In a competitive economy where talented individuals have ample opportunities and attrition of employees is widespread, employers must find ways to retain their quality talents. One such way is by offering loyal employees rewards for their service in it. This piece will cover what ‘gratuity’ is, who is eligible for it, how it is calculated, and its general terms and conditions.

    What is gratuity?

    What is Gratuity?

    Gratuity is a monetary benefit or surplus amount of money from an employer to certain employees upon completion of a service period. But, unlike a loyalty bonus, its amount is usually paid out when an employee’s service tenure is over under specific circumstances.

    Its payment comes under the Gratuity Act or Payment of Gratuity Act, 1972. All registered organizations must pay the same as part of employee compensation.

    What is the eligibility for gratuity?

    Public and private sector employees with more than ten employees can receive it under the Payment of Gratuity Act, 1972. To receive it, an employee should be:

    • Retiring from the organization after completion of service
    • Eligible for superannuation
    • Leaving the company after having completed five continuous years of service

    Even those employees who have not completed five years of service but have been disabled by an accident or illness during their service are also eligible for gratuities. If an employee dies during their service, its amount is payable to their nominee.

    Gratuity calculation formula

    The gratuity amount payable is dependent on the last received gross salary of an employee and the years of service completed. At the payout time, an eligible employee can receive the monetary benefit equivalent to 15 days amount of last drawn salary multiplied by the tenure of service completed which is divided by the standard number of working days.

    Gratuity Formula:

    Gratuity amount = (15 x last drawn salary x tenure of working) /26
    • The last drawn salary to be considered should be the gross salary, which includes the basic salary and the dearness allowance.
    • The factor of 26 stands for 26 working days in a month.
    • The tenure of working is the number of years of continuous service completed by the employee. If the service tenure is in terms of some years and months, the year value is rounded up to the nearest year value if the number of months exceeds 6.
    • For instance, the tenure can be considered ten years for a service duration of 9 years and eight months. In other cases, if the period is nine years and five months, the tenure will be nine years only.

    This formula varies slightly for employees working in organizations with less than ten employees that do not come under the Act. The standard working day 26 will be replaced by 30, and the formula becomes:

    Gratuity = (15 x last drawn salary x tenure of working) /30

    Calculation of Gratuity amount

    Let’s assume an example to understand how it is calculated. Assume the last drawn gross salary of Rs. 1,00,000 (basic + dearness allowance) for an employee leaving the current organization before retirement. The employee has completed a continued service tenure of 12 years and is eligible for it.

    If any company is covered under the Act, then its amount for the employee can be calculated as:

    Gratuity amount = (15 x 100000 x 12)/ 26   = Rs. 6,92,307

    If the organization is not covered under the Act, the calculation and its value will change.

    New gratuity amount = (15 x 100000 x 12)/ 30 = Rs. 6,00,000

    Over the years, as an employee’s salary undergoes appreciation and the last drawn salary amount increases, the  amount also naturally increases.

    Some employers can also pay out an additional monetary benefit with the eligible gratuity amount as an incentive for good performers. But such practice is not mandated by the law and can be up to the employer’s discretion.

    Gratuity formula

    Maximum limit for Gratuity

    It is paid to any government employee is free from taxes under the Payment of Gratuity Act, 1972. For private-sector employees, however, the tax-exempt gratuity amount can be the lower of the following three:

    • Gratuity amount eligible as per last salary and years of service
    • Actual gratuity received
    • Rs. 20 lakhs

    The difference amount shall be taxable if the actual gratuity received is higher than its amount is eligible.

    By law, it is paid by a company to an individual employee can’t exceed Rs. 20 lakhs. Any amount over Rs. 20 lakh is considered ex gratia and is not tax-exempt.

    Employees must apply for their gratuity payment when leaving the organization, which the employer should process within 30 days. If there is any delay on the employer’s part, simple interest is also payable for the delay duration and the amount.

    In closing

    It is nearly impossible for organizations with an employee base running up in thousands and several of them staying with the organization for more than five years to keep track of every individual’s gratuity. Fortunately, there are several payroll software in India that can be used to maintain updated gratuity records for all employees.

    Employee salary details, tenure, and any incentive to be included with the gratuity can be maintained in a centralized database. Organizations can accurately calculate its value during employee exit and full-and-final settlement. Using cloud-based payroll software automatically shares the gratuity application form with the employee, making the entire process seamless.

    Besides, HR can use a gratuity calculator to easily calculate the amount paid out at retirement or completion of service. In a gratuity calculator, the HR team only needs to enter details about the last drawn salary and tenure of service to derive the gratuity amount.

    With the help of such automated tools, the payout can be simplified and naturally integrated into employee compensation as well as enhance the accuracy of the payroll calculations.

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