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How to Calculate Gratuity?

M Venkat 
on 12 January 2021

LinkedIn


CALCULATION OF GRATUITY & ITS TAXABILITY

Gratuity is a cash benefit in lump sum provided by the employer to his employees as a sign of gratitude for the services rendered. In India payment of Gratuity is governed by the "Payments of Gratuity Act, 1972". In simple terms, Gratuity works as a Retirement benefit for the employee for rendering his services.

Applicability of Gratuity as governed by the payments of Gratuity Act,1972.

1. employees engaged in factories, mines, oilfields, plantations, ports, railway companies.

2. shops, or other establishments with 10 or more employees or such other establishments as may be notified by the Central
Government.

*The Central government has notified Motor transport undertakings, Clubs, chambers of commerce and industry, Institutions, societies, Trusts and circus industry in which 10 or more persons are employed or were employed on any day of the preceding 12 months, as classes of establishments to which the Act shall apply.

Note: If the act applies once, then it is subsequently applicable even if the number of employees falls below 10.

How to Calculate Gratuity

Eligibility

Gratuity is payable to an employee who and

  • Is eligible for superannuation
  • Retires
  • Resigns
  • has worked for at least 5 years

The 5 years working term will not be applicable in case of situations of demise (if an employee passes away, gratuity will be paid to the employee’s nominee) or disablement of an employee.

Note: For calculation of 5 years, 1 year = 240 working days, 190 working days (in case working in mines or such other fields)

Calculation of gratuity

Gratuity is calculated based on the last drawn salary and years of service. The calculation differs for the employees covered under the Payments of Gratuity Act,1972 and those not covered under the act.

Employees covered under the Act

Employees not covered under the Act

Gratuity = (15*last drawn salary*Number of completed years of service)/26

Note

^Salary includes basic + D.A

^ Where Completed years of service includes 6 months or more it will be treated as 1 Year

For Example: If 15 years 8 months then the completed years of service will be 16 years

Gratuity = (15*Average salary for last 10 months*Number of years employed)/30

Note

^Salary includes basic + D.A

^ Where the number of years employed does not include the part period.

For Example: If 15 years 8 months then the Number of years employed will be 15 years

 

Taxability of Gratuity under Income Tax Act,1961

The Payment of Gratuity(Amendment) Act, 2018 enables the government to raise the limit of tax-free gratuity. The change can be made through an executive order by the prime minister.

On February 1, 2019, India’s interim budget hiked the tax-free gratuity limit from Rs 20 lakh to Rs 30 lakh. Earlier the government had raised the tax free gratuity from Rs 10 lakhs to Rs 20 lakh in March 2018.

Gratuity received by an employee covered by the Payment of Gratuity Act,1972 is exempt from Tax.

1. Gratuity received on account of death cum retirement by central & state govt. employees, defence employees & employees in local authority shall be FULLY EXEMPT.

*(It may be noted that gratuity received during the service is TAXABLE)

2. Gratuity received by the employees

covered under the Payment of Gratuity Act,1972 - the least of the following three amounts shall be exempted from tax

  • Rs 20 lakh.
  • Eligible Gratuity (as shown in the calculation table above)
  • Actual Amount of Gratuity received

Not covered under the Payment of Gratuity Act,1972 – the least of the following three amounts shall be exempted from tax

  • Rs 10 lakh.
  • Eligible Gratuity (as shown in the calculation table above)
  • Actual Amount of Gratuity received
 

Forfeiture of gratuity

Section 4 (6)(a): gratuity of any employee whose service has been terminated for any act, willful omission or negligence causing any damage or loss to, or destruction of, property belonging to the employer, gratuity shall be forfeited to the extent of damage or loss caused.

Section 4 (6) (b): deals with a case where the services of an employee have been terminated

1. For riotous and disorderly conduct or any other act of violence on his part, or

2. For any act which constitutes an offence involving moral turpitude provided that such offence is committed by him in the course of his employment.


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