Gratuity Scheme
This page provides all the details you need to know about the Gratuity Scheme.
Table of Contents
What is Gratuity?
Gratuity is a retirement and loyalty reward scheme for the salaried employees.
Gratuity is a defined benefits scheme in which a lump sum amount will be paid to the employee, by the employer, when he leaves the organisation after serving for certain number of years.
It is more like a reward from the employer appreciating the employee's service.
Gratuity is a part of employee's salary and it is paid by the employer for the services offered by the employee.
History of Gratuity
Before 1972, it was not compulsory for an employer to provide some reward to an employee when he leaves the organisation.
But, in 1972, Government of India came up with Payment of Gratuity Act.
As per this Act, if the employer is having more than 10 employees, then Gratuity is a compulsory benefit.
Employer should pay Gratuity when the employee leaves the organisation after serving certain number of years.
How does Gratuity Work?
When an employee joins an organisation, he automatically becomes a part of employer's Gratuity scheme
Employer specifies the gratuity benefits on the Offer Letter given to the employee
Employer contributes to the Gratuity fund on his own or through a life insurance company
When the employee leaves the organisation after serving for at least 5 years, employer pays the gratuity amount as a one time lump sum amount appreciating employee's service
If the employee leaves before 5 years, then employee will not get any gratuity benefits
Features of Gratuity
It is a retirement or resignation benefit scheme
No contribution from the employee. The Employer pays the entire contribution
Income tax benefits
Eligibility
An employee is eligible to receive gratuity benefits if he serves the organisation for at least 5 years of continuous service as an employee.
If an employee leaves the organisation before 5 years, then no gratuity will be paid.
In case of death or disablement of the employee before 5 years, the eligibility rules are not applicable.
In case of death, employee's nominees will get the gratuity benefits
When Will Employee Get Gratuity?
Gratuity is a one time lump sum payment and it is paid to the employee when he leaves the organisation after serving for at least 5 years of continuous service as an employee.
The reason for leaving the organisation can be one of the following.
resignation
laid off by employer
voluntary retirement
retirement
disability due to accident or disease
death
How to Calculate Gratuity?
Gratuity benefit amount is calculated based on the following two things.
Employees covered under Gratuity Act
Employees NOT covered under Gratuity Act
Let us see the calculation details for each category.
1. Employees covered under Gratuity Act:
For the employees covered under Gratuity Act, it is calculated using the following formula.
| Gratuity = (number of years of service x last drawn monthly salary x 15) / 26 |
where
"number of years of service" is the total number of years of service of employee to the employer
if the employee's service is more than 6 months, then it will be considered as 1 year
if the employees's service is less than or equal to 6 months, then it will be ignored
For example, if employee's service is 8 years and 7 months, then it will be considered as 9 years. If employee's service is 8 years and 5 months, then it will be considered as 8 years only
Last drawn monthly salary is the amount employee received just before leaving the organisation
Monthly salary includes Basic Pay and DA (Dearness Allowance) only
2. Employees NOT covered under Gratuity Act:
For the employees who are NOT covered under Gratuity Act, it is calculated using the following formula.
| Gratuity = (number of completed years of service x average monthly salary x 15) / 30 |
where
"number of completed years of service" is the total number of completed years of service of employee to the employer
only the completed number of years will be considered. Any Service in months will be ignored
for example, if the employee's service is 8 years and 10 months, then only 8 years will be considered
Average monthly salary is the average of last 10 months' salary just before leaving the organisation
monthly salary includes Basic Pay, DA (Dearness Allowance) and commissions, if any, only
Limit on Gratuity Benefits
There is an upper limit on the Gratuity benefit amount payable to the employees. The limit details are given below.
| Employee Type | Gratuity Limit |
Government employee | Rs. 20 Lakhs from 01-Jan-2016. Before that, the limit was Rs. 10 Lakhs |
| Non-Government employee | Rs. 20 Lakhs from 29-Mar-2018. Before that, the limit was Rs. 10 Lakhs |
Government Employees:
The limit is Rs. 20 Lakhs only. Earlier, the limit was Rs. 10 Lakhs. It was increased to Rs. 20 Lakhs with effective from 01-Jan-2016.
