Gratuity
What is Gratuity?
Gratuity is a lump sum monetary benefit provided by an employer to an employee as a token of appreciation for the services rendered to the organization over a long period. It serves as a form of financial security upon retirement, resignation, or death. Gratuity is governed by the Payment of Gratuity Act, 1972 in India, and is a statutory benefit for employees who have completed a minimum period of continuous service.
Unlike a part of the salary that is paid monthly, gratuity is paid only once, at the end of the employee's tenure. It reflects the employer’s commitment to employee welfare, loyalty, and long-term retention.
What Are the Benefits Associated with Gratuity?
Gratuity offers both financial and emotional benefits to employees. It not only contributes to the post-retirement corpus but also strengthens the employee-employer relationship.
1. Financial Security
Gratuity acts as a retirement cushion, helping employees manage post-employment expenses or emergencies. It is a form of deferred benefit that adds to the financial independence of employees after years of service.
2. Reward for Loyalty
This benefit is typically reserved for employees who have shown long-term commitment to the organization. Receiving a gratuity amount reflects the value the company places on loyalty and tenure.
3. Legal Protection
Since gratuity is regulated by law, eligible employees are legally entitled to receive it. This ensures transparency, trust, and security in employment contracts.
4. Boosts Morale and Retention
Knowing there’s a financial reward for long-term association motivates employees to stay with the organization longer, thereby reducing attrition and improving engagement.
What Are the Laws Related to Gratuity?
In India, gratuity is primarily governed by the Payment of Gratuity Act, 1972. This legislation ensures that employees who have provided five or more years of continuous service are entitled to gratuity.
Key Provisions of the Payment of Gratuity Act
- Applicable to establishments with 10 or more employees.
- Gratuity is payable on retirement, resignation, death, or disablement.
- The maximum gratuity amount exempt from tax is ₹20 lakhs as per the current Income Tax Act.
- In case of the employee’s death, gratuity is paid to the nominee or legal heir.
Recent Updates
In the last few years, the ceiling for tax-free gratuity has been revised from ₹10 lakhs to ₹20 lakhs, showing the government’s effort to improve employee benefits under labor reforms.
What is the Eligibility Criteria for Gratuity?
To qualify for gratuity, an employee must meet the following conditions:
1. Minimum Service Requirement
The employee should have completed a minimum of five years of continuous service with the same organization. However, this condition is waived in case of death or disablement due to accident or illness.
2. Type of Employment
Gratuity is applicable to:
- Permanent employees
- Full-time employees
- Contract employees under certain terms (if stated in the employment contract or policy)
3. Organization Criteria
The law applies to:
- Every factory, mine, oilfield, port, and railway company
- Every shop or establishment with 10 or more employees on any day in the last 12 months
Note: Even if the number of employees drops below 10 later, the gratuity act still remains applicable.
How to Calculate Gratuity?
Gratuity is calculated based on a fixed formula under the Payment of Gratuity Act, 1972. It differs for employees covered under the act and those not covered by it.
For Employees Covered Under the Act
Gratuity = (Last drawn salary × 15 × number of completed years of service) ÷ 26
- Last drawn salary includes basic salary + dearness allowance
- 15 represents 15 days of wages for every year of service
- 26 is the average number of working days in a month
Example: If an employee has a last drawn salary of ₹30,000 and has worked for 8 years, the gratuity will be:
(30,000 × 15 × 8) ÷ 26 = ₹1,38,462
For Employees Not Covered Under the Act
In such cases, the employer can decide the method of calculation, often similar to the one used under the act, or as per employment contract terms.
Is Gratuity Taxable?
Gratuity is partially exempt from income tax under Section 10(10) of the Income Tax Act, 1961, depending on the category of the employee.
1. Government Employees
Fully exempt from tax, irrespective of the amount.
2. Non-Government Employees Covered Under the Gratuity Act
Tax exemption is the least of the following:
- ₹20,00,000
- Actual gratuity received
- Gratuity calculated using the formula under the act
3. Non-Government Employees Not Covered Under the Act
For these employees, tax exemption is calculated as the least of:
- ₹20,00,000
- Actual gratuity received
- Half of average salary for the last 10 months × completed years of service
To ensure full tax benefits, HR should help employees with timely declarations and accurate salary structures.
Back to Glossary