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April 25, 2018
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April 25, 2018

Gratuity in India – Explained in Detail

Last Update Date : August 11, 2018

Gratuity Calculation

If you look at your salary structure, you will find that it has several components. The taxability of these components varies depending upon the relevant provisions of the Income Tax Act India. One such important component is Gratuity. This guide by H&R Block will help you understand everything you want to know about Gratuity.

What is Gratuity?

Gratuity is a loyalty benefit provided by the employer for rendering services continuously to an organisation for five or more years. Hence, the amount of Gratuity is given by the employer to an employee for the services rendered by him towards the organisation. The amount of gratuity can be paid by an employer in cash, cheque or by demand draft.

Payment of Gratuity Act 1972 Rules and Regulations

In most cases, an employee can get gratuity at the time of his/her retirement or resignation, only if s/he has completed five years of his/her service. But, there are exceptions too when it comes to period. It can also be paid before completion of five years in one-off cases as mentioned below:

  • Death of the employee
  • Disability of the employee due to either disease or accident

In all cases, certain conditions should be met. An employee is eligible to receive the amount of gratuity in the following cases:

  • On superannuation
  • On retirement
  • On resignation at the end of 5 or more years of service
  • On death or disability due to an accident

An employee eligible for gratuity can apply within 30 days from the date it is payable. However, if the date of retirement or superannuation is known, then, the application can be made 30 days prior to such date. On the other hand, an employer needs to stipulate the gratuity amount payable and mention the date of payment within 15 days of the receipt of application. The payment must be made within 30 days from the date of receipt of application. The employer cannot reject the application even after 30 days if the delay is caused due to a valid reason. And, in case the application is rejected, the employer needs to state a valid and acceptable reason behind it.

Gratuity Calculation Formula

The amount of payable gratuity completely depends upon two factors:

  • Last drawn basic salary (basic pay, dearness allowance, and commission based on sales)
  • Tenure of service

The computations of gratuity differs for both government organisations and private organisations. In other words, gratuity calculations differ for both government employees and non-government employees. As per the Payment of Gratuity Act, 1972 – non-government employees are categorised in two groups.

  • Employees covered under the Act
  • Employees NOT covered under the Act

An employee working with the organisation that has at least 10 persons on a single day in a preceding 12 months will be covered under the Act. And once an organisation comes under the purview of the Gratuity Act, then it will always remain covered even if the number of employees falls below 10.

Gratuity Calculation for Government Employees with example

Formula: Last drawn basic salary x Year of service x 15/26

This formula is based on the 15 days of last drawn basic salary. While considering the year of service, if an employee has completed more than 6 months of a particular year, the full year is considered for the computation and vice-versa i.e. less than 6 months is completed for a particular, those months aren’t considered as a whole year. Briefly, the tenure in service is rounded off to the nearest full year.

Let’s understand this with the help of example given below.

Example: Rucha’s last drawn basic pay is Rs 75,000 per month. She was employed with Zoya Corporation for 20 years and 8 months.
Here, her gratuity amount would be computed as:

75,000 x 21 years x 15/26 = Rs 9,08,654 i.e. 9.09 lakhs

Note: The tenure is considered as 21 years since she has worked for 20 years and 8 months (i.e. excess of 6 months). In case, she would have worked for 20 years and 5 months, the tenure would be considered as 20 years.

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Income Tax Exemption on Gratuity

Gratuity is an income and hence under certain scenarios, it can be taxable. Let’s understand the exemption for the employees covered by Payment of Gratuity Act – 1956.

Calculation of Amount of Gratuity Exempted from Tax

The least of the following three amounts is exempt from income-tax:

  • Computed gratuity (as per formula: Last drawn basic salary x Tenure of service x 15/26)
  • Rs.20,00,000 (which has been hiked from Rs.10,00,000 as per the latest amendment);
  • Actual amount received as gratuity

Let’s understand this with the following example:

Pratik’s last drawn salary (Basic + Dearness Allowance) was Rs.90,000 per month. He is entitled to receive a gratuity of Rs.12,00,000. His tenure of employment was 19 years and 9 months.

Tax-exemption on gratuity – lower of the below three

Sr. No. Particulars Previously As Amended
1 Gratuity computed 10,38,461 10,38,461
2 Exemption allowance (maximum) 10,00,000 20,00,000
3 Actual received 12,00,000 12,00,000

In option-1, lowest of all is Rs 10,00,000
Hence, Taxable gratuity = Received gratuity – Exempted gratuity
= 12,00,000 – 10,00,000
= 2,00,000

In option-2, lowest of all is Rs 10,38,461, but maximum exemption allowance is Rs 20,00,000; hence, the entire amount of gratuity is exempt from tax.

Calculation of gratuity
Last drawn salary (Basic + DA) (Rs.) 90,000
Number of years of employment (rounded off) 20
Gratuity (Rs.) (90,000 x 20 x 15/26) = 10,38,461

How to Calculate Gratuity for Private Sector Employees

For the non-government employees’ i.e. private sector employees aka employees not covered by Payment of Gratuity Act – 1956, the calculation of gratuity is done as per the formula mentioned below:

Gratuity = Average salary x Tenure of service x 1/2

Note: here ‘Average salary’ means, it comprises, your Basic Salary + DA (Dearness Allowance) + commission (as a % of turnover achieved by you, if any).

