Understanding Gratuity: How Do You Calculate It and Why Does It Matter?

What is gratuity? How is it calculated?

Gratuity is a sum of money that an employer pays to an employee in gratitude for their years of service upon leaving the organization. The calculation of gratuity is based on a formula that considers the employee's last drawn salary and the number of years they have worked for the company.

To calculate gratuity, the following formula is commonly used:

Gratuity = (Last drawn salary x 15 days x number of years of service) / 26

In this formula:
- Last drawn salary refers to the basic salary and dearness allowance of the employee.
- 15 days represent half a month's salary.
- 26 represents the number of working days in a month.

It's important for employers to understand the gratuity calculation process to ensure that employees receive their entitled benefits accurately and fairly.

Hi,

Gratuity is payable to an employee if he has rendered continuous service of at least 5 years. As per the Act, it is computed as (Last Month Salary + DA) x 15/26 x Number of service years.

Hope it's fine.

Gratuity is a lump sum payment to an employee when he retires or leaves service. It is basically a retirement benefit to an employee so that he can live life comfortably after retirement. However, under the Gratuity Act, gratuity is payable even to an employee who resigns after completing at least 5 years of service.

In DTC Retired Employees v. Delhi Transport Corporation 2001(4) SCALE 30 = 2001 AIR SCW 2005, it was observed that gratuity is essentially a retiring benefit which, as per statute, has been made applicable on voluntary resignation as well. Gratuity is a reward for good, efficient, and faithful service rendered for a considerable period.

THE ACT PROVIDES FOR MINIMUM GRATUITY ONLY - The Gratuity Act provides only for the minimum gratuity payable. If an employee has the right to receive higher gratuity under a contract or under an award, the employee is entitled to get higher gratuity. [Section 4(5)].

Employers liable under the scheme - The Act applies to every factory, mine, plantation, port, and railway company. It also applies to every shop and establishment where 10 or more persons are employed or were employed on any day in the preceding 12 months. [Section 1(3)]. Since the Act is also applicable to all shops and establishments, it will apply to motor transport undertakings, clubs, chambers of commerce and associations, local bodies, solicitor's offices, etc., if they are employing 10 or more persons.

Employees eligible for gratuity - 'Employee' means any person (other than an apprentice) employed on wages in any establishment, factory, mine, oilfield, plantation, port, railway company, or shop, to do any skilled, semi-skilled, or unskilled, manual, supervisory, technical, or clerical work, whether the terms of such employment are express or implied, and whether such person is employed in a managerial or administrative capacity. However, it does not include any Central/State Government employee. [Section 2(e)]. Thus, the Act is applicable to all employees - workers as well as persons employed in an administrative and managerial capacity.

Gratuity is payable to a person on (a) resignation (b) termination on account of death or disablement due to accident or disease (c) retirement (d) death. Normally, gratuity is payable only after an employee completes five years of continuous service. In the case of death and disablement, the condition of a minimum 5 years' service is not applicable. [Section 4(1)].

The Act is applicable to all employees, irrespective of the salary.

Amount of gratuity payable - Gratuity is payable at 15 days' wages for every year of completed service. In the last year of service, if the employee has completed more than 6 months, it will be treated as a full year for the purpose of gratuity. In the case of a seasonal establishment, gratuity is payable at 7 days' wages for each season. [Section 4(2)].

Wages shall consist of basic plus D.A, as per the last drawn salary. However, allowances like bonus, commission, HRA, overtime, etc., are not to be considered for calculations. [Section 2(s)].

In the case of employees paid on a monthly wages basis, per day wages should be calculated by dividing the monthly salary by 26 days to arrive at daily wages. For example, if the last drawn salary of a person (basic plus DA) is Rs. 2,600 per month, his salary per day will be Rs. 100 (2,600 divided by 100). Thus, the employee is entitled to get Rs. 1,500 [15 days multiplied by Rs. 100 daily salary] for every year of completed service. If he has completed 30 years of service, he is entitled to get gratuity of Rs. 45,000 (Rs. 1,500 multiplied by 30). The maximum gratuity payable under the Act is Rs. 3.50 lakhs (the ceiling was Rs. 1,00,000 which was increased to 2.50 lakhs on 24.9.97 by an ordinance which was later increased to Rs 3.50 lakhs while converting the ordinance into an Act].

