Gratuity Act

Dear Readers,

Wish You a Happy May Day-2024

Gratuity is one of the many retirement benefits offered by a company to an employee. It is a lump sum amount that employers pay their employees as a sign of gratitude for the services provided. However, only those employees who have been employed by the company for five years or more are given the gratuity amount. It is governed by the Payment of Gratuity Act, 1972.

All central and state government departments, defense, and local governing bodies are covered under this act. Private organizations can come under its purview subject to fulfilment of certain conditions.

Gratuity Act shall be applicable to

(a)    Every factory, mine, oilfield, plantation, port and railway company.

(b)    Every shop or establishment to which Shops & Establishment Act of a State applies in which 10 or more persons are employed at any time during the year end.

(c)     Any establishment employing 10 or more persons as may be notified by the Central Government.

(d)    Once Act applies, it continues to apply even if employment strength falls below 10.

To receive the gratuity, you must meet the following eligibility criteria:

You should be eligible for superannuation.

You should have retired from service.

You should have resigned after continuous employment of five years with the company.

You on disablement on account of a sickness or an accident.

In case of your death the gratuity is paid to the nominee.

However, the condition of completion of continuous service of five years shall not be necessary in case the termination of the employment of any employee is related to their death or disablement. In this case, ‘completed year of service’ would refer to as continuous service for one year and an employee shall be said to be in continuous service for a period if he/she has been in uninterrupted service, including service which may be interrupted on account of sickness, accident, leave, absence from duty without leave, lay off, strike or a lock-out or cessation of work not due to any fault of the employee.  There is a judgment by the Madras High Court, which states that an employee would be eligible for gratuity even in case he/she has completed 4 years 240 days.

In addition to above, in the case of death or incapacitated, the employer is mandated by law to pay gratuity to the now ex-employer or his nominee/legal heir, as the case may be, irrespective of the number of years of continuous service.

The law further states that in case the nominee of the employee is a minor, then the assistant labour commissioner shall invest the money in nominee’s name in a term deposit with the State Bank of India or a nationalized bank for the minor’s benefit until he/she becomes a major.

Formula for gratuity calculation is G=S*N*15/26

  Gratuity (G)= Last Drawn Salary(S) × No. of Years of Service(N)× 15/26

  The ratio 15/26 represents 15 days out of 26 working days in a month.

  S = Last drawn salary = (Basic Salary + Dearness Allowance).

  N = Years of Service are rounded down to the nearest full year. 

If the number of years you have worked in the last year of employment is more than six months, then it will be rounded to the nearest figure. Suppose your tenure of service is 16 years 7 months, then you receive the gratuity for 17 years. Otherwise, it’s for 16 years if it happens to be 16 years 4 months.

The tax treatment of the gratuity amount depends on the type of employee who has to receive the gratuity.

The amount of gratuity received by any government employee (whether central/state/local authority) is exempt from the income tax.

Any other eligible private employee whose employer is covered under the Payment of Gratuity Act. The maximum amount of gratuity specified is Rs 20 lakh, irrespective of the number of years of service. Please note that in your entire working life, the maximum tax-exempt gratuity amount you may claim, cannot go beyond Rs 20 lakh. Any excesses would be treated as ex-gratia and liable for tax as per the tax bracket.

Gratuity paid to the widow or legal heir of an employee will be exempt of tax – Upon an employee’s demise, the gratuity that is paid to his widow or legal heir will be exempt from tax. Any ex-gratia payment made to an employee or his legal heir on account of an injury caused will also be tax-free.

Forfeiture of gratuity- According to the Payment of Gratuity Act of 1972, when the employee has been terminated due to disorderly conduct wherein, he/she tries to physically harm individuals during his/her employment, an employer holds the right to forfeit their gratuity payment, either wholly or partially despite the employee having completed 5 and more years of service in a company.