Gratuity is a payment given by an employer to an employee who has served the organization for at least five years upon leaving the job. It can be seen as a monetary token of appreciation from the employer for the dedication and loyalty shown by the employee over five consecutive years. According to regulations, companies with 10 or more employees must offer a gratuity to their staff.
To be considered eligible for this benefit, an employee must have successfully completed a minimum of five consecutive years of service. However, there are some exceptions to this requirement for periods of absence due to strikes, lockouts, accidents, leaves, layoffs, unauthorized absence, or termination initiated by the employer.
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The duration of a year is recognised as 240 working days for non-mining positions and 190 days for mining roles. In certain private sector companies, gratuity is disbursed after an employee has completed 10 years of service
In the event that an employee is injured or disabled in an accident or due to a disease, they may be eligible for gratuity before completing five years of service. All gratuity payments are governed by the regulations outlined in the Payment of Gratuity Act 1972, with the amount being determined by the individual’s final salary and length of tenure with the company.
Exceptions to the Five-Year Rule
There are two exceptions that allow employees to become eligible for gratuity before reaching the five-year mark:
In the case of termination due to death or disablement, employees are eligible for gratuity regardless of their length of service.
Under the 4 Years 240 Days Rule, employees can qualify for gratuity with just four years and seven months of service under specific conditions.
Gratuity Formula
The Gratuity is calculated as follows: (15 × Last Drawn Salary × Number of Working Years) / 26
The Last Drawn Salary consists of the Basic Salary and Dearness Allowance (DA).
A Working Year is recognized upon completing six months or more in a year.
Taxability of gratuity
“Gratuity received during employment is fully taxable in the hands of employees, irrespective of whether they are employed in government or non-government sectors. However, employees receiving death-cum-retirement gratuity can be categorized into three distinct groups: Government employees, Employees covered under the Payment of Gratuity Act, 1972, an other employees.This classification is essential for determining the applicable tax treatment,” said CA (Dr.) Suresh Surana
Taxability of gratuity in the hands of these classes of employees at the time of death / retirement, can be analyzed as under:
Government Employees
The amount of gratuity received by the employees of the Central Government, State Governments, local authorities and members of the Defense services is wholly exempt from tax.
Employees covered by the Payment of Gratuity Act, 1972
The amount of gratuity received shall be exempt to the extent of the least of the following:
a. 15 days salary* for each completed year of service or part of the year in excess of 6 months, or
b. Rs. 20,00,000 or
c. actual gratuity received.
“Salary for the purpose of this clause includes Basic Salary and Dearness Allowance and is calculated by dividing salary last drawn by 26 days i.e. maximum number of working days in a month,” Dr Surana said.
Other Employees not covered under the Gratuity Act
The amount of gratuity received by an employee on his retirement or on his becoming incapacitated prior to such retirement or on termination of his employment, or any gratuity received by his widow, children or dependents on his death shall be exempt to the extent of the least of the following:
a. one-half month’s salary# for each year of completed service, calculated on the basis of the average salary for the last 10 months or,
b. Rs. 20,00,000 or,
c. actual gratuity received.
“Salary for the purpose of this clause includes Basic Salary, Dearness Allowance (if provided in the terms of employment) and commission as a percentage of turnover achieved by the employee,” he added.