MAXIMUM GRATUITY PAYABLE - The maximum gratuity payable is Rs 4 lakhs. [Section 4(3)]. [Of course, the employer can pay more. The employee also has the right to get more if obtainable under an award or contract with the employer, as made clear in Section 4(5)].

INCOME-TAX EXEMPTION - Gratuity received up to Rs. 3.50 lakhs is exempt from Income Tax. Gratuity paid above that limit is taxable. [Section 10(10) of the Income Tax Act]. However, the employee can claim relief u/s 89 in respect of the excess amount.

No Compulsory insurance of gratuity liability - Section 4A provides that every employer must obtain insurance of his gratuity liability with LIC or any other insurer. However, Government companies need not obtain such insurance. If an employee is already a member of the gratuity fund established by an employer, he has the option to continue that arrangement. If an employer employing more than 500 persons establishes an approved gratuity fund, he need not obtain insurance for gratuity liability. However, this Section has not yet been brought into force. Hence, presently, such compulsory insurance is not necessary.

Gratuity cannot be attached - Gratuity payable cannot be attached in execution of any decree or order of any civil, revenue, or criminal court, as per Section 13 of the Act.

(Basic Salary + DA) x 15/26 x No. of service years.

Please go through the attached file.

Thanks & Regards,
Mohnish.

Hi Kapil,
Your note says "MAXIMUM GRATUITY PAYABLE – Maximum gratuity payable is Rs 4 lakhs. [Section 4(3)]. [Of course, employer can pay more. Employee has also right to get more if obtainable under an award or contract with employer, as made clear in Section 4(5)]."
I think it is still Rs 3.50 lakhs as per Act.

Major Salary Components

Money received under an Employer-Employee relationship is called Salary. If one is a freelancer or hired by an organization on a contract basis, their income would not be treated as salary income. In such cases, your income would be treated as income from business and profession.

The salary consists of the following parts:

Basic Salary: As the name suggests, this forms the very basis of salary. This is the core of salary, and many other components may be calculated based on this amount. It usually depends on one's grade within the company's salary structure. It is a fixed part of one's compensation structure, and the complete amount becomes a part of your in-hand salary.

Allowances: Apart from basic salary, there are some allowances your CTC will contain. Examples include HRA, conveyance allowance, and leave travel allowance. Some of these allowances are tax-free up to a certain limit, and some of them depend on your actual spending. It is the amount received by an individual paid by his/her employer in addition to basic salary to meet some service requirements such as Dearness Allowance (DA), House Rent Allowance (HRA), Leave Travel Assistance (LTA), Lunch Allowance, Conveyance Allowance, Children's Education Allowance, City Compensatory Allowance, etc. Allowances can be fully taxable, partly taxable, or non-taxable.

Claims or Perquisites: A part of your salary may also be made up of your billed claims. These include components like mobile allowance and medical allowance. There is a maximum limit set to these components, and they are paid when you submit your bills. These are usually tax-free. It is any benefit or amenity granted or provided free of cost or at a concessional rate, such as a rent-free unfurnished house, rent-free furnished house, motor car facility, reimbursement of gas, electricity & water, club facility, domestic servant facility, interest subsidy on loan, reimbursement of medical bills, reimbursement of hospital bills, reimbursement of telephone bills, benefits derived by employee stock options, and so on.

How are Perquisites Taxed? Since these are non-cash components, they cannot be taxed directly. So, the income tax laws attach a certain value to each of these components and charge a tax on them. The calculation of this value varies from category to category. Nevertheless, the thumb rule across all categories is that only those benefits that you use for personal purposes will be considered as perquisites.

