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What is Gratuity?

Gratuity is an amount paid by an employer to their employee for services rendered over a period of time. Gratuity is usually paid when an employee decides to retire, but if certain criteria are met Gratuity can be paid before that.

Only employees that have completed a minimum service of 5 years are eligible to receive Gratuity from a company. But if an employee gets disable due to an accident or disease they can receive this amount earlier. On the passing of an employee, the Gratuity will be given to the employee’s immediate family or next of kin.

How is Gratuity calculated?

There are no set standards for the amount of Gratuity payable. Employers can calculate Gratuity payable by either using a formula or can pay an amount higher. The amount of Gratuity depends on the tenure of employment and last drawn salary of the employee. The Government of India has put in place the Payment of Gratuity Act, 1972 to ensure that employees of organizations have some form of a pension at the time of retirement. Any organization that employs more than 10 individuals at any point in time is required by the Government of India to pay its employees Gratuity. Since there are two types of employees, employees that are covered by the act and employees that are not covered by the Payment of Gratuity Act, 1972, there are two ways of calculating Gratuity. The first method is by a formula:

The formula for calculating Gratuity is based on the 15 days of the last drawn salary and the number of years in the employee’s tenure. The formula is as below

(15 * Last Drawn Salary * Years of tenure)/26

*26 denotes the number of working days in a month. An average of 26 days considering 4 Sundays.

For organizations not covered in the purview of the Payment of Gratuity Act, 1972 the formula to calculate Gratuity is quite similar.

(15 * Last Drawn Salary * Years of tenure)/30

*30 denotes the average number of days in a month, not taking into consideration non-working days.

Gratuity Tax Treatment

Gratuity paid to Government employees is completely exempt from tax. Non-Government employees are divided into two categories for taxation, Employees that fall under the purview of the Payment of Gratuity Act, 1972 and employees that don’t fall under its purview. The tax exempted amount of Gratuity is the same for both these types of employees, but the formula to calculate Gratuity is different. For employees of organizations that fall under the purview of this act, the tax is calculated as follows:

The minimum of the following is exempt from tax:

Rs. 10 Lakhs

Actual Gratuity received