The Applicability and Calculation of Gratuity in India
Gratuity is a lump sum that a company pays when an employee leaves an organization, and is one of the many retirement benefits offered by a company to an employee.
In India, gratuity rules and requirements are set out under the Payment of Gratuity Act, 1972. An employer may also choose to pay gratuity outside of that which is required by this Act.
In 2016, the government considered the proposal to increase the tax-free gratuity US$15,350 (Rs 1 million) cap to US$30,700 (Rs 2 million) for the private sector; this is already available to government employees under the Sixth Pay Commission. (US$1=Rs 65.14).
On March 22, 2018, India’s upper house of parliament finally approved the Payment of Gratuity (Amendment) Bill, 2018.
The Gratuity Amendment Act will now enable the government to raise the limit of tax-free gratuity. It will also fix the period of maternity leave so that it will qualify as a continuous service period.
The change can be made through an executive order by the prime minister.
In this article, we discuss India’s gratuity rules in terms of:
- Tax exemption;
- Payment; and
The Payment of Gratuity Act, 1972 (the Gratuity Act) is applicable to employees engaged in factories, mines, oilfields, plantations, ports, railway companies, shops or other establishments with ten or more employees. The full official text of the Gratuity Act can be found here. Gratuity is fully paid by the employer, and no part comes from an employee’s salary.
To be eligible for gratuity under the Gratuity Act, an employee needs to have at least five full years of service with the current employer, except in the event that an employee passes away or is rendered disabled due to accident or illness, in which case gratuity must be paid.
Gratuity is paid when an employee:
- Is eligible for superannuation;
- Resigns; or
- Passes away or is rendered disabled due to accident or illness (if an employee passes away, gratuity will be paid to the employee’s nominee).
Gratuity Calculation Formula
Gratuity in India is calculated using the formula:
Gratuity = Last Drawn Salary × 15/26 × No. of Years of Service
- The ratio 15/26 represents 15 days out of 26 working days in a month.
- Last drawn salary = Basic Salary + Dearness Allowance.
- Years of Service are rounded down to the nearest full year. For example, if the employee has a total service of 20 years, 10 months and 25 days, 21 years will be factored into the calculation.
Gratuity received under the Gratuity Act is exempt from taxation to the extent that it does not exceed 15 days’ salary for every completed year of service calculated on the last drawn salary (subject to a maximum of US$15,430 or Rs 10 lakh).
Any other gratuity is exempt to the extent that it does not exceed one half-month salary for each year of completed service calculated on the basis of average salary for 10 immediately preceding months (subject to a maximum of US$15,430). The upper limit of US$15,430 applies to the aggregate of gratuity received from one or more employers in the same or different years.
The employer shall arrange to pay the amount of gratuity within 30 days from the date it is billed to the person to whom the gratuity is allocated.
If the amount of gratuity payable under the section is not paid by the employer within the period specified, he will have to pay simple interest on it from the date on which the gratuity becomes payable at the rate not exceeding the rate stipulated by the Central Government.
Gratuity should be paid in cash, or if so desired by the payee, by demand draft or bank check to the eligible employee, nominee, or legal heir.
The gratuity payable to an employee shall be wholly forfeited if:
- The service of such employee has been terminated for his or her lawless or disorderly conduct or any other act of violence on his or her part; or
- The service of such employee is terminated for any act which constitutes an offense involving moral turpitude, provided that such offense is committed by him or her in the course of his or her employment.
In order to forfeit gratuity of an employee, there must be a termination order containing charges as established to the effect that the employee was guilty of any of the aforesaid misconducts. In one case, it has been held that in the absence of a termination order containing any of the above allegations, the gratuity of an employee cannot be forfeited.
Editor’s Note: This article was originally published on June 4, 2013, and has been updated on March 23, 2018 to include the latest gratuity regulations.
India Briefing is published by Asia Briefing, a subsidiary of Dezan Shira & Associates. We produce material for foreign investors throughout Eurasia, including ASEAN, China, Indonesia, Russia, the Silk Road, & Vietnam. For editorial matters please contact us here and for a complimentary subscription to our products, please click here.
Dezan Shira & Associates provide business intelligence, due diligence, legal, tax and advisory services throughout India and the Asian region. We maintain offices in Delhi and Mumbai and throughout China, South-East Asia, India, and Russia. For assistance with India investment issues or into Asia overall, please contact us at email@example.com or visit us at www.dezshira.com.