Gratuity
Gratuity is derived from the word ‘Gratitude’. As the term indicates, Gratuity is a part of salary that is received by an employee from the employer in gratitude for the services offered by the employee to the company.
Eligibility for Gratuity
An employee becomes eligible for gratuity only after completion of 5 or more years of full time service with the same employer. It is more of a retirement benefit and social security benefit received by the employee when they are leaving their job. For the purpose of gratuity calculation, the number of years of service is rounded off to the nearest full number. For example, if you have completed 6 years and 8 months, it will be rounded off to 7 years. In case you have completed 8 years and 5 months, the number of years will be rounded off to 8 years only.
Contribution to Gratuity
Unlike EPF, the employer pays gratuity amount, and employee doesn’t have to contribute in gratuity. Employer can either choose to pay for gratuity from their own fund or approach a life insurer to purchase a group gratuity plan. In case of a group gratuity plan, the employer should make annual payments as decided by the insurer. The employee can make contributions to gratuity in this case but it is not mandatory.
Calculation of Gratuity
The formula to calculate gratuity differs for employees who are covered under gratuity act and the ones who are not.
For employees under gratuity act:
Any employee whose workplace consists of more than 10 employees will be covered under the gratuity act. The formula for calculation of gratuity is:
Gratuity = [(Basic Pay + D.A) x 15 days x No. of years of service] / 26.
For employees not covered under gratuity act:
If the number of employees are less than 10, the company is not covered under the gratuity act. Even if the company is not covered under gratuity act, an employer can always choose to give gratuity to the employee for their service.
The formula for calculation of gratuity is:
Gratuity = [Average of last 10 months salary x No. of years of service] / 2.
Taxability of Gratuity
Some portion of gratuity received is exempt from tax as per Section 10(10) of the Income Tax.
The tax exemption on gratuity differs for following 3 categories:
Any gratuity received by an employee of the Central Government, State Government or local authority, on death or retirement is fully exempted from tax.
- Non-government Employees covered under Gratuity Act:
Maximum tax exemption will be least of the following 3:
- Actual gratuity received
- Rs. 10,00,000
- 15 days’ salary for each completed year of service or part thereof (*) (number of days in a month is considered as 26. Therefore, 15 days’ salary = (Salary * 15/26))
Salary = Basic + D.A.
*Completed year of service or part thereof – Full time service of more than 6 months is considered as 1 completed year of service; and less than 6 months is ignored. For example, if you have completed 6 years and 8 months, it will be rounded off to 7 years. In case you have completed 8 years and 5 months, the number of years will be rounded off to 8 years only.
Example:
Sam worked with company X (covered under Gratuity Act) for 12 years and 9 months. At the time of leaving, his salary was Rs. 50,000 and he received Rs. 6,00,000 as gratuity. Here’s how the tax exemption will be calculated:
1. Actual gratuity received: Rs. 6,00,000
2. Rs. 10,00,000
3. 15 days’ salary for each completed year of service or part thereof: [50,000 * 13 * 15]/26 = Rs. 3,75,000
The least of the 3 is Rs. 3,75,000 and thus this amount will be tax exempted. Remaining amount of Rs. 6,00,000 – Rs. 3,75,000 = 2,25,000, will be taxable.
- Non-government employees not covered under Gratuity Act:
Maximum tax exemption will be least of the following 3:
- Actual gratuity received
- Rs. 10,00,000
- Half-month’s average salary for each completed year of service and no part thereof (#).
Salary = Basic + D.A.
#Completed year of service and no part thereof – Full time service of more than 1 year is considered as 1 completed year of service; and less than 1 year is ignored. For example, if you have completed 6 years and 8 months, it will be rounded off to 6 years.
Example:
Abhishek worked with company Y (not covered under Gratuity Act) for 15 years and 8 months. He receives Rs 7,00,000 as a gratuity and his average monthly salary of 10 months immediately preceding month of completing service is Rs 30,000. Here’s how the tax exemption will be calculated:
1. Actual gratuity received: Rs. 7,00,000
2. Rs. 10,00,000
3. Half-month’s average salary for each completed year of service and no part thereof: [30,000 * 15]/2 = Rs. 2,25,000
The least of the 3 is Rs. 2,25,000 and thus this amount will be tax exempted. Remaining amount of Rs. 7,00,000 – Rs. 2,25,000 = 4,75,000, will be taxable.
Related: How do I configure gratuity for my employees on Keka?