Gratuity - Meaning, Eligibility Criteria & How to Calculate it

For Employers Covered Under the Gratuity Act:

Gratuity = (N*B*15)/26

where,

N = Number of Years Serviced in the Organization

B = Basic Salary including DA

What is 15/26? - 15 defines half-month compensation of 15 days and 26 represents the number of working days in a month (excluding Sundays)

1. Example:
   1. 15 years of service, last drawn salary = Rs.55,000
   2. Gratuity = (15 × 55,000 × 15) / 26 = Rs.4,75,962

Important Notes:

1. Gratuity amount is capped at Rs.20 lakh for private sector employees; excess is treated as ex-gratia. While the amount is capped at Rs.25 lakh for central government employees.

1. If service in the final year exceeds 6 months, round up to the next full year (e.g., 18 years 7 months = 19 years).

For Employers Not Covered Under the Gratuity Act:

1. Formula: Gratuity = (15 × last drawn salary × years of service) / 30
2. Example:
   1. 8 years of service, last drawn salary = Rs.65,000
   2. Gratuity = (15 × 65,000 × 8) / 30 = Rs.78 lakh

Eligibility Criteria for Payment of Gratuity

Following are the few instances when you will be eligible to receive gratuity:

1. An employee should be eligible for superannuation.
2. Employee should retire from the company.
3. An employee resigns after working for 5 years with a single employer.
4. When an employee passes away or suffers disability due to illness or accident.

How to Calculate Gratuity with Example?

For example, Amit has worked with a company for 20 years and had Rs.25,000 as his last drawn basic plus DA amount, then,

Gratuity Amount for Amit = 20*25,000*15/26 = Rs.2,88,461.54

However, an employer can choose to pay more gratuity to an employee. Also, for the number of months in the last year of employment, anything above six months is rounded off to the next number while anything below six months in the last year of employment is rounded off to the previous lower number.

Gratuity Calculation for Non-Gratuity Act Employers

Even if the organization is not part of the Act, they can pay gratuity. However, the calculation of gratuity is based on an individual's half month's salary for every year that has been completed. The salary includes commission (sales-based), dearness allowance, and basic salary.

For employees not covered under the Gratuity Act, the formula used is:

Gratuity Amount = (15 * Last drawn salary amount * period of service) / 30

For Example:

1. Last Drawn Salary: Rs.31,000

1. Tenure: 5 years

1. Gratuity Calculation:

Gratuity = (15 * 31,000 * 5) / 30 = Rs.77,500

An employee's tenure is counted as one year for purposes of calculation. The previous number of completed years is taken into account if the number of months worked in the most recent year is less than six months.

However, the year is regarded as a full year for the purposes of calculation if the number of months completed in the most recent year of service is greater than six months. Therefore, 11 years have been determined to be the working period.

The number of years of service would have been ten years only if the service duration had been ten years and four months (or anything less than 6 months).

As per the rules recorded on the pensioner's portal of the government, the amount of gratuity at the time of retirement is calculated as follows:

1. Gratuity Amount is equal to one-fourth of the last-drawn basic salary of an employee for each completed six-month period. The retirement gratuity amount which is payable is 16 times the basic salary. However, it is subject to a cap of Rs.20 lakh.

Calculation of Gratuity in Case of Death of an Employee

If an employee dies before completing five years of continuous service, the gratuity amount is still payable, subject to certain conditions as outlined in the Payment of Gratuity Act, 1972.

1. Minimum Service Requirement: Gratuity is payable if the employee had completed at least one year of continuous service before death.

1. Recipient of Gratuity: Paid to the nominated person; if no nominee exists, it goes to the legal heirs.

1. Gratuity Calculation:
   1. Based on completed years of service up to the date of death.
   2. Any service exceeding six months is rounded up to the next full year.

1. Formula Used:
   1. Gratuity = (Last drawn salary × 15 × completed years of service) / 26

1. Tax Implications: Gratuity received by nominee/legal heir is tax-exempt up to a specified government limit; excess may be taxable.

1. Payment Timeline: Employers must pay the gratuity within 30 days from the date it becomes due (date of death).

The exact treatment of gratuity in case of death before five years can vary depending on the employment contract and company policy. It is advisable for the family or legal heirs to seek legal advice to understand the full implications and ensure that the applicable laws are followed.

In case of the death of an employee, the gratuity benefits are calculated based on the tenure of service of the employee. The amount is, however, subject to a maximum of Rs.20 lakh. The following table shows the rates at which the gratuity will be payable in case of death of an employee:

Advantages of Gratuity

The benefits of gratuity are outlined below:

1. Boosts Employee Confidence: Enhances employee confidence by providing a sense of financial security for the future.

1. Employee Loyalty: Demonstrates that employers value their employee's contributions and long-term financial well-being, fostering loyalty and a positive work environment.

1. Ensures Fair Compensation: Ensures employees are fairly compensated for their years of service, especially in cases of termination, death, or disability.

