Gratuity: Meaning, Calculation, & Eligibility

Gratuity is the silent investment employees make by staying longer with an organization. Since salaries are paid after deduction of gratuity amount from the Cost To Company (CTC), employees are not directly affected by it.

On the other hand, an employer is liable to pay gratuity in lumpsum when an employee leaves their organization after a long tenure. Hence, it is beneficial to the employer too, as it motivates the employees to stay longer with their company, increasing their retention rate.

So, what exactly is gratuity in salary? What are its eligibility criteria in India? How to calculate the gratuity amount, and what are the applicable taxes? We will be discussing all aspects of gratuity in this blog.

What is Gratuity?

Gratuity is the lump-sum amount paid to an employee as a token of appreciation for continuous long-term service. It is usually paid upon retirement, resignation after a long tenure, death, or permanent disability. In India, gratuity is governed by the Payment of Gratuity Act, 1972, which makes it a statutory regulation to be followed by all applicable organizations in both the public and private sectors.

Being a financial reward paid to employees for their long-term commitment to an employer, it is usually paid at the end of their tenure along with their FnF settlement. It is calculated based on the number of years served by an employee and their last drawn salary.

What is the Gratuity Eligibility in India?

In India, the gratuity eligibility is controlled by the Payment of Gratuity Act, which stipulates that any company with more than 10 employees should pay any employee who has completed at least 5 years of continuous service a lump sum amount as gratuity. This payment should be made when they resign, retire, or are laid off. Additionally, the 5 years is waived in cases of death or disablement of the employee.

On a side note, the Code on Social Security, 2020 stipulates that the eligibility time period for fixed-term employees is reduced to 1 year of continuous service.

• The following factors are applicable for an employee to receive gratuity:
• 5 years of continuous service with the same employer.
• The Act applies to factories, oilfields, plantations, mines, railway companies, shops, and other establishments employing 10 or more employees.
• In the event of death or disability, the 5-year rule restriction is waived.
• The maximum gratuity amount should not exceed ₹20 lakh.

How to Calculate Gratuity Amount?

Gratuity is calculated separately based on whether the employee is covered or not covered by the Payment of Gratuity Act. Hence, let us understand its calculation under both scenarios:

Calculation of Gratuity for Employees covered under the Payment of Gratuity Act

In this scenario, the calculation of gratuity involves two important parameters, namely the accurate number of years worked and the last drawn salary.

The formula for calculating gratuity for employees is:

Hence, we can observe that the gratuity amount is directly proportional to and dependent on the number of years of service and the last salary.

Let us understand this with an example:

Consider an employee, Jane, who resigned from her organization. Let us assume that she has completed 7 years and 4 months, and her last drawn salary was ₹50,000.

According to the formula, her gratuity will be:

So, Jane will be receiving ₹2,01,923 as gratuity.

Do note that in this scenario, her gratuity was calculated by excluding the 4 months, as it was under the threshold of 6 months. If it were above the threshold, we would have considered the number of years to be 8.

Calculation of Gratuity for Employees not covered under the Payment of Gratuity Act

In this scenario, the formula changes to:

According to the formula, Jane’s gratuity will be:

So, Jane will be receiving ₹1,75,000 as gratuity.

We can observe that the gratuity amount has reduced in this scenario.

Also Read: New Gratuity Rule 2025 Explained: Eligibility & Key Changes

How to Check Gratuity Amount?

Knowing your gratuity amount helps you make future financial decisions with confidence. Since it is a long-term investment, gratuity helps you plan for the future, providing you with a lump sum amount that you can use for any major expenses or re-invest in other avenues.

There are 3 options to check the gratuity amount:

1. Our Easy Gratuity Calculator

The easiest way to calculate gratuity is to use our handy Gratuity Calculator. With this easy-to-use tool, you can easily calculate your gratuity amount based on your last drawn salary and the total tenure with your organization.

2. Check with your Employer

Another simple method to check gratuity is to simply check with your employer. Your HR or accounts department head will have the exact salary details of all employees in your organization. Hence, they will be able to provide the exact gratuity amount based on your tenure with the company. You may also check your ESS portal to get exact details about your gratuity.

3. Calculate Yourself

If you do not wish to utilize the above options, you can also calculate your gratuity by using the formula provided above. Do note that, while the formula is set by statutory regulations, your employer can pay you more depending on various factors such as company policies, your relationship with your employer, etc.

