A Complete Guide to Gratuity Rules in India

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Gratuity allows you to earn a large amount of money by investing time in a company, rather than money. Know more about gratuity and its regulations in India in the sections below!

What is Gratuity?

Gratuity is the amount that an employee is entitled to receive from their employer if they leave the company after working there for 5 years or more. Each year of service entitles the employee to 15 days of wages. The facility is governed under the Payment of Gratuity Act 1972.

Recent Gratuity Rules in India

Based on the Payment of Gratuity Act of 1972, a new labour law was made effective on July 1, 2022 for all organisations and corporations. Under the new rules, multiple factors were affected, such as working hours, provident fund, in-hand salary, etc. The following were some of the key changes made:

1. Organisations must ensure that 50% of employees’ CTC (cost to company) is basic pay. The remaining 50% is composed of employee allowances, house rent, and overtime. Any additional allowances or exemptions that exceed 50% of the CTC, is treated as remuneration.
2. The maximum basic pay is now limited to 50% of CTC which will increase the gratuity incentive that must be offered to employees. The gratuity amount will now be calculated on a large salary base comprising basic pay and allowances.
3. Employees get paid for overtime work of 15 minutes or more.
4. The working capacity is a maximum of 48 hours.

Gratuity Eligibility in India

As per the Payment of Gratuity Act, all organisations with at least 10 employees working on a single day in the preceding 12 months must pay gratuity. Employees may be paid gratuity even if they do not fall under the above-mentioned act. To receive the gratuity, the employee must:

1. Be eligible for superannuation or retirement benefits.
2. Have resigned after continuous employment of 5 years with the company. However, the employee can receive the amount even before 5 years if they get disabled due to an accident or disease, if they opt for VRS, or if they get laid off during retrenchment.

In case of the employee’s death, the gratuity is paid to the nominee. If the employee’s disablement is due to sickness or accident, the gratuity is paid to the employee.

Taxation on Gratuity

Taxation on the gratuity amount depends on whether the employee works for the government or in the private sector.

For government employees (central/state/local authority), the gratuity received is entirely exempt from the income tax.

For eligible private employees, the lowest of the following amounts will be exempt from taxation:

1. ₹20 lakh
2. The actual amount of gratuity received
3. The eligible gratuity

Forms for Gratuity Application

• Form I: For requesting Gratuity Payment
• Form J: Application for gratuity payment for the nominee
• Form K: Application for gratuity payment for the legal heir
• Form F: Application for nomination
• Form G: Application for a new or renewed nomination
• Form H: Application for modifying nomination
• Form L: The employer provides this to the employee. The document includes the date and exact amount of compensation.
• Form M: This document is provided by the employer to the employee to state the reason for rejection.
• Form N: Employment application to the Labour Commission.
• Form O: This is a form to attend a case hearing. It is issued by the relevant authorities.
• Form P: This rerers to a summon issued by the relevant authorities for appearing in court.
• Form R: This form includes instructions from the relevant authorities for making the gratuity payment.

The calculation of gratuity is done by two different formulas for the following two categories of employees:

1. Employees covered under the Payment of Gratuity Act, 1972
2. Employees not covered under the Payment of Gratuity Act, 1972

The only difference between the two formulas is that in the first case, the number of working days in a month is taken as 26, and in the second case, it is taken as 30 days.

The following is the gratuity formula for employees falling under the Payment of Gratuity Act 1972:

Gratuity = Last Drawn Salary × Number of Years of Service × 15/26

In this case, the gratuity calculation is accounted for at the rate of 15 days’ wages. The last drawn salary includes:

1. Basic pay
2. Dearness allowance (DA)
3. Sales commissions (if any)

The gratuity formula for employees who fall outside the purview of the Payment of Gratuity Act, 1972 is,

Gratuity = Last Drawn Salary × Number of Years of Service × 15/30

Note: Completed years of service include any year when the employee worked for over 240 days. However, if the work involves underground work i.e. mining, then the minimum number of days is reduced to 180.

Final Words

Once you get your gratuity payment, it could be a good idea to deploy the money in instruments that give you higher returns than an average savings deposit or fixed deposit. Stock market and mutual funds are places where you can invest the money. Better still, you can start investing when you start earning itself, so that you can get the benefits of compounding over a longer period of time. If you wish to explore the stock market, open a demat account with Angel One, India’s trusted stockbroker, today!

FAQs

What are the new rules for gratuity in 2023?

The new rules for gratuity effective from July 2022 include the following:

1. 50% of employees’ CTC must be basic pay. The remaining 50% can be employee allowances, house rent, and overtime. Allowances or exemptions beyond 50% of the CTC, is considered remuneration.
2. Maximum basic pay is now limited to 50% of CTC. The gratuity amount will now be calculated on a large salary base.
3. Overtime work of 15 minutes or more must be paid for.
4. Maximum work capacity of 48 hours.

Is 4 years 9 months eligible for gratuity in India?

Yes. Any year during which the worker worked for more than 240 days is considered as a completed year of service and must be counted in gratuity calculation. Therefore the 9 months additional to the 4 years will be considered as an entire year, thus completing 5 years of service.

Are 15 day wages for gratuity calculated based on 26 days or 30 days per month?

For employees falling under the Payment of Gratuity Act, 1972, the calculation is done assuming 26 working days per month. But for those employees falling outside the act, 30 days per month is assumed.

I am eligible for a gratuity of ₹10 lakh but my employer has given me a gratuity of ₹25 lakh. How much of my gratuity will be taxed?

The lowest of the following amounts will be exempt from taxation:

• ₹20 lakh
• The actual amount of gratuity received
• The eligible gratuity

Therefore, only ₹15 lakh will be taxed as the lowest amount here is ₹10 lakh and ₹15 lakh still remains out of the ₹25 lakh.

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