Deductions: A major part of your CTC comprises compulsory deductibles. These include deductions for provident fund, medical insurance, etc. They form a part of your compensation structure, but you do not get them as part of your in-hand salary. As such, although it increases your CTC, it does not increment your net salary. Compulsory deductions include Provident Fund, Income Tax, and Professional Tax (where applicable). Optional deductions include recovery for advance or loan if taken, voluntary contribution to P.F., etc.

Provident Fund Contribution: Provident fund contribution has two sides – the employer's contribution and the employee's contribution. This is usually 12 percent of the basic salary. However, this contribution is not paid out. It is directly deposited in the Provident Fund (PF) account and paid to the employee when they retire or resign. There is also the employee's contribution to PF. This amount is deducted from their monthly salary and deposited in their PF account. For details on provident fund, you can read Provident Fund (PF) and Voluntary Provident Fund (VPF).

Performance Linked Pay: Linking a part of the salary to productivity and performance has become a trend today. You get the complete amount only on 100% achievement of the target, but it forms a part of your CTC, fattening it up.

Different Types of Salary:

- Gross Salary: The amount of salary paid after adding all benefits and allowances and before deducting any tax.
- Net Salary: What is left of your salary after deductions have been made.
- Take Home Salary: Usually the Net Salary unless there are some personal deductions like loan or bond repayments.
- Cost to Company: Companies use the term "Cost to Company" to calculate the total cost to employ, i.e., all the costs associated with an employment contract. A major part of CTC comprises compulsory deductibles. These include deductions for provident fund, medical insurance, etc. They form a part of your compensation structure, but you do not get them as a part of in-hand salary. As such, although it increases your CTC, it does not increment your net salary.

Taxes: Taxes are an unavoidable evil, and they eat up a large chunk of your salary. Taxes are obviously never mentioned in your offer letter. So, ensure that you calculate your tax liabilities with the new income in accordance with tax policies to figure out the amount you will receive in your paycheck.

The salary structure varies from company to company based on their policies. Some of the common pay heads used are:

1) Basic – 35% – 50% of Gross
2) HRA – 40% of Basic for Non-metro & 50% of Basic for Metro (Delhi, Mumbai, Chennai, or Kolkata)
3) Conveyance – Max Rs. 800/ PM, which is Max of Rs. 9600 PA
4) Medical Reimbursement – Max Rs. 1250 / PM, which can be max of Rs. 15000 PA
5) Special Allowance – Balance of Gross will be provided as Special Allowance

Statutory:

1) PF
- Employee Contribution – 12% on Basic (can be subjective to 780, which is 12% of the min basic salary, i.e., 6500)
- Employer's Contribution - (EPS – 8.33% (subject to a ceiling of Rs. 541)
- PF – Rest of the amount out of 12% (can be subjective to 780, which is 12% of the min basic salary, i.e., 6500)
- PF administration charges – 1.1%
- EDLI – 0.5% (subject to a ceiling salary of Rs. 6500)
- EDLI administration charges – 0.01%

2) ESI – Applicable to employees whose Gross Salary is less than or equal to Rs.15000
- Employee Contribution – 1.75% on Gross
- Employer's Contribution – 4.75% on Gross

3) PT – It varies from state to state

Gratuity = Basic/26*15*(no. of years - It is payable to the employee who completes 5 years of service in the organization. It can be shown as a part of CTC.)

OT Calculation = basic+da/26/8*no.of hrs * 2

If employees come under a high salary, then you can again split up the amount in Special Allowance as:

1) Food coupons
2) Car Hire
3) Petrol and Maintenance for Car
4) LTA

FBT is applicable apart from LTA.

Dear All, I have a clarification regarding gratuity payment. Is there a specific slab for gratuity payment? Do directors or proprietors come under this scheme, or do all employees fall under this scheme? Please clarify the same. Thank you very much.

Best regards, Arun