Application of Rules for Gratuity in India

Gratuity is a lump-sum amount paid to employees as a form of social security provided by employer in monetary terms for the service provided by an employee.

Gratuity is that part of the salary of an Employee which they receive from their employer in gratitude for the services offered to the employer’s company. It is one of the retirement benefits given by the employer to the employee upon leaving the job.

An ‘Employee’ as per ‘The Payment of Gratuity Act’, 1972, is defined as any person (other than an apprentice) who is employed on wages in an establishment to do any skilled, semi­skilled, or unskilled, manual, supervisory, technical or clerical job. A person who holds a Government post and is governed by any other Act providing for the payment of gratuity cannot come under the definition of an ‘employee’ for payment of gratuity.

Eligibility to Claim Gratuity:

Five years continuous service: An employee in order to be eligible to claim gratuity, should have worked with a particular employer for at least five years (as per Section 10(10) of the Income Tax Act).

Section 2A of the Gratuity Act, states that ‘continuous period’ shall also include the following:

If in case employee is not in continuous service of one year, they will be deemed to be in continuous service of one year if- they have, in immediately preceding twelve calendar months, worked under the employer for not less than:
  • 190 Days (in case of employee employed in mines below ground)
  • 190 Days (in case if employee employed in an establishment which works for less than six days in a week)
  • 240 Days ( in any other case)
If in case an employee is not in continuous service of six months, they will be deemed to be in continuous service of six months if- they have, immediately preceding six calendar months, worked under the employer for not less than:
  • 95 Days (in case of employee employed in mines below ground)
  • 95 Days (in case if employee employed in an establishment which works for less than six days in a week)
  • 120 Days ( in any other case)
If an employee of seasonal establishment is not in continuous service of twelve or six months, they can be deemed to be in continuous service of twelve or six months; if they have actually worked for not less than seventy five percent of the number of days on which the establishment was in operation during such period.

By continuous service for the purpose of gratuity it is meant uninterrupted service which may be interrupted due to accident, sickness, absence for duty without any leave, leave, lay-off, lock-out, strike or cessation of work (due to not any fault of the employee) are considered as continuous service.

Following days shall also be included while calculating the actual days of an employee has worked for:
  • If an employee has been laid-off under an agreement
  • If an employee has been on leave with full wages
  • If an employee has been absent on his duty due to temporary disablement caused by an accident arising out of and in the course of his employment
  • Maternity leave for female employee, not more than twelve weeks                                             
When is an Employee Entitled to Claim Gratuity?

  • On leaving the job: One of the occasions when an employee is entitled to claim gratuity is on the termination of his employment. There can be many reasons for this such as retirement/voluntary retirement, resignation, sometimes the employer may terminate the employee (not for some bad conduct of the employee as in this case the employee may lose his chance of claiming gratuity) or sometimes the employee may find some better opportunity so he might opt for a job-switch.
  • Death or permanent disablement: The other circumstance where an employee can claim gratuity is in case of his/her death or disablement which renders him permanently incapable of working in that company forever. However in such cases the Income Tax has relaxed the five years criteria, therefore an employee can claim his/her gratuity even if he/she has worked for less than five years. In case of death the nominees of the employee is given the gratuity. If case of the nominee being a minor, the amount of gratuity shall be deposited with the controlling authority. Controlling authority deposit/invest the gratuity amount in a financial institution or bank for benefit of minor, as may be prescribed, until such minor attains majority.
Entities to which the Gratuity Rule Applies:

Generally every factory and establishment pays gratuity to its employees for the services rendered to it. However the gratuity rules does not mandatorily applies to such entities which have less than 10 persons and the number of employees for this purpose are counted as an average of the last 12 months.

Forfeiture of gratuity:

The employer may even forfeit the gratuity to which an employee may be entitled to if he leaves his job after 5 years if the company suffers any loss on account of the employees fault or negligence.
 
Calculation of Gratuity:

Calculation of gratuity depends upon two variables:
  • Salary
  • Superannuation
In calculating the gratuity fifteen days salary is given for every completed year and as the number of working days in a month is considered to be 26 only (excluding the Sundays) therefore the formula for calculating the gratuity would be:

Formula: Last drawn salary x 15/26 x Completed years of Service (including a part of year in excess of six months)

In case of an employee working in a seasonal establishment he shall be paid gratuity at the rate of 7 days wages for each season.

Gratuity for a disabled employee:

If a worker or an employee becomes disabled due to a disease or an accident and as a result is not able to perform the task which they were performing prior to such disability, but are re-employed on some other task/job on reduced wages, then they will be paid gratuity as follows:

1. For the period preceding the disablement: On the basis of last drawn wages by the employee at the time of disablement.
2. For the period subsequent to disablement: On the basis of last drawn reduced wages by the employee at the time of termination of employment.

When the Employer Approaches a Life Insurer:

There are two ways an employer may pay gratuity to their employee, either from the employer’s own funds or they may approach a life insurer to purchase a group gratuity plan. When an employer opts for the latter, they have to pay annual contributions as decided by the insurer. However, the employee is also free to make contributions to their own gratuity fund. The gratuity will be paid by the insurer based upon the terms of the group gratuity scheme.

Tax Treatment of Gratuity:

Gratuity is not entitled to any exemption from tax. When an employee receives gratuity it would be taxable under the head ‘Income from salary’. And when the employee is entitled to gratuity on account of their death it would befall in the hands of their nominee and would be charged under the head ‘Income from other sources’.  
 
For the purpose of calculation of exempt gratuity, employees may be divided into 3 categories
  • Government employees: They are fully exempt from receipt of gratuity.
  • Non-government employees covered under the Payment of Gratuity Act, 1972: Maximum exemption from tax is least of the 3 below:
  1. Actual gratuity received;
  2. Rs 10,00,000;
  3. 15 days’ salary for each completed year of service or part thereof
  •  Non-government employees not covered under the Payment of Gratuity Act, 1972: Maximum exemption from tax is least of the 3 below:
  1. Actual gratuity received;
  2. Rs 10,00,000;
  3. Half-month’s average salary for each completed year of service
Gratuity not a Subjects of Attachment:

Gratuity offered to an employee is exempted from being attached in case of a decree against the employee as from a Civil or a Criminal Court, as a fine, as the case may be.