Gratuity is given by the employer to his/her employee for the services rendered by him during the period of employment. It is usually paid at the time of retirement but it can be paid before provided certain conditions are met.
A person is eligible to receive gratuity only if he has completed minimum five years of service with an organisation. However, it can be paid before the completion of five years at the death of an employee or if he has become disabled due to accident or disease.
There is no set percentage stipulated by law for the amount of gratuity an employee is supposed to get – an employer can use a formula-based approach or even pay higher than that. Gratuity payable depends on two factors: Last drawn salary and years of service. To calculate how much gratuity is payable, the Payment of Gratuity Act, 1972 has divided non-government employees into two categories:
a) Employees covered under the Act
b) Employees not covered under the Act
An employee will be covered under the Act if the organisation employees at least 10 persons on a single day in a preceding 12 months. And once an organisation comes under the purview of the gratuity Act, then it will always remain covered even if the number of employees is falls below 10.
Calculation of gratuity
a) For employees covered under the Act
There is a formula using which the amount of gratuity payable is calculated. The formula is based on the 15 days of last drawn salary for each completed year of service or part of thereof in excess of six months.
The formula is as follows:
(15 X last drawn salary X tenure of working) divided by 26
Here last drawn salary means basic salary, dearness allowance, and commission received on sales.
Suppose A’s last drawn basic pay is Rs 60,000 per month and he has worked with XYZ Ltd for 20 years and 7 months. In this case, using the formula above, gratuity will be calculated as:
(15 X 60,000 X 21)/26 = Rs. 7.26 lakh
In the above case, we have taken 21 years as tenure of service because A has worked for more than 6 months in year. Had he worked for 20 years and 5 months, 20 years of service would have been taken into account while calculating the gratuity amount.
b) For employees not covered under the Act
There is no law that restricts an employer from paying gratuity to his employees even if the organisation is not covered under the Act.
The amount of gratuity payable to the employee can be calculated based on half month’s salary for each completed year. Here also salary is inclusive of basic, dearness allowance, and commission based on sales.
The formula is as follows:
(15 X last drawn salary X tenure of working) divided by 30
In the above mentioned example, if A’s organisation was not covered under the Act, then his gratuity will be calculated as:
(15 X 60,000 X 20) /30 = Rs 6 lakh
Here the number of years of service is taken on the basis of each completed year. So, since A has worked with the company for 20 years and 7 months, his tenure will be taken as 20 and not 21.
As per the government’s pensioners’ portal website, retirement gratuity is calculated like this: one-fourth of a month’s basic pay plus dearness allowance drawn before retirement for each completed six monthly period of a qualifying service. The retirement gratuity payable is 16 times the basic pay subject to maximum of Rs 20 lakh.
In case of death of an employee, the gratuity is paid based on the length of service, where the maximum benefit is restricted to Rs 20 lakh.