Gratuity is a lump-sum payment an employer in India makes to an employee as a reward for long and continuous service, usually when they leave the company. It is a statutory benefit under the Payment of Gratuity Act, 1972, payable on resignation, retirement, death, or disablement once the employee has completed the required period of service. It is funded entirely by the employer, not deducted from the employee's pay.
Who is eligible for gratuity?
Gratuity rewards tenure, so eligibility is tied to length of service, with exceptions for events outside the employee's control. The main conditions are clear.
- Five years of service: an employee generally qualifies after completing five years of continuous service with the same employer.
- Covered establishments: the Act applies to establishments with 10 or more employees.
- Death or disablement: the five-year condition is waived if service ends due to death or disablement.
How is gratuity calculated?
For employees covered by the Act, gratuity is based on the last drawn salary and the number of completed years of service. The standard formula is:
Gratuity = (15 / 26) x last drawn monthly salary x completed years of service.
Here the salary means basic plus dearness allowance, 15 represents 15 days of wages for each year, and 26 is the assumed number of working days in a month. As a worked example, an employee with a last drawn salary of 52,000 rupees (about 624 US dollars) and 10 completed years would receive (15 divided by 26) times 52,000 times 10, which is 300,000 rupees (about 3,600 US dollars).
A period of more than six months in the final year is usually rounded up to a full year. Gratuity received is tax-exempt up to 2,000,000 rupees (about 24,000 US dollars) over an employee's career, with amounts above that taxed as per the rules.
Gratuity vs other exit payments
Gratuity is often confused with other amounts paid when an employee leaves. It helps to see how it differs from provident fund and leave encashment.
| Payment | What it is | Funded by |
|---|---|---|
| Gratuity | Reward for 5+ years of service | Employer |
| Provident fund | Retirement savings built monthly | Employer and employee |
| Leave encashment | Payment for unused leave | Employer |
What are the employer's gratuity obligations?
Gratuity is a long-term liability that an employer must plan for and pay promptly when it falls due. The key duties are as follows.
- Track each employee's length of service and accrue the liability over time.
- Calculate the amount correctly on exit using the last drawn salary and completed years.
- Pay the gratuity within the timeframe set by law, usually within 30 days of it becoming due.
- Apply the correct tax treatment and keep records of the calculation and payment.
This information is for general guidance. Confirm current limits and consult experts for your specific situation.
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