Everything You Need to Know About Gratuity: A Complete Guide for Employees in India

Introduction

Gratuity is a monetary benefit paid by an employer to an employee for the services rendered over a period of time. It is a lump sum amount paid at the time of retirement, resignation, or termination, as a token of appreciation for the employee's loyalty and service. Gratuity is governed by the Payment of Gratuity Act, 1972, in India.

Unlike other retirement benefits such as Provident Fund (PF) and Pension, gratuity is not deducted from the employee’s salary. Instead, it is fully funded by the employer.

Who is Eligible for Gratuity?

To be eligible for gratuity, an employee must meet the following conditions:

• Minimum Service: The employee must have completed at least 5 years of continuous service with the same employer.

• Type of Employment: Gratuity applies to employees in both private and public sectors, and it includes salaried as well as wage-earning employees.

• Termination Events: Gratuity is payable in the following situations:
  • Upon retirement or resignation.
• In the case of death or disablement due to an accident or illness (in such cases, the 5-year rule is waived).
• Upon termination of the employment contract.

How is Gratuity Calculated?

The amount of gratuity an employee receives is calculated using a simple formula based on their last drawn salary and the number of years of service.

Gratuity Formula:

$$\text{Gratuity} = \text{Last Drawn Salary} \times 15 \times \frac{\text{Number of Years of Service}}{26}$$​

• Last Drawn Salary: Includes basic salary and dearness allowance (DA).
• 15 Days' Salary: Represents 15 days of wages for every completed year of service.
• 26: Represents the number of working days in a month.

Let’s assume an employee has worked for 12 years and their last drawn salary (basic + DA) is ₹30,000. The gratuity would be calculated as:
$$\text{Gratuity}=30,000\times 15\times \frac{12}{26}=\text{₹}2,07,692$$

Note: If an employee has worked for more than 6 months in a particular year, it is rounded up to the next year. For instance, if they worked for 12 years and 7 months, it would be considered 13 years for the calculation.

Maximum Gratuity Limit:

The maximum gratuity payout is capped at ₹20 lakhs as per the Payment of Gratuity (Amendment) Act, 2018.

Tax Implications of Gratuity

The tax treatment of gratuity depends on whether the employee works in a government or non-government organization.

For Government Employees:

• Gratuity received by government employees is fully tax-exempt.

For Non-Government Employees:

• Gratuity received by non-government employees is partially tax-exempt under Section 10(10) of the Income Tax Act. The tax exemption limit is the lowest of the following three:

• Actual gratuity received.

• ₹20 lakh (the upper limit set by the government).

• 15 days' salary for each completed year of service, calculated as per the formula mentioned above.
• Any gratuity amount exceeding the tax-exempt limit is taxable as per the employee’s income tax slab.

Gratuity Payment Process

Gratuity is typically paid to the employee upon leaving the organization. Here’s how the process works:

• Application: The employee (or their nominee, in case of death) must apply for gratuity in writing to the employer.

• Payment Timeline: The employer is required to calculate and pay the gratuity within 30 days of the application.

• Delayed Payments: If the employer delays payment beyond 30 days, they are liable to pay an interest rate on the gratuity amount, which is usually not more than the rate payable on the employee’s EPF contributions.

Required Documents:

• Service certificate
• Identity proof
• Bank account details

Gratuity for Different Types of Employers

Gratuity applies differently depending on the type of employer. Let’s look at how gratuity works across various employment sectors.

1. Gratuity in Private Sector

In the private sector, gratuity is mandatory for organizations with 10 or more employees. The rules governing the payment, calculation, and tax implications are in line with the Payment of Gratuity Act, 1972.

2. Gratuity in Public Sector

Public sector employees are also eligible for gratuity. Government employees often receive gratuity as a pension benefit in addition to other post-retirement schemes.

3. Gratuity in Case of Contract Employees

Gratuity applies to contract employees as long as they are hired directly by an organization and meet the minimum 5 years of service criterion. However, if the employee is hired through a third-party contractor, the principal employer may not be liable to pay gratuity.

In unfortunate cases of death or disablement of an employee, the employer is liable to pay gratuity to the employee’s nominee or legal heir, even if the employee has not completed 5 years of service. The calculation remains the same, based on the employee’s last drawn salary and the years of service completed before death or disablement.

How to Maximize Your Gratuity?

Though gratuity is governed by law and your employer’s policies, there are ways to ensure you make the most of it:

• Stay with one employer: The longer you stay with a single employer, the higher your gratuity amount will be. The formula favors longer years of service.

• Negotiate your salary: Since gratuity is based on your basic salary and DA, negotiating for a higher salary during appraisals can result in a bigger gratuity payout.

• Gratuity insurance plans: Some employers may offer gratuity insurance plans, where they invest in financial products that help ensure the payment of gratuity to employees.

