratuity amount for Amit=20*50,000*15/30=Rs. 5,00,000.
An employer, however, can choose to pay a gratuity amount that is higher than the amount that this formula calculates. The govt. has recently revised the cap on this amount to Rs. 20 lakhs. This will be applicable to employees of the private sector, public undertakings, and autonomous organisations under the govt not covered under Central Civil Services (Pension) Rules. This puts them on par with central government employees.
Taxation treatment for gratuity received:
The amount of tax that will be levied depends on the employee who will be receiving the gratuity amount. Three kinds of scenarios may arise in this regard:
- Government employee receiving the gratuity amount: In case any employee under the state government, central government or local authority receives a gratuity amount from his employer, then the amount is fully exempt from Income Tax.
- A salaried individual receiving gratuity amount from an employer who is covered by the Payment of Gratuity Act: In case any employee whose employer is covered by the Gratuity Act, receives a gratuity, only the following amount is exempt from tax: 15 days salary as per the last drawn salary of the individual.
- A 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 is exempt from tax:
- The actual gratuity that the employee receives
- Half month’s salary for every year of service that the employee has completed with the employer
Gratuity is a benefit provided by the employer that can provide social security to individuals post-retirement. An employer rewards its employees for their service with a gratuity payment that will come to their financial rescue during retirement.
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