How to calculate the payment of Gratuity?

(This post offers calculation of Gratuity in two different methods and also discusses tax liability on Gratuity received)

The tax-exempt gratuity limit had already been raised to Rs. 20 lakh for government employees effective from 1 January 2016.

Payment of Gratuity (Amendment) Act, 2018 is notified in the Government Gazette on 29^th March 2018. The above amendment enables the employees to receive tax-free gratuity up to Rs 20 lakh from the existing Rs 10 lakh under the Payment of Gratuity Act. According to the notification Payment of Gratuity (Amendment) Act, 2018 (12 of 2018), shall come into force from the 29th day of March 2018. The amendment makes formal (private and public) sector employees eligible for a tax-free gratuity limit of Rs.20 lakh at par with Central Government employees.

 The below post discusses the impact of the raise in the increase of gratuity on bank employees as well as private and other public sector employees.

Q: Who is eligible for gratuity?

Ans.: As per the gratuity act 1972, any establishment which has more than 10 employees/workers shall pay Gratuity to its employees/workers. On any single day in the preceding 12 months if the number of employees working in the establishment is 10 or more then such establishment is covered under the gratuity act and it shall continue to bind the employer even when the number of employees falls below ten.

Q: What is the exgratia payment?

Ans.: The establishment which is not covered under the gratuity act normally pays an exgratia payment to their employees out of goodwill. The exgratia is paid by the employer, even though there was no obligation or liability to pay it.

Q: When the gratuity is paid to an employee?

Ans.: Gratuity is paid to an employee on his/her superannuation/retirement from the service. The employees who have put in more than 5 years of continuous service (without interruption) in an organization are also eligible for the payment of gratuity.  However, interruption in service due to sickness, accident, layoff, strike or lockout of the unit, are not considered as an interruption in service.  Gratuity is also paid on the occasions of death of an employee/or disability of employees to work in the same organization, due to accident or disease even though 5 years of service is not completed.

Q: How the rate of gratuity is calculated?

The amount calculated at the rate of one month’s salary for each year of service, subject to a maximum of 15 months’ salary and where a Member has completed Service of over 30 years, an additional amount calculated at the rate of half a month’s salary for each year of service beyond 30 years, provided that for the purpose of calculating the gratuity the term ‘Salary’ shall mean (I) the average of the Salary as defined in Sub-Rule (n) (ii) (a) of Rule 2, payable during a period of 12 months immediately preceding the date on which the contingency has occurred, as the case may be.

Q: In banks which type of Gratuity is paid?

There are two types of gratuity payment systems in India viz. Gratuity paid under the Payment of Gratuity Act, 1972 and another category is gratuity paid to others who are not covered under the Payment of Gratuity Act, 1972. In the banks (except SBI), Gratuity is paid to employees and officers under the Gratuity Act, 1972 as well as under the provisions of Bipartite Settlement [for bank officers as per Officers Service Regulation (OSR)] whichever is higher.  The Gratuity is paid to employees and officers of SBI only under the Gratuity Act.

Q: What is the major difference between Gratuity paid under Gratuity Act and other systems?

Ans.: They are basically different in the method of calculation of Gratuity. The method of calculation of gratuity under both the system is as under.

1. The calculation method of  gratuity payable under the Payment of Gratuity Act, 1972

Formula 1:

(Last drawn Salary x 15 days x Number of years of service) divided by 26

Under the Payment of Gratuity Act, 1972, the service in excess of six months is taken as a full year for calculation of gratuity.

*The payment of Gratuity is restricted to a ceiling of Rs.20 lakh after the amendment to the act.

Example: If a person retires after 28 years 7months of continuous service, his gratuity is calculated as follows.

(Last drawn salary×15×29)÷26

*The payment of Gratuity is restricted to a ceiling of Rs.20 lakh after an amendment to the act. (Earlier ceiling Rs.10 lakh changed to Rs.20 lakh with effect from 29.03.2018 vide Gazette notification [No. S-42012/02/2016-SS-II]

2.The calculation method of gratuity payment for the employees not covered under the Act

Formula 2:

Half a month’s average salary for each completed year of service.

No ceiling on gratuity payable

(The number of months exceeding six months, will not be considered as a full year).

Example: If a person retires after 30 years and 8 months of continuous service, his gratuity is calculated as follows.

Calculation of gratuity payable:

(Average salary of preceding 10 months×30) ÷2

i. No ceiling on gratuity payable

ii. [The average salary is taken as the average of the salary of the last 10 months immediately preceding the last working month.]

Q: Whether last paid mean all allowances included?

Ans.: Salary includes basic salary plus the dearness allowance and other allowances eligible as per bipartite settlement between employees and establishment.

Q: Whether gratuity received is Taxable?

Ans.: The gratuity received by government employees is not taxable. In the case of non-government employees, as per the present rule, the gratuity paid to an employee up to Rs.10 lakh (to be increased to 20 lakhs) is exempted from income tax and anything more than the above amount shall be accounted for taxable income of the financial year.

1. Tax rules for the employees covered under the Act:

The least of the following (Gratuity amount) is exempted from tax:

a) Ceiling of Rs .20 lakh

b) Actual gratuity received.

c) Gratuity calculated as per formula 1 (under gratuity act).

2. Tax rules for the employees who have not covered the Act,

The least of the following is exempted from tax:

a) Rs 10 lakh as per existing rule (Rs.20 lakhs after amendment)

b) Actual gratuity received.

c) Half a month’s average salary for each completed year of service.

Q: How much gratuity paid by banks?

Ans.: There is no ceiling for Gratuity payable to bank employees under the BPS/OSR/Gratuity Act. When an employee or officer retires from the Bank, his/her Gratuity entitlement would be calculated both under the Act and under BPS/OSR. The higher of the two will be paid. In case the amount paid is in excess of the limit fixed under the above methods of calculation then such excess amount is taxable under the income tax act.