Based on the calculations formulas mentioned in the previous section, if the Gratuity benefit is more than Rs. 20 Lakhs, the employer can pay a maximum of Rs. 20 Lakhs only as per the law.
However, the employer can choose to pay the amount in excess of Rs. 20 Lakhs in the form of Bonus or other salary components.
Non-Government Employees:
The limit is Rs. 20 Lakhs only. Earlier, the limit was Rs. 10 Lakhs. It was increased to Rs. 20 Lakhs with effective from 29-March-2018.
Based on the calculations formulas mentioned in the previous section, if the Gratuity benefit is more than Rs. 20 Lakhs, the employer can pay a maximum of Rs. 20 Lakhs only as per the law.
However, the employer can choose to pay the amount in excess of Rs. 20 Lakhs in the form of Bonus or other salary components.
Income Tax Benefits
Income tax benefits will be same on both old and new tax systems.
The income tax impact on Gratuity amount is based on whether the employee is Government or non-Government.
The details of each category are given below.
1. Government Employees:
The gratuity amount received is completely (100%) tax free for Government employees.
2. Non-Government Employees:
Tax treatment for non-Government employees can be divided into the following 2 categories.
Non-Government employees covered under Gratuity Act
Non-Government employees NOT covered under Gratuity Act
The details of each category are given below.
a) Non-Government employees covered under Gratuity Act:
For the non-Government employees covered under the Payment of Gratuity Act, the Gratuity amount received will be tax free to a certain limit.
That limit will be the lowest of the following 3 items.
|
Any amount received more than the above mentioned limit will be added under the head "Income from Salary" and it will be taxed as per employee's income tax slab.
Note:
The limit of Rs. 20 Lakhs was effective from 29-Mar-2018 onwards. Before that, the limit was Rs. 10 Lakhs only.
Rs. 20 Lakhs is the maximum tax free limit for an employee for his entire service. It may be from one employer or from many employers.
If any tax free Gratuity amount is already received, then the current limit will be reduced from Rs. 20 Lakhs to the extent of the gratuity received.
For example, let us assume that an employee has received Rs. 2 Lakhs as Gratuity benefit in the past. It means, in current and future employments, his eligible tax free limit will be Rs. 18 Lakhs only, not Rs. 20 Lakhs.
b) Non-Government employees NOT covered under Gratuity Act:
For the non-Government employees NOT covered under the Payment of Gratuity Act, the Gratuity amount received will be tax free to a certain limit.
That limit will be the lowest of the following 3 items.
|
Any amount received more than the above mentioned limit will be added under the head "Income from Salary" and it will be taxed as per employee's income tax slab.
Note:
The limit of Rs. 20 Lakhs was effective from 29-Mar-2018 onwards. Before that, the limit was Rs. 10 Lakhs only.
Rs. 20 Lakhs is the maximum tax free limit for an employee for his entire service. It may be from one employer or from many employers.
If any tax free amount is already received, then the current limit will be reduced from Rs. 20 Lakhs to the extent of the gratuity already received.
For example, let us assume that an employee has received Rs. 2 Lakhs as Gratuity benefit in the past. It means, in current and future employments, his eligible tax free limit will be Rs. 18 Lakhs only, not Rs. 20 Lakhs.
Death of an Employee
In case of death of the employee, the eligible gratuity amount will be paid to his nominees or legal heirs.
In case of death of the employee, the eligibility criteria of 5 years of continuous service will not be applicable.
Even if the employee's service is less than 5 years, the gratuity amount will be paid to his nominees.
Can employer deny paying Gratuity?
There are certain situations where the employer will not pay gratuity to employee even if the employee is eligible for gratuity.
The Employer can choose NOT to pay gratuity to an employee if he is laid off for reasons such as misconduct, violence, moral offence, causing damage to employer's properties, etc.
Nomination
Nomination facility is available in Gratuity scheme.
After 1 year of service, an employee can make a nomination with his employer to pay the Gratuity benefits just in case of his death before retirement.
Nomination can be made in the name of one or more family members.
Nominees should be family members only. Employee can't nominate any one outside of family.
Employee can update nomination during the employment as and when family situation changes.
Maternity Leave for Gratuity calculation
For female employees, the maternity leave has been increased to 26 weeks from 12 weeks. This is for the calculation of continuous service in Gratuity.
This has been effective since 29-Mar-2018.