What are the Taxes Applicable on Gratuity?

Tax rules for gratuity are based on your employment. If you are a government employee, your gratuity is completely exempt from income tax. For private employees covered by the Payment of Gratuity Act, the least of the following 3 amounts will be exempt from income tax:

• ₹20 lakhs
• The eligible gratuity amount
• The actual gratuity amount.

For example, let us consider the example of Jane we shared above. In her case, the eligible gratuity amount is ₹2,01,923. Let us consider that the company paid her ₹3,00,000 as gratuity. In this case, she need not pay any income tax on her gratuity as the amount received is below the exemption limit of ₹20 lakhs.

On the other hand, for the sake of our understanding, let us assume her company gave her ₹30 lakhs as gratuity. In this scenario, the least amount of the three variables is the calculated gratuity amount, which is ₹2,01,923. Hence, it will be exempt from income tax. However, since the actual gratuity paid is ₹10 lakhs above the threshold of ₹20 lakhs, she will have to pay income tax on this amount of ₹10 lakhs.

What are the Advantages of Gratuity?

Since gratuity is a long-term benefit, it provides both the employee and the employer with various advantages, such as:

• Tax Benefits: Since gratuity is exempt from income tax up to the limit of ₹20 lakhs, it offers tax savings on your investment.
• Financial Security: Since it provides a lump sum amount after retirement or resignation, it provides the employee with financial security.
• Employee Retention: Employees will be motivated to stay longer with an organization because of gratuity, improving the overall employee retention rate.
• Better Compliance: Companies that provide gratuity remain compliant with the related regulations, while also promoting a better work environment.

Conclusion

So, that is gratuity! It is not only a long-term financial investment for the employees but also provides financial security in case of resignation and retirement. On the other hand, it provides employers with better employee retention as they remain with the organization for longer to become eligible for gratuity.

Hence, gratuity plays a major role in employment, while staying invisible to both parties. We hope this blog has helped provide you with a robust idea about gratuity, its calculation, and the applicable taxes.

FAQs on Gratuity

1. What is Gratuity in salary?

Gratuity is the monetary benefit paid to employees by their employer as a token of appreciation for serving them for a long period of time. It is given to the employees at the time of their resignation or retirement, with death and disability also being reasons for their disbursal.

2. What is the maximum Gratuity amount?

There is no predefined maximum gratuity amount set by statutory regulations. However, the maximum gratuity amount that is exempt from income tax is ₹20 lakhs. Beyond this threshold, employees are required to pay income tax on the difference, according to their income tax slabs.

3. Is Gratuity taxable in India?

Gratuity is taxable in India under the ‘income from salary’ header. If it exceeds the limit of ₹20 lakhs (for private employees), then it becomes taxable, which is borne by the employee. On the other hand, the gratuity paid to government employees is completely tax-free.

4. Is 4 years 7 months eligible for Gratuity?

According to the provisions of the Payment of Gratuity Act, 1972, employees who have completed a minimum of 5 continuous years of service with the same organization are eligible for gratuity. Hence, an employee with 4 years and 7 months of service is not eligible for gratuity.

5. What is 15/26 in a Gratuity calculation?

The relevance of 15/26 in gratuity calculation is:

• 15 days, since gratuity is calculated at the rate of 15 days for each completed year of service, and
• 26 days, which is the standard number of working days in a month.

6. How much Gratuity after 5 years?

If an employee completes 5 years of continuous service, they become eligible to receive gratuity.

The amount is calculated using the following formula:

Example:

If your last drawn salary is ₹30,000 and you have worked for
5 years, the gratuity will be calculated as:

So, after completing 5 years in the company, you would receive
around ₹86,538 as gratuity.

7. Is Gratuity part of CTC?

Yes, gratuity is part of CTC as the entire cost of gratuity is borne by the employer. Since it is a statutory benefit typically paid after 5 continuous years of service, companies are required to pay the amount, making it a part of Cost-To-Company (CTC).

8. Is Gratuity taxable for private employees?

Yes, gratuity is taxable for private employees if the amount exceeds ₹20 lakhs, based on the employee’s tax slab. The tax is borne by the employee under the ‘income from salary’ option, making it a part of income tax.

9. Is Gratuity deducted from salary?

No, gratuity is not deducted from an employee’s salary. Instead, it is paid as a lump sum upon completion of an employee’s tenure with the organization, provided they have been with the company for at least 5 years of continuous service.