1. Financial Security: Provides crucial financial support after retirement, helping employees cover expenses like healthcare, travel, and other post-retirement needs.

1. Helps in Retirement Planning: Forms an essential part of retirement planning, providing a lump sum payment that supplements pension or personal savings.

1. Improves Employer-Employee Relationship: Builds trust and mutual respect, as offering gratuity shows the employer’s commitment to supporting their workforce.

1. Legal Protection: The Payment of Gratuity Act, 1972, ensures employees’ right to gratuity, guaranteeing payment and preventing denial or delay by employers.

1. Tax Benefits: Gratuity is tax-free up to a certain limit, offering employees tax savings and reducing their overall tax liability.

Taxation Rules for Gratuity

The taxation process for gratuity depends upon the employee who is receiving the gratuity amount. Two standard cases arise for the calculation of tax on gratuity:

1. Government Employee Receiving Gratuity Amount: In case any employee under the state government, central government or local authority receives gratuity amount than the amount is fully exempt from Income Tax.
2. Any Other Salaried Individual Receiving Gratuity Amount from an Employer who is Covered by Payment of Gratuity Act:
   1. In such a case the least of the following three amounts is exempt from tax. 
   2. Rs.20 lakh
   3.  Gratuity actually received by employee
   4. The gratuity amount eligible to be received
      
3. Any Other Salaried Individual Receiving Gratuity Amount from an Employer who is not Covered by Payment of Gratuity Act: In such a case the least of the following three amounts is exempt from tax
   1. Rs.10 lakh
   2. (Average salary of last 10 months x 15/30) x number service year completed
   3. Actual amount of gratuity received

Tax Exemptions on Gratuity

Based on the policy changes made during the 2016 budget, here's what gratuity laws looks like:

1. Gratuity received by government employees upon retirement, termination, or superannuation is fully tax-exempt and applies to central and state government staff, defence personnel, civil service members, and employees of local authorities.
2. Tax exemption on gratuity for private sector employees:
   1. (*15/26) X Last drawn salary** X completed year of service or part thereof in excess of 6 months.
   2. Rs.10 lakh.
3. Gratuity amount that is actually received.

* 7 days in case an individual is an employee of a seasonal establishment.

** Salary amounts to the total salary received by an employee including Dearness Allowance and excluding any other benefits like bonus, HRA, commission, and any other such perquisites.

1. Tax exemption on gratuity for private sector employees who are not covered under the Act:
   
   1. Average salary of last 10 months (basic + DA) x number of employment years.
   2. Rs.20 lakh as per the amendment.

*Average salary = Average Salary of last 10 months immediately preceding the month of retirement ** Salary = Basic Pay + Dearness Allowance (to the extent it forms part of retirement benefits) + turnover based commission.

Key Highlights of the 2025 CCS Gratuity Amendment Rules

The highlights of Central Civil Services (Payment of Gratuity under National Pension System) Amendment Rules, 2025 signifying notable changes of gratuity rules under the National Pension System (NPS) are mentioned below:

Broader Definition of Gratuity

1. Gratuity now includes: Retirement, Death, and Residuary Gratuity.

1. New Rule 4A restricts gratuity benefits for employees re-employed post-retirement.

Recognition of Service in State/Autonomous Bodies

1. Service in State Governments or Autonomous Bodies counts toward gratuity if:

1. Transition occurred with due approval.

1. No previous gratuity claim was made.

1. The Central Government will bear the gratuity cost without seeking reimbursement from States.

Gratuity for Missing Employees

1. Defined process for granting gratuity to families of missing government servants.

1. Death Gratuity allowed after 7 years or sooner if death is confirmed.

1. Requires FIR and confirmation from the police.

Rules for Withholding or Recovery of Gratuity

1. Gratuity can be withheld/recovered if the retiree is found guilty of:

1. Corruption

1. Misconduct

1. Negligence leading to financial loss

1. UPSC consultation needed before the President issues final orders.

Notional Pay Included in Gratuity Calculation

1. Retrospective promotions or revised pay post-retirement will now factor into gratuity and emoluments.

Interest on Late Gratuity Payments

1. Delay due to administrative reasons will attract interest.

1. Officials responsible for the delay will be held accountable.

Extraordinary Leave Treatment

1. Medical leave taken as extraordinary leave will count as qualifying service.

1. Specific guidelines issued for counting non-medical extraordinary leave.

Gratuity in Case of Death During Penalty Periods

1. Gratuity will be based on original pay, disregarding penalties in effect at the time of death.

Employment Types Affected by New Gratuity Rules

The type of employees who will be impacted by the new gratuity rules are:

1. Seasonal and temporary workers

1. Workers in startups

1. Terminated employees due to misconduct

1. Fixed-term contract employees with less than one year of service

1. Gig economy workers, such as share-ride drivers, freelancers

1. Newly hired employees or employees on probation

Gratuity Rules

The regulations concerning gratuity are established within the framework of the Payment of Gratuity Act of 1972.

