What Is Gratuity in Salary? Calculations and Eligibility Criteria for Gratuity

There are certain benefits to working in one company for a long time. It makes the employer consider you a valuable member of the organisation and gives you access to several employment benefits. 

One such benefit is gratuity, a lump sum amount paid by employers to acknowledge the services of their long-term employees. 

Read along to know everything about gratuity in salary, its calculation and eligibility.  

What Is Gratuity in Salary?

Gratuity is the amount an employer pays to its employee as a sign of thankfulness or gratitude. Employees are eligible to receive gratuity along with their salary only after serving in the same company for 5 consecutive years.

Any public or private sector companies with 10 and more employees must provide gratuity benefits to their employees. The Payment of Gratuity Act, 1972 (Gratuity Act) monitors payments and calculations of gratuity from employers to employees.

Gratuity is payable on superannuation, retirement, resignation, and on death or disablement of the employee due to accident or disease. 

Companies that are not covered under the Gratuity Act can voluntarily offer gratuity to their employees. 

How is Gratuity Calculated?

You can calculate gratuity using this formula:

Gratuity= N * B * 15/26

Here, N is the number of completed years or part of a year in excess of 6 months that the employee has served in the organisation. B is the employee’s last drawn basic salary (including any dearness allowance).

There is another variation of the gratuity formula for employers who do not fall under the Gratuity Act. For employees of such employers, gratuity is calculated using the employee’s half-month salary based on the average of the last ten months’ salary.

Therefore, the new formula for calculating gratuity becomes

Gratuity= (15 * average of the last ten months salary * working tenure)/30

Also Read: Are Retirement Benefits Taxable?

Calculation of Gratuity with Example

Let’s understand the calculation of gratuity with this easy example.

Mr Kumar has worked in ABC Pvt Ltd for 17 years. His last drawn basic salary with dearness allowance was ₹30,000. The amount of gratuity that he would be eligible to receive would be:

Gratuity= N * B * 15/26

= 17*30,000*(15/ 26)

= ₹2,94,230 (approx.)

Now, let’s assume another scenario of gratuity calculation where Mr Sharma works in a company not covered under the Gratuity Act. He has received a basic salary of ₹30,000 for the last 10 months and has worked for this company for 7 years. We will use the following formula to calculate the gratuity amount.

Gratuity= (15* average of the last ten months’ salary*working tenure)/30

Gratuity= (15*30,000*7)/30 

= ₹1,05,000

What Are the Eligibility Criteria for Receiving Gratuity?

Employees meeting the following criteria are eligible to receive gratuity.

• A retiring employee
• An employee who has resigned
• An employee eligible for superannuation
• When an employee passes away or becomes disabled due to illness or an accident

The minimum eligibility for any employee to receive gratuity in cases of retirement, resignation or death is a continuous service of 5 years under the same organisation. In case of death or disablement due to illness or accident, gratuity is payable even if the employee has not rendered continuous service for 5 years.

What Are Some Important Rules of Gratuity?

Every employee must keep in mind these essential rules regarding gratuity payments under the Gratuity Act:

1. Limit of compensation

According to the Gratuity Act, the amount of gratuity that employers have to pay should be worth at least 15 days of salary for each completed year of service rendered. If an employee has rendered service in excess of 6 months in the final year, that year is considered as a whole for the purpose of calculating gratuity. Employers can pay more, but the total amount should be less than ₹20 lakh. Any excess amount would be treated as ex-gratia and not eligible for tax exemption.

2. Forfeiture of gratuity

The Gratuity Act empowers employers to totally or partially forfeit an employee’s gratuity, despite 5 or more years of continuous service rendered. An employer can forfeit gratuity if the employee is proven of any wrongdoing or is terminated from service. Also, employers can forfeit gratuity if they physically harm or attempt to harm another employee. 

3. Steps to claim gratuity

If you are eligible to receive gratuity, you can follow these steps:

• You can request gratuity by submitting an application to your employer.
• The employer will acknowledge the application and calculate the gratuity amount. Following this, the employer will forward a notice to you and the controlling body constituted under the Gratuity Act mentioning the gratuity amount.
• The employer will arrange to pay the amount of gratuity within 30 days from the date it becomes payable.

How is Gratuity Taxed?

Gratuity received by an employee in excess of the exemption provided under section 10(10) of the Income-tax Act, 1961, is taxable under the head ‘Salaries’. 

Gratuity received during employment is not eligible for any tax exemption. However, gratuity received on resignation, retirement, superannuation, death or disablement is eligible for tax exemption. The exemption provided under the Income-tax Act for different categories of employees are as follows:

• All government employees are exempt from tax on gratuity without any upper limit.
• For employees covered under the Gratuity Act, the least of the following amounts are eligible for tax exemption:

1. 15 days salary (Basic + DA) each completed year of service or part of the year in excess of 6 months;
2. ₹ 20,00,000; or
3. Amount of gratuity actually received.

• Employees who receive gratuities from organisations not covered under the Gratuity Act are also eligible for a tax exemption to the extent of least of the following amounts:

1. Half month’s salary (Basic + DA) for each completed year of service, on the basis of the average salary for the last 10 months;
2. ₹ 20,00,000; or
3. Amount of gratuity actually received.

Final Word

Gratuity is a one-time monetary benefit that an employer pays employees in recognition of their service. Using the above gratuity on salary formula will help employers calculate the gratuity amount for their employees. However, the manual calculation might seem time-consuming and inaccurate. One can use various gratuity calculators available online to get accurate answers quickly. 

Frequently Asked Questions