In order to compute ‘Average Salary,’ the average of last 10 months salary (Basic + DA + Commission) preceding the month of the retirement/resignation is considered. It means For instance, if your total tenure of service is 21 years and 10 months, only 21 years will be considered in the calculation

Calculation of amount of gratuity exempted from tax

The least of the following three amounts is exempt from income-tax:
Computed gratuity (as per formula Average salary x Tenure of service x 1/2)
Rs 20,00,000 (which has been hiked from Rs 10,00,000 as per the latest amendment);
Actual amount received as gratuity
Let’s understand this with the following example:

Pratik’s last drawn salary (Basic + Dearness Allowance) was Rs 70,000 per month. He is entitled to receive a gratuity of Rs 12,00,000. His tenure of employment was 35 years and 9 months.

Tax-exemption on gratuity – lower of the below three:

Sr. No. Particulars Previously As Amended
1 Gratuity computed 12,25,000 12,25,000
2 Exemption allowance (maximum) 10,00,000 20,00,000
3 Actual received 12,00,000 12,00,000

In option-1, lowest of all is Rs.10,00,000
Hence, Taxable gratuity = Received gratuity – Exempted gratuity
= 12,00,000 – 10,00,000
= 1,00,000

In option-2, lowest of all is Rs 12,00,000, but maximum exemption allowance is Rs 20,00,000; hence, the entire amount of gratuity is exempt from tax.

Calculation of gratuity

Average salary of 10 months (Basic + DA) (Rs.) 70,000
Number of years of employment (rounded off) 35
Gratuity (Rs.) (70,000 x 35 x 1/2) = 12,25,000

Payment of Gratuity In Case of Death of Employee

There are certain clauses in Section 6 of Gratuity Act which applies to an employee to declare nominee for his/her gratuity. These requirements/clauses are elaborated below:

  • Section 6 (1): an employee is authorised to declare nominee only after his/her one year of completion. The employee can declare nominee within 30 days from the date of completion of service.
  • Section 6 (2): under the Act, there can be one or more nominees.
  • Section 6 (3) and (4): in case at the time of nomination if employee has no family member, he/she can nominate to any person/s. However, if employee has a family at the time of nomination, it shall be made in favour of one or more family members only.
  • Section 6 (5): at any time, an employee can make modifications in nominee by giving written application to the employer.
  • Section 6 (6): in case of sudden death of nominee, an employee can make another fresh nomination by informing the employer.

In case of the death of an employee, gratuity being a voluntary payment by the employer to the employee, the payment is made to his/her nomination as prescribed in Form F. As stated in the gratuity Act 1972, in case of death of employee, payable gratuity shall be paid to the nominee of the employee. In the absence of nomination, the payment is made to his/her heirs. In case, heirs is a minor, the share of such minor shall be deposited with the controlling authority (i.e. government officer) who shall invest the same for the benefit of such minor in such bank or other financial institution, as may be prescribed until such minor attains majority.

Forfeiture of Gratuity

All employees who are eligible for gratuity have right to receive their amount of gratuity even if the employer organisation goes bankrupt. However, under Indian laws, the amount of gratuity can be forfeited under the below mentioned two cases:

  • If employee has been terminated for any act that has caused damage or destruction to the employer’s property
  • If employee has been terminated due to unaccepted behaviour or disorderly act

This is how the same has been stated by law:

According to Section 4 (6) (a) of the Payment of Gratuity Act in India, “the amount of Gratuity payable to an employee can be forfeited by the employer if such employee’s services have been terminated for any act, wilful omission or negligence, causing damage or loss or destruction to property belonging to the employer, to the extent of the damage or loss so caused.”

According to Section 4(6) (b) of the Gratuity Act, “Gratuity payable to an employee may be wholly or partially forfeited – if the employee’s services have been terminated due to riotous behaviour, disorderly conduct or any act of violence, or for any act of moral turpitude – provided such offence has been committed in the course of his employment.”

However, the government has laid down pre-conditions for employers to forfeit the gratuity considering employee’s right to gratuity. They are summarised below:

  • the damages suffered by the employer should be quantified and proved
  • principles of natural justice must be adhered to and the concerned employee must be given an opportunity of being heard
  • the employer must pass an order to forfeit the gratuity (or any part thereof) pursuant to the proceedings carried out

Various Gratuity Forms

1. Form A Rule 3(1) : Notice of opening
2. Form B Rule 3(2): Notice of change
3. Form C Rule 3(3) : Notice of closure
4. Form D Rule 5(1) : Notice for excluding husband from family
5. Form E Rule 5(2) : Notice of withdrawal of notice for excluding husband from family
6. Form F Rule 6(1) : Nomination
7. Form G Rule 6(3) : Fresh Nomination
8. Form H Rule 6(4) : Modification of nomination
9. Form I Rule 7(1) : Application of Gratuity by an Employee
10. Form J Rule 7(2) : Application for gratuity by a Nominee.
11. Form K Rule 7(3) : Application for gratuity by a Legal Heir.
12. Form L Rule 8(1)(i) : Notice for payment of gratuity
13. Form M Rule 8(1)(ii) : Notice rejecting claim for payment of gratuity
14. Form N Rule 10(1) : Application for direction to controlling Authority.
15. Form O Rule 11(1) : Notice for appearance before the Controlling Authority
16. Form P Rule 14: Summons to appear before Controlling Authority.
17. Form Q Rule 16(1) : Particulars of application under Section 16
18. Form R Rule 17 : Notice for Payment of Gratuity
19. Form S Rule 18(8) : Notice for payment of gratuity as determined by Appellate Authority
20. Form T Rule 19 : Application for recovery of gratuity
21. Form U Rule 20 : Abstract of the Act and Rules

Just like Gratuity, you can save your taxes by claiming the right amount of tax deductions on various other components of your salary. Tax experts at H&R Block India can help you save your taxes better with their expertise in tax planning and Income tax return filing.

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