1. Gratuity Applies to Companies with more than 10 Employees:
   1. Organizations with at least 10 employees on any single day in the last 12 months must pay gratuity.
   2. The obligation continues even if the employee count later drops below 10.

1. Minimum 5 Years of Continuous Service Required:
   1. Employees must complete 5 years of uninterrupted years to qualify, except in cases of death or disablement.
   2. A year is considered as 240 working days (or 190 for underground workers).
   3. Service continuity includes periods, such as strikes, leave, layoffs, and non-fault termination.

1. Gratuity Is Not Limited to Retirement: It is also payable on resignation, death, disablement, or termination (under eligible conditions).

1. Gratuity Calculation Depends on Salary & Tenure:
   1. For employees covered under the Gratuity Act:
      1.  Formula: (15 × Last Drawn Salary × Completed Years of Service) / 26
      2. For example: 15 × Rs.87,000 x 14 years = Rs.7,02,692.31
   2. For employees not covered under the Act:
      1. Formula: (15 × Average Last 10 Months’ Salary × Years of Service) / 30
      2. For example: 15 years × Rs.72,550 x 13 years = Rs.4,71,575

1. Gratuity Can Be Forfeited in Certain Cases: Employers may deny gratuity if the employee is terminated for misconduct, fraud, or damaging the employer’s property.

1. Bankruptcy Does Not Nullify Gratuity Liability: Even if a company declares bankruptcy, it must still pay in gratuity, and courts cannot overrule this.
   

1. Tax Exemption Up to Rs.20 Lakh:
   1. Gratuity up to Rs.20 lakh is tax-free for employees of organisations covered under the Gratuity Act (excluding government departments and local bodies).
   2. The exemption limit was previously Rs.10 lakh.

1. Tax Rules Vary Based on Employment Type: Different tax treatments apply to employees covered and not covered under the Gratuity Act.

1. Rs.20 Lakh Exemption Is Cumulative:
   1. Tax-free limit applies to the total gratuity received from all employers combined.
   2. Example: If total received is Rs.23 lakh, tax applies to Rs.3 lakh.

1. Gratuity to Legal Heirs Is Fully Tax-Exempt:
   1. Gratuity paid to a deceased employee’s widow or legal heir is not taxable.
   2. Additional compensation for injury or death is also tax-free.

Forfeiture of Gratuity

The Payment of Gratuity Act of 1972 states that an employer has the authority to withhold all or part of an employee's gratuity payment, even if the employee has completed five or more years of service. This only functions when the employee has been fired for disorderly behaviour, which includes attempting to physically injure others while on the job.

Even if eligibility criteria are met, gratuity may be denied under following circumstances:

1. Proven involvement in corruption at the workplace.

1. Serious misconduct or violent behaviour at or outside the workplace.

1. Negligence or other offenses causing damage to company property; in such cases, repair costs may be deducted from the gratuity amount.

Timeline for Gratuity payment

There are three steps involved regarding gratuity payment. These include:

1. Initiation: An individual or an authorized person must send in an application to an employer regarding the gratuity he/she is owed by a company.
2. Acknowledgement and calculation: The organization that owes gratuity will compute the amount as soon as the application is received and will also send a notice of the same to the person and the governing authority with the amount stated.
3. Disbursal: The employer, having sent the acknowledgement, has a time period of 30 days to pay the gratuity amount to the individual.

Nomination Procedure for Gratuity

Once an employee completes one year of service, they are required to submit a nomination within 30 days. This nomination should be in favour of one of their family members.

Any nomination made in favour of a person outside the family will be deemed invalid. If the nominee passes away before the employee, the interest in the nomination reverts back to the employee. In such instances, the employee must create a new nomination for that interest using Form F.

Gratuity Application Form

To claim gratuity, individuals can complete the relevant form based on their role:

1. The Employee (Form I)
2. Designated Nominee of the Employee (Form J)

1. Designated Legal Heir of the Employee (Form K)

After filling out the appropriate gratuity application form, it must be submitted to the employer for the commencement of the gratuity payment process.

Investment Options for Gratuity Amount

When investing in gratuity funds, it's essential to consider financial goals, risk tolerance, and investment duration. Here are some options:

1. Fixed Deposits (FDs): This is a low-risk option giving secure returns with capital preservation.

1. Public Provident Fund (PPF): This is a tax-efficient option with long-term savings with a 15-year lock-in.

1. Employee Provident Fund (EPF): Secure retirement savings with tax benefits.

1. National Pension System (NPS): Mix of equity and debt for long-term growth.

1. Mutual Funds (Equity & Debt): Equity for higher returns, debt for stability.

1. Sovereign Gold Bonds (SGBs): Paperless gold investment with tax perks.

1. Real Estate & REITs: Direct property or market-based real estate exposure.

1. Stock Market: Direct investment in high-risk, high-reward opportunities.

1. Recurring Deposits (RDs): Systematic, monthly savings with fixed returns.