What is Gratuity? and How to Calculate Gratuity?

What is Gratuity?

Gratuity refers to the money which the employer pays to the employee as a service award. This payment is given to an employee who has been working in that company for a period exceeding five years or so. The amount of gratuity is determined on the last salary of the employee and the number of years they have worked for the company. The employee may be covered if they incur an accident or disease before completing a five-year service and they may still get gratuity despite the fact that they have not reached the five-year mark of service. Gratuity is a type of award that is regulated by the law called the Payment of Gratuity Act, which lays down the basic norms and regulations for the payment of gratuity.

How to calculate Gratuity?

Gratuity is typically calculated based on a formula that takes into account the employee’s length of service and their final salary. The formula commonly used for calculating gratuity is:

Gratuity = (Last drawn salary) x (15/26) x (Number of years of service)

Where:

• Last drawn salary refers to the employee’s basic salary plus any dearness allowance or other fixed monetary benefits.
• 15/26 represents 15 days out of 26 working days in a month.
• Number of years of service refers to the total number of years and any part of a year (more than 6 months is considered a full year) the employee has completed in the organization.

Here’s a step-by-step process to calculate gratuity:

1. Determine the last drawn salary: Find out the last drawn salary of the employee that normally consists of basic salary and the allowance for dearness or other fixed monetary benefits.
2. Calculate the number of years of service: Calculate the total number of years, plus any part of a year over 6 months, for which the employee has worked at the organization.
3. Apply the formula: Employ the above formula to determine the amount of gratuity by considering the last drawn salary and the number of years of service.
4. Example: Take, for example, an employee who last drew the salary of $5,000 per month and has been in service for 10 years and 7 months. The calculation would be as follows: Gratuity = $5,000 x (15/26) x 11 = $5,000 x 0.5769 x 11 = $31,8

The amount which is calculated is the salary of employee.

It should be highlighted that the exact approaches and policies regarding gratuity calculation may depend on the country, organization and contract of employment. A good practice is to contact the labor laws or the HR department for an exact calculation.

What are the eligibility criteria to receive gratuity?

The rules and laws governing the eligibility for gratuity usually differ from country to country, as stipulated by their respective employment laws. However, there are some common criteria that are often considered.

1. Completion of minimum service:

Normally, the employee needs to have completed a certain period of service with the employer without any break to be eligible for gratuity. This time can vary but it is usually 5 years of employment with no breaks.

2. Termination of employment:

Gratuity is payable by the employer at the time of termination of employment, usually upon reaching retirement age, resignation, or death. In certain situations, it can also be paid upon discharge for reasons of disability or layoff, depending on the laws and regulations of the area as well as the company policies.

3. Employment status:

Gratuity schemes normally cover fulltime or regular staff members who are on the organization’s payroll. The absence of a contract, temporary employment, or casual services may not lead to the eligibility of gratuity, unless provided for by the local laws or employment contracts.

4. Nomination:

 The employees can be required to nominate their beneficiaries who shall receive the gratuity amount in the event of the death of the employees. It is a common practice that the employers send a nomination form for completion by the employee.

5. Compliance with legal requirements:

Employers should follow any legal obligations regarding gratuity, such as allocating money to gratuity fund or scheme as prescribed by the labor laws or regulations of their locality.

What are the taxation rules for gratuity payment? 

• Government employees: Gratuity amount is entirely tax-exempt for government employees at the central, state, or local level.
• Private employees under Gratuity Act: Tax exemption for eligible private employees is determined as the lowest of the following three:
  1. Rs 20 lakh.
  2. The actual received gratuity amount.
  3. The eligible gratuity calculated as per the Gratuity Act.

This means that private employees covered by the Gratuity Act can receive tax exemption on their gratuity amount, subject to the conditions mentioned above.

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