Any individual needs financial security during their life. Planning is a constant process and all the major decisions of life need a proper plan. Short and long-term fund requirements should be identified in order to be self-sufficient. None of the stages in our life is less important. But a few surely need more attention. For example buying your own house, children’s education, and retirement.
The need for money could arise due to many reasons. An unprecedented event might call for financial support. Retirement is one of the phases in everybody’s life when health takes priority and sources of income must be able to meet the ends. Those who are salaried can get the benefit of pension, gratuity, and PPF over and above their salary. Pension is available mostly to only those who are working for a government undertaking. Rest others depend upon other options.
One of the most dependable sources among them is Gratuity. It is a sum of money paid by an employer to an employee for services rendered in the company. Gratuity is paid to those employees who complete a period of 5 or more years with the company. It is like a token amount paid by the company showing gratitude to the employee for their services to the organization. Gratuity is payable to the employee under the Payment of Gratuity Act 1972.
The various factors associated with gratuity will be discussed in the following paragraphs.
The eligibility criteria to receive Gratuity
As an employee,
- You should be eligible for superannuation.
- You should have retired from service.
- You should have resigned after continuous employment of five years with the company.
- In case of death, the gratuity is paid to the nominee, or to the employee on disability on account of a sickness or an accident.
There is no defined percentage stipulated by law for the amount of gratuity an employee is supposed to receive. The employer can use a formula-based approach or opt to pay a higher amount than that. The gratuity payable depends on two factors-
- Last drawn salary and
- The number of years of service.
For this purpose, the Payment of Gratuity Act, 1972 has divided non-government employees into two categories:
- Employees covered under the Act and
- Employees not covered under the Act.
An employee will be covered under the Act if the organisation employs at least 10 persons on a single day in the preceding 12 months. Once it comes under the purview of the Gratuity Act, it will always remain covered even if the total number of employees falls below 10.
Payment of Gratuity Act applies to employees of factories, mines, oilfields, plantations, ports, railway companies, shops or other establishments related to them, private and public sector companies, and other establishments. All kinds of government jobs have been included under the purview of this Act. It is applicable in all states of India except Jammu and Kashmir.
The completion of continuous service of five years shall not be necessary where the termination of the employment of any employee is due to death or disablement.
It should be noted that in the case of death of the employee, gratuity payable to him shall be paid to his nominee or, if no nomination has been made, to his heirs, and where any such nominees or heirs is a minor, the share of such minor shall be deposited with the controlling authority who shall invest the same for the benefit of such minor in such bank or other financial institution, as may be prescribed, until such minor attains majority.
Disablement that incapacitates an employee for the work which he was capable of performing before the accident or disease resulting in such disablement.
Gratuity Calculator
A gratuity calculator is a tool that gives you an estimate of the amount that you would receive, on quitting the job, after rendering continuous service of five years. It is very easy to use this calculator. You can enter the figures of your last drawn salary and the tenure of your continuous service with the company. This calculator is quite handy and it shows the gratuity figure in no time. It can be used as many times as one wants to.
The last drawn salary is your basic salary including the dearness allowance and the commissions that you have earned from sales. The formula is based on 15 days of last drawn salary for each completed year of service or part thereof in excess of 6 months. The wages paid for any overtime work shall not be taken into account. The formula is as follows:
The following formula is used to calculate gratuity for the employees covered under the Gratuity Act=(15*last drawn salary*tenure of working)/26 OR,
Gratuity=N*B*15/26
N=number of years of service in a company
B=last drawn basic salary plus DA
The example given here further explains the calculation of gratuity-
An individual worked with a company for 25 years and had Rs. 35,000 as his last drawn salary. This includes DA then,
Gratuity amount=25*35,000*15/26=Rs.5,04,808.
The employer may pay more gratuity to the employee. The number of months in the last year of employment, anything above 6 months is rounded off to the next number. Anything below 6 months in the last year of employment is rounded off to the previous lower number. If the period served by an employee is 12 years and 9 months, then it should be taken as 13 years as the last year of service is more than 6 months and the year is taken as a full year for the purpose of calculation. Similarly, if the last year of service is say 3 months, the period of service shall be rounded off to 12 years.
The Gratuity Amount for employees not covered under the Act=(15*Last drawn salary amount*period of service)/30.
The gratuity amount would be calculated as per the half-month salary on each completed year of service. If an employee has served a company for 15 years, and their salary is Rs. 40,000 then the gratuity will be: (15*40,000*15)/30=Rs.3,00,000.