Gratuity vs. Other Retirement Benefits

Criteria	Gratuity	Provident Fund (EPF)	Pension	National Pension System (NPS)
Contribution	Fully funded by the employer	Contributions from both employee and employer	Funded by employer and government in some cases	Contributions by employee (voluntary) and employer
Eligibility	Minimum 5 years of continuous service	Automatic for employees in EPF-covered organizations	Typically available after retirement or long service	Open to all Indian citizens, voluntary participation
Tax Treatment	Tax-exempt up to ₹20 lakh (Section 10(10))	Employee contribution eligible for tax deduction (up to ₹1.5 lakh under Section 80C); interest is tax-free	Pension income is taxable	Tax benefits under Section 80C and 80CCD(1B); lump sum partially tax-exempt
Withdrawal	Paid as a lump sum at retirement, resignation, or termination	Withdrawable upon retirement or after leaving service	Paid as a regular monthly pension	Up to 60% as a lump sum at retirement, 40% must be used to buy an annuity
Risk	Low risk; fixed benefit based on service duration	Low risk; government-backed returns	Low risk; fixed monthly income post-retirement	Moderate to high risk; market-linked returns based on asset allocation
Return on Investment (ROI)	Fixed formula-based; depends on last drawn salary	Fixed interest rate declared annually (currently 8.15%)	Fixed pension amount determined by salary and service	Varies; returns can range from 8%-12% depending on equity exposure
Liquidity	Payable only after resignation, retirement, or death	Partial withdrawals allowed for specific needs	Non-liquid; regular payouts post-retirement	Less liquid; partial withdrawals allowed after 3 years for specified needs

FAQs

Q: Is the gratuity amount taxable? 

A: Gratuity is tax-exempt up to a certain limit. For government employees, the gratuity amount is fully tax-exempt. For non-government employees, the gratuity is tax-exempt up to ₹20 lakhs. Any amount above this limit is subject to taxation as per the applicable income tax slab rates.

Q: What is the maximum limit for gratuity payment? 

A: As per the Payment of Gratuity Act, 1972, the maximum limit for gratuity payment is ₹20 lakhs. This limit can be revised by the government from time to time.

Q: Who is eligible to receive gratuity? 

A: An employee is eligible for gratuity if they have completed at least five years of continuous service with the same employer. Exceptions are made in cases of death or disability, where the five-year requirement is waived.

Q: Am I eligible for gratuity if I have worked for 4 years and 6 months in the same organization?

A: According to the Payment of Gratuity Act, 1972, an employee must complete a minimum of five years of continuous service with the same employer to be eligible for gratuity. However, there are certain nuances to consider:

• Continuous Service: The requirement is generally interpreted as 5 years of continuous service. However, there are judicial rulings and interpretations that consider 4 years and 6 months (or more) as meeting the eligibility criteria for 5 years.

• Judicial Interpretation: Some courts have ruled that if an employee has completed 240 days of work in the fifth year (which is roughly 8 months), they are considered to have completed one year of service. This means if you have completed 4 years and 240 days of service, you might be eligible for gratuity.

If you have worked for 4 years and 6 months (i.e., 4 years and 180 days), you would typically be seen as completing the required 5 years of service due to the judicial interpretation of continuous service.

Q: Can an employee claim gratuity while still employed with the same organization?

A: No, an employee cannot claim gratuity while they are still employed with the same organization. Gratuity is payable only upon the termination of employment, which includes resignation, retirement, or termination of service. However, there are certain exceptional circumstances where gratuity can be claimed:

• Retirement: An employee can claim gratuity upon retirement from the organization after completing the required period of service.

• Resignation: An employee can claim gratuity if they resign from the organization after completing five years of continuous service.

• Termination: If an employee is terminated (not due to misconduct), they are eligible to claim gratuity if they have completed five years of continuous service.

Q: What is the process for claiming gratuity? 

A: To claim gratuity, an employee needs to apply in writing to the employer. The employer will then verify the details and calculate the gratuity amount. The payment must be made within 30 days of the application approval.

Q: What happens to the gratuity if an employee dies or becomes disabled? 

A: In cases of death or disability, the five-year continuous service requirement is waived. The gratuity amount is paid to the employee's nominee or legal heir.

Q: Can an employer deny gratuity to an employee? 

A: An employer can deny gratuity if the employee is terminated due to misconduct involving moral turpitude. In all other cases, the employer is legally obligated to pay the gratuity amount.

Q: How is gratuity different from provident fund and pension? 

A: Gratuity is a lump sum payment given by the employer, while the provident fund is a retirement benefit where both employer and employee contribute, and the pension is a regular monthly payment post-retirement based on years of service and salary. Gratuity provides immediate financial support, whereas provident fund and pension provide long-term financial security.

Q: What are the common issues employees face while claiming gratuity? 

A: Common issues include delayed payment, incorrect calculation, and disputes regarding eligibility. Employees can address these issues by ensuring they have all the required documents, applying in a timely manner, and seeking legal recourse if necessary.