All about Gratuity calculation,taxation (With latest rules)

Job hopping may lead to increase in your salary pay package, but staying on with your employer for long has its own benefits. Gratuity is one those benefits.

Those who understand gratuity restrict themselves from shifting job in the 4^th year of continuous service and if at all they decide to move, forgone gratuity becomes a point of negotiation between new employer and employee.

This article is about Gratuity, gratuity calculation, taxation and other important points related to it.

What is Gratuity?

Gratuity is a defined benefit scheme and mandatory payment b an employer covered under payment of gratuity act 1972.

This act states that every establishment which has or had employed 10 or more persons on the payrolls on any day of preceding 12 months, has to show gratitude to its employee who has rendered at least 5 years of continuous service by paying a Gratuity amount as per the gratuity calculation formula specified under this act. An establishment which does not cover under this act may also pay gratuity.

When is gratuity payable?

Gratuity becomes payable on Retirement, Resignation, termination, retrenchment, death or disablement. In case of death or disability, the condition of 5-year continuous service is waived off. In this case, even if someone has worked for 1 year, his/her nominee will be paid gratuity.

Gratuity is a kind of Thanksgiving from employer to employee.

Here continuous service includes all approved leaves, weekly offs, legal strike etc. It means that if you are absent from work for a valid, legal and approved reason that it should not be treated against any continuous service condition.

You need not be present in an establishment for 365 days a year. In fact, there is a judgment by Hon’ble Madras high court declaring that even if an employee has completed 4 years 10 months and 18 days service without break i.e 4 years and 240 days, it should be considered as completed 5 years in payment of gratuity act.

But let’s keep things simple, and keep only complete 5 years in mind for gratuity eligibility and gratuity calculation with a minimum 240 days of presence every year.

If gratuity is a part of your CTC and it is showing as a deduction from your salary slip every month, this does not mean that you can claim your gratuity anytime. 5 years continuous employment is Mandatory.

Gratuity is a payment mandated by law, so no employer can refuse it on grounds of financial losses to the company. And it is something which a company has to pay as a “Severance pay” in case company is getting wound up for whatever reason.

How to calculate gratuity?

As per law, the gratuity amount would be 15 days or half month’s salary (as the case may be) for every full year of your employment with a maximum limit of Rs 10 lakh.

Latest Amendment in 2017, in gratuity act which has increased the Tax-free limit of gratuity from 10 lakh to 20 lakh.

An employer may pay this amount out of his own funds or can even buy a group gratuity scheme from Life Insurance Company. The gratuity calculation amount differs between companies which are covered in payment of gratuity act and which are not. Below are the details.

Calculation of Gratuity amount where company is covered under Payment of Gratuity act.1972

In this case Salary includes Basic pay plus Dearness allowance plus Commission (if a fixed %age of sales turnover). Dearness allowance is generally a part of government employee’s salary.  The gratuity calculation formula is as under

Monthly salary*15/26* Number of years of completed service or part thereof

In this case, if an employee has covered more than 6 months of service, it will be treated as a full year. Like if someone is on the job for 6 years 7 months, then for gratuity calculation the numbers of completed years of service will be taken as 7 and not six. Had this been 6 years 5 months, then the number of completed years would be counted as 6.

Let’s understand it as an example:

Smita has resigned from a multinational company after completing 7 years and 8 months of continuous service. Her monthly salary breaks up details are as under. What would be the gratuity amount she’s eligible for?

Basic: Rs 35000, HRA: Rs 14000, Special allowance: Rs 25000, Medical Allowance: Rs 1250, Conveyance allowance: Rs 800

Her gratuity calculation would be as follows:

Salary = Rs 35000 (only basic)

Number of completed years in service = 8 years (8 months will be rounded off as 1 year)

Gratuity = 35000*15/26*8 = Rs 161538/-

Calculation of Gratuity amount where company is not covered under payment of Gratuity Act

In This case formula would be as below:

Monthly salary*15/30*Average salary for each completed year of service

Here Salary definition is the same which includes basic plus Dearness Allowance plus Commission (if fixed %age of sales turnover).

Point to note here is that only full years’ service is considered in this case and no part thereof applies here. Also, Average salary means last 10 month’s salary immediately preceding the month of leaving the job divided by 10. Let’s understand this with the same example as above.

Smita has resigned from a company not covered by payment of gratuity act after completing 7 years and 8 months of continuous service. Her monthly salary which she’s drawing for last 12 months breaks up as under. What would be the gratuity amount she’s eligible for?

Basic: Rs 35000; HRA: Rs 14000; Special allowance: Rs 25000; Medical Allowance: Rs 1250; Conveyance allowance: Rs 800

Her gratuity calculation would be as follows:

Salary = Rs 35000*10/10 = Rs 35000 (only basic)

Number of completed years in service = 7 years (no part thereof to be considered here)

Gratuity = 35000*15/30*7 = Rs 122500/-

Gratuity taxation rules

–         Gratuity received by Government employees are 100% tax exempt.

–        For Nongovernment employees covered by payment of gratuity act, 1972 the tax-exempt amount of gratuity will be the least of following:

• Actual Gratuity Received
• Rs 20 lakh ( As per the amendments announced in 2017)
• 15 day’s salary for each completed year of service or part thereof

With reference to the above example of Smita, let’s assume that out of gratitude employer pays her gratuity of Rs 2 lakh instead of Rs 161358/- then the extra amount received i.e Rs 38642/- will be taxed under Income from other sources.

(Also Read : All you wanted to know about HRA exemption)

–          For Nongovernment employees not covered underpayment of gratuity act’1972 the tax-exempt amount of gratuity will be least of the following:

• Actual Gratuity Received
• Rs 20 lakh (As per the amendments announced in 2017)
• Half month’s salary for each completed year of service (No part thereof)

With reference to the above example of Smita, let’s assume that out of gratitude employer pays her a gratuity of Rs 2 lakh instead of Rs 1,22,500/- then the extra amount received i.e Rs 77,500/- will be taxed under Income from other sources.

Also, note that the above-mentioned limits are for all your full years of service. If you have taken gratuity 4 times from different employers and your gratuity amount exceeded Rs 20 lakh (maximum exempted amount), then whatever extra you have earned has to be taxed by adding in “Income from other sources”.

Hope you find this article on Gratuity and how to calculate gratuity useful? Please share your views and queries in the comments section.