As per the Pensioner’s portal of the government, the amount of gratuity at the time of retirement shall be – Gratuity amount is equal to one-fourth of emoluments for each completed six monthly periods of qualifying service can be paid to a Government servant who has completed five years’ qualifying service and has become eligible for service gratuity of pension under Rule 44. It is subject to a maximum of 161/2 times the emoluments.
Gratuity in case of death of an employee
In this case, the gratuity amount is calculated on the basis of the tenure of service of the employee. It is subject to a maximum of Rs. 20 lakh. To nominate one or more heirs for your gratuity amount, you need to fill in Form F when joining a company. Here is a table showing rates at which the gratuity will be payable in case of death of an employee:
The above death gratuity rates are also applicable in case of the death of a Government servant by suicide. If a government retired servant dies within 5 years from the date of retirement and without receiving an amount equal to or 12 times of his emoluments are gratuity of pension, then a residuary gratuity equal to the deficiency may be granted to his family, according to Pension Rules 2021.
The following is a list of points that affect the payment of gratuity by an employer to an employee:
- The employer has the right to reject payment of gratuity due to an employee if the employee has been asked to leave the job owing to their misconduct. When termination takes place due to an act that constitutes an offence and involves moral turpitude if such an offence is committed during the course of employment. Terminations occur due to disorderly conduct or any other act of violence. The employee must have received termination orders which contain charges as established to the effect that the employee was found guilty of the aforesaid misconduct. Forfeiture of gratuity is possible in such cases In the absence of a termination order arising out of the above allegations, the gratuity of an employee cannot be forfeited.
- In case of death, the nominee or heir of the employee receives the gratuity amount. And the tax calculation shall be made for the receiver by including the same amount under the head- “Income from other sources”.
- An employee can receive a gratuity amount higher than Rs.20 lakh from his/her employer, the exemption from tax will be as per the discussion that follows, about taxation of gratuity later in this article. The bar for the amount of gratuity ceiling is raised to Rs. 20 lakhs from the last limit of Rs. 10 lakhs. This is as per the Seventh Pay Commission recommendations.
- Labour laws mandate weekly offs for all employees. For employees covered under the Act, the benefit of a lower denomination is given. Hence, the number of working days per month is not more than 26 days. The monthly salary for an employee is for 26 days of work. The formula for gratuity calculation considers the per day salary to be the total monthly salary divided by 26 and not 30.
- While ascertaining the period of five years, a period of more than 240 days of continuous services shall be taken as a full year. A person leaving his/her job rendered services for four years and two hundred and forty days. Then the person is eligible for gratuity. In the case of persons working with establishments that work for less than six days a week continuous service for more than four years and one hundred and ninety days is considered a continuous service of five years for determining the eligibility.
New Gratuity Rules:
There have been advancements in the Gratuity Act as three Labour Code Bills have been passed in Parliament. Chapter 5 of the Social Security Bill,2020 gives information about the rule of gratuity. The new labour law was implemented in April 2021. The Union Government has proposed many security measures for the workforce due to the COVID-19 outbreak. Finance Minister Nirmala Sitharaman has announced that the government plans to offer the payment of gratuity after the completion of one year of service. This will also apply to the fixed-term employees of a firm.
The proposed changes which are yet to be implemented as per new gratuity rules 2021-The companies shall have to make changes in their CTC and allowances while applying the new labour law. Because according to the new law, the allowances of an employee cannot exceed 50 percent of the total salary. Employers have to increase the basic salary of their employees by 50 percent. Limiting the allowance to 50 percent of the total salary will increase the employer’s payment on staff gratuity, which is paid to the staff working in a company for more than five years. This gives them more retirement benefits than before.
As per the new definition, bonus, pension, PF contributions, conveyance allowance, HRA, overtime, and gratuity will be excluded from salary. The share of the basic salary will be kept at 50 percent or more. The salary structure has undergone a big change due to these rules. In-hand pay of employees could be cut. But the deduction in the name of social security schemes like PF will increase.
Gratuity rules 2020-The Government has made an arrangement for fixed-term employees/those working on a contract basis. Even if individual works with a company for a fixed term of one year on a contractual basis, they will be eligible for gratuity. The employee shall be treated on par with any other regular employee of the company. Those working in the seasonal establishment will also be given the benefit of gratuity. For the fixed-term employees, there is no specified period or condition for minimum service.
Five consecutive years of service will not be necessary where the death or disability of an employee or fixed-term appointment or any such notice is notified by the central government.
In the case of a working journalist, the gratuity period is three years instead of five years.
