Gratuity: Meaning, Eligibility, Calculation & Tax Rules

Gratuity represents an obligatory payment which employers must provide to their employees as a mark of appreciation for their extended tenure with the company. The program serves as a financial safety net for retirement while offering monetary assistance to workers who exit their jobs after fulfilling their required time commitments.

The Payment of Gratuity Act from 1972 governs gratuity regulations in India with its 2018 amendments.

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What is Gratuity?

Gratuity is a lump sum amount paid by an employer to an employee upon:

• Retirement
• Resignation
• Superannuation
• Death
• Permanent disability

The program exists to provide rewards to employees who dedicate their time to the company and demonstrate their enduring dedication.

The Payment of Gratuity Actmandates gratuity payments to eligible employees after they complete five years of continuous employment except for cases involving death or permanent disability which bypass this requirement.

Who is Eligible for Gratuity?

An employee becomes eligible for gratuity if:

• They have completed at least 5 years of continuous service with the same employer
• The organization employs 10 or more employees (covered under the Act)
• They resign, retire, or are terminated (except for certain misconduct cases)

Gratuity payment becomes mandatory when an employee dies or suffers permanent disability, even if they have not yet worked five years.

All organizations which reach a minimum employee count of 10 must continue their Gratuity Act coverage even if their workforce drops below 10 employees in the future.

What is Continuous Service?

Continuous service indicates that an employee maintains their position with the same employer without taking any breaks in work. Workers can experience certain work interruptions, which will still count as part of their continuous service time, including:

• Sickness
• Accident
• Paid leave
• Maternity leave
• Lay-off declared by employer
• Strike or lockout
• Temporary closure not caused by employee

This process guarantees that employees receive their justified gratuity payments regardless of their legitimate work interruptions.

Minimum Working Days Requirement

Even if an employee does not maintain complete work continuity, they will receive recognition for continuous service after they have completed:

• 240 days in a year (for establishments working 6 days a week)
• 190 days (for mines or establishments working less than 6 days a week)

Employees at seasonal establishments must achieve a minimum of 75% attendance during the operational schedule.

How is Gratuity Calculated?

The calculation depends on whether the employer is covered under the Gratuity Act.

1. For Organizations Covered Under the Gratuity Act

The formula is:

Gratuity = (15 × Last Drawn Salary × Completed Years of Service) ÷ 26

Where:

• Last drawn salary = Basic Pay + Dearness Allowance
• 26 = Number of working days in a month
• Service above 6 months is rounded up to the next year

Example

If an employee’s last drawn salary is ₹65,000 and they have completed 11 years and 7 months of service:

Years considered = 12 years

Gratuity = (15 × 65,000 × 12) ÷ 26
= Rs.4,50,000 (approx.)

If service is 11 years and 5 months, only 11 years will be considered.

2. For Employers Not Covered Under the Act

In such cases, gratuity payment is voluntary and the formula usually applied is:

Gratuity = (15 × Last Drawn Salary × Completed Years of Service) ÷ 30

Only completed years of service count towards their total work time (no rounding off applies).

3. In Case of Death of Employee

Gratuity is paid to the nominee or legal heir, regardless of years completed. The amount is calculated based on years of service completed at the time of death.

Maximum Gratuity Limit

As per the 2018 amendment:

• The maximum gratuity payable is ₹20 lakh.
• This limit applies to both government and private sector employees covered under the Act.

Taxation of Gratuity

For Government Employees

Gratuity received is fully exempt from tax.

For Private Sector Employees Covered Under the Act

Tax exemption is available up to the least of:

1. Actual gratuity received
2. ₹20 lakh (lifetime limit)
3. Calculated gratuity as per Act formula

Any excess amount is taxable under “Income from Salary.”

Can Gratuity Be Forfeited?

Yes, gratuity can be partially or fully forfeited if:

• The employee causes financial loss to the employer
• Termination is due to riotous or disorderly conduct
• The employee commits an offence involving moral turpitude

Why is Gratuity Important?

• Acts as a retirement savings cushion
• Encourages long-term employment stability
• Provides financial security in case of resignation or retirement
• Helps in emergency liquidity planning

Gratuity serves as an essential element which salaried employees use to construct their financial strategies for the long term.