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What is Gratuity?

In simple words, gratuity, also at times referred as tip, means sum of money given by a client or employer to a service worker or employee in addition to his basic price or salary. While in some countries giving tip or gratuity could be customary while in some, it is up to your discretion. In India, gratuity is a type of retirement benefit and the idea of the same is to ensure that the employee is self-sustainable after retirement. The Payment of Gratuity Act was passed by Indian Parliament in the year 1972 and it came into effect on 16th Sept 1972. It was Indian Hume Pipe Co Ltd v Its Workmen when it was held by the Supreme Court of India that the employee is entitled certain amount as his retirement benefit, provided he has spent a considerable time as employee, in specific at least 5 years. The Payment of Gratuity Act is applicable to entire India except Jammu and Kashmir and is payable to an employee on termination of his employment where termination could be due to one of the following reasons:

  1. Superannuation
  2. Retirement or resignation
  3. Disablement or on death due to accident or disease.

Gratuity is a well defined benefit plan and is one of the many retirement benefits which an employee is entitled to upon leaving his job and his last drawn salary is used to calculate the same. Since calculation of gratuity is salary dependent, the payment liability of the employer increases tends to increase with the tenure and salary of the employee.

What is Gratuity?

Payment of Gratuity Act, 1972

Administered by the Central Government, this act is applicable for payment of gratuity is applicable to all employees engaged in factories, plantations, mines, oilfields, railway companies, shops, mines or any other establishments. The Payment of Gratuity Act gives employers the freedom to decide if they want to pay the gratuity from their revenues or establish a separate fund for the same. Most of the companies, especially the insurance ones have designated funds and schemes which relate to gratuity.

Also Read: ESI Registration Online in India

The Payment of Gratuity Act is mainly applicable under below mentioned circumstances:

  1. Every factory, mine, oilfield, plantation, railway corporations and port;
  2. Any such establishments or class of establishments having at least 10 or more employees on any day of the preceding 12 months;
  3. Every shop or establishment having at least 10 or more employees on any day of the preceding 12 months.

As defined under the act, an employee can claim gratuity after he has rendered his service for a period of not less than five years, provided these five years are in continuation. An employee shall be said to be in continuous service for a certain period if he has done an uninterrupted service including the services which may be interrupted on account of sickness, absence from duty without leave, accident, leave, lay off, strike or cessation of work, happening not because of his fault. However, in case of death of an employee, the applicable gratuity is paid to his nominee(s) and if there is no nominee, the applicable amount goes to his heir. If the heir is a minor, then the gratuity amount goes to the controlling authority that in turn invests the amount in a bank or in a financial institution till the minor heir or the nominee attains majority. For a male employee, his family involves himself, his wife, his children (unmarried or married), his dependant parents, dependant parents of his wife and the widow and children of his predeceased son, if any. In case of a female employee, her family includes herself, her husband, her children (unmarried or married), her dependant parents, dependant parents of her husband and the widow and the children of her predeceased son, if any.

As per the Act, every employer has to pay the applicable gratuity amount to his employee(s) if he/she satisfies all the conditions and eligibility criteria. However, if the employer fails to give the same to his employee, later can approach the Controlling Authority under the Payment of Gratuity Act within the area he was working at the time of his termination. Once the application for the same is submitted to the Controlling Authority, it issues a certificate of equivalent amount to the Collector, whose job is to collect the same with the applicable compound interest. Complaint to the Controlling Authority can be made under following conditions:

  1. If your applicable for the payment of gratuity is rejected by your employer.
  2. If you have received lesser gratuity amount than what you have expected or calculated.
  3. If the employer doesn’t make the payment or doesn’t specify the payable amount within specified time period. In case of any dispute happening, you must ensure that the complaint is filed with the Controlling Authority within or before 90 days from the event occurred.

There is as such no such predefined amount or no set percentage stipulated by law, an employer can use any formula-based approach to decide the gratuity amount or even pay higher than that, however, in general, payable gratuity depends on two factors i.e. last drawn salary and years of service one has put in. The Payment of Gratuity Act 1972 divides non-government/private employees into two categories i.e. Employees who are covered under the Act and Employees who are not covered under the Act.

Also Read: Special Allowance For Employee in India

As per The Payment of Gratuity Act 1972, there are certain rules that need to be followed at the time of payment of gratuity, such as:

  • If as an employee you are entitled to certain amount of gratuity, you can apply for the same within 30 days from the date it becomes payable and if you have planned your resignation or retirement date or superannuation and know the date in advance, then also you need to apply for the gratuity 30 days in advance. However, even if your application is received after the expiry of 30 days and the reasons for the delay are valid, the employer cannot reject your application and in case the employer rejects the application for any reason, he needs to mention the same.
  • Once the application is received, the employer need to specify the amount payable and the date on which payment will be made within 15 days of receipt of application.
  • In case the claimant is the nominee or the legal heir, he might need to submit the evidence or produce a witness to establish his identity and genuinity of his claim and in this case, the application is accepted by the employer from the date the witness or evidence is produced by the claimant.
  • The payable gratuity can be made either in cash, demand draft or by cheque.

Gratuity Calculation For the Employees Covered Under the Act

For the employees covered under The Payment of Gratuity Act 1972, the formula to calculate the amount is based on the 15 days of the last drawn salary for every completed year of service. Formula can be summed as below:

(Last drawn salary x 15 days x years of service) / 26

For example: For an employee, if the last drawn salary is Rs 50,000 per month and he has worked with the organization for 20 years and 9 months, his gratuity amount would be (50,000 x 15 x 21) / 26 = 6.05 Lakh. Here the total tenure is taken as 21 months because the employee has worked for more than 6 months in a year.

Gratuity Calculation For the Employees Not Covered Under the Act

In this case, the basis of gratuity calculation will be based on half month’s salary for each completed year served in the organization. Formula for the same can be summed up as below:p>

(Last drawn salary x 15 days x years of service) / 30

For example: For an employee, if the last drawn salary is Rs 50,000 per month and he has worked with the organization for 20 years and 9 months, his gratuity amount would be (50,000 x 15 x 20) / 30 = 5 Lakh. Here the total tenure is taken as 20 months because when the employee is not covered under the act, the years of service is taken on the basis of each completed year.In case of death of an employee, the amount of gratuity paid to him is based on the length or years of service he has put in and it can extend up to 20 lakhs and various rate at which gratuity is calculated in this case is as below:

Qualifying Service Rate
Less than 1 year Twice of basic pay
1 year or more but less than 5 years Six times of basic pay
5 years or more but less than 11 years 12 times of basic pay
11 years or more but less than 20 years 20 times of basic pay
20 years or more Half of salary for every 6 monthly period subject to maximum of 33 times of salary.

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