Nomination
Nomination is required to be made by an employee within 30 days of the completion of one year of service. Employers usually require employees to submit the nomination form at the time of joining the organisation. An employee can nominate only family members and if there is no family member then the nomination can be made in anyone else’s name.
It should be noted that in the case of a female employee, the option to remove her husband and his dependent parents from the list of nominees is not allowed. Under the EPF scheme, a female employee has such an option.
Gratuity nomination does not get canceled automatically after marriage. You must file a fresh nomination after marriage as your spouse will also qualify as your family if you had nominated anyone else other than the defined family members presuming that you did not have any family. However, if your dependent parents have been nominated before marriage, they will continue to be valid nominees even after marriage. The nominated persons shall be paid the gratuity benefits by the employer in the event of the untimely death of the employee.
Where a nomination is made validly, the nominee holds the funds on behalf of the legal heroes of the deceased employee and he is bound to pay the same in accordance with a will or general succession laws. If someone who is not family is nominated by the employee, they would not be entitled to receive the gratuity proceeds even if they are a beneficiary under a will. A will cannot override the framework of the Gratuity Act.
Taxation of Gratuity
Gratuity forms part of the financial package that one gets as retirement benefits. A gratuity is a form of appreciation for the amount of time an employee puts into work.
Employees Covered under the Payment of Gratuity Act:
The least of the following is exempt from tax:
- Last salary (basic+DA)*the number of years of employment*15/26.
- Rs. 20 lakhs.
- Gratuity actually received.
- 15 days salary based on the salary drawn for every completed year of service or part thereof i.e. 15/26.
- The number of years in service is rounded off to the nearest full year.
Employees Not Covered Under the Payment of Gratuity Act:
The amount of gratuity payable to the employee can be calculated based on half a month’s salary for each completed year. There is no restriction on an employer from paying gratuity to his employees even though the organisation is not covered under the Payment of Gratuity Act.
- Last 10 months average salary (basic+DA)*number of years of employment *½
- Gratuity actually received.
- Rs.20 lakhs
- An average salary of the previous 10 months is considered.
- The number of years in service is rounded off to the nearest full year.
Gratuity paid by the government to government employees is fully exempt from tax u/s 10(10)(i). Likewise, the employees of municipalities and defence forces are fully exempt without any upper monetary limit.
The amendment that has expanded the limit to Rs.20 lakhs reduces the taxable gratuity amount. Those who are earning higher salaries benefit in the short run. If a long time is left before employees’ retirement, it will benefit most of them.
Where gratuity is received from two or more employers in the same year then the aggregate amount of gratuity exempt from tax would not exceed Rs. 20 lakhs.
Where gratuity is received in any earlier year from a former employer and again received from the same/another employer in a later year, the limit of Rs. 20 lakh will be reduced by the amount of gratuity exemption earlier.
The limit of Rs. 20 lakhs has been changed from time to time. A person retiring between 24.09.1997 to 23.05.2010 will be entitled to a maximum exemption of Rs. 3.50 lakhs u/s 10(10). If a person is retiring between 24.05.2010 to 28.03.2018, he is entitled to a maximum exemption of Rs. 10 lakhs and if he is retiring on or after 19.03.2018, he is entitled to a maximum exemption of Rs. 20 lakhs u/s 10(10).
Taxability of Enhanced Compensation
An employee can get enhanced compensation of gratuity for many reasons. A certain amount is paid on the date of retirement/ separation in those cases and the balance amount is paid on a later date. The exemption limits keep on changing from time to time, so the original amount and the enhanced amount of gratuity when paid on different dates, there arises confusion as to their taxability.
For example, Mrs. ABC got enhanced compensation of gratuity of Rs. 7 lakhs on 25.01.2019. The exemption limit of Rs. 20 lakhs will be applicable for those who retired or separated on or after 19.03.2018. So she will not be allowed an enhanced exemption of Rs 20 lakhs and Rs. 7 lakhs entirely received on the above date will be taxable. The reason is that the subsequent gratuity amount is not on account of retirement/separation.
The benefit amount received by the nominee or the legal heir, a widow, or other legal heirs of any employee in case of death of the employee is not taxable. If the gratuity amount becomes due or is paid before the death of the employee, it is taxable under the head ‘Income from other sources’ and they have to disclose the gratuity amount while filing ITR.
Gratuity is a simple tool to ensure that the employee is rewarded for his work and dedication to an organisation. It is not all complex to study the simple rules that govern gratuity. And by reading this article, the relevant factors affecting gratuity can be understood easily.
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Bhoi Smrutirekha Dharanidhar