Gratuity Calculation Dilemma: Should It Be Based on Actual or Reduced Salary?

One of our employees resigned this week after working for us for 6 years. Since last year, we have been experiencing a 30% salary reduction. In this case, I would like to inquire whether the gratuity should be based on the actual salary or the reduced salary. Your advice on this matter would be greatly appreciated.

Thank you,

What's the reason for the salary reduction? Is it a temporary measure of austerity due to business reverses? Was the reduction done by the management unilaterally or by means of a bipartite agreement?

Reduction of the existing salary of the employees is a complicated issue as it involves legal and ethical questions. Admittedly, it is only a temporary measure of austerity due to the pandemic situation. Instead of going without a job, the employees might have meekly accepted the decision of your management as the ground reality. Therefore, to avoid ethical and substantial legal questions, it is better for the management to pay gratuity based on the last salary the employee would have received but for the temporary reduction.

So, is it better to pay the gratuity based on the actual salary rather than on the reduced salary, correct, Sir?

Gratuity Calculation Based on Salary Changes

While it is best to pay gratuity on the full salary, the law actually states that it should be based on the last drawn salary. If an employee receives an increment just before resignation, they will be entitled to a higher gratuity. Conversely, if they agree to a lower salary before resignation, the gratuity amount will be lower.

I am curious about what will happen with the Gratuity Insurance provided by LIC in such cases. Will LIC insist on a lower payout if the salary was reduced before resignation?

Dear Saswata,

Your curiosity is quite genuine, logical, and, in fact, a legally valid one too.

Understanding the Payment of Gratuity Act, 1972

Apart from the mandatory requirement under Section 4-A of the Payment of Gratuity Act, 1972, which is yet to be enforced through notification by many State Governments, an insurance policy taken with LIC in this regard covers the employer's liability to pay gratuity under the Act when needed.

Premium Calculation and Salary Adjustments

As you are well aware, the premium is calculated and collected on an actuarial basis only, based on the average salary payable to the employee during the preceding 12 months. Therefore, there is reason to believe that any shortfall in the last drawn salary for any lawful reason would be automatically adjusted by the value of the actual maturity amount of the policy.

Employer's Liability in Case of Salary Reduction

Moreover, in the case of a salary cut during the last period of the employee's service, like the one mentioned in the original post, if the Insurer is willing to pay a lesser amount than the statutory gratuity based on a lower premium rate, the employer is still liable to compensate for the loss.

I hope this clarifies your query. Let me know if you need any further information.

Best regards