Payment of Gratuity Act 1972

Gratuity calculation is based on the employee's last drawn salary and their years of service. There are two formulas used for the calculation of gratuity as per two categories:

For employees covered under the act

This clause is covered under the Payment of Gratuity Act 1972, wherein an organisation employs at least ten employees in a single day in the preceding 12 months.

Gratuity= (15 x the last drawn salary including basic +DA) x the number of years of services completed divided by 26

Here, any year wherein an employee works for over six months will be counted as a year of service. If the employee works for less than six months in a year, that year will be excluded from the gratuity calculation.

For employees not covered under this act

This clause is for organisations not covered under the purview of the Payment of Gratuity Act 1972 but can still pay gratuity to employees.

In such cases, the formula for gratuity is-

Gratuity= (15 x the average salary of the last ten months including basic+ DA+ commission x number of years employed) x 30

Employees can also calculate their gratuity by using an online gratuity calculator. As for those who are not covered under this act, they only have to know their average salary for the last ten months.

The tax treatment of gratuity depends on the employee's category and the amount received. While gratuity is a valuable retirement benefit under the Payment of Gratuity Act, its taxability is governed by the Income Tax Act.

• Government Employees: Gratuity received by Central and State Government employees is fully exempt from income tax.

• Private Sector Employees Covered Under the Act: Tax exemption is available up to ₹20 lakh, subject to prescribed conditions.

• Private Employees Not Covered Under the Act: Gratuity remains eligible for tax exemption up to ₹20 lakh based on applicable calculation rules.

• Tax on Excess Amount: Any gratuity amount exceeding the exempt limit is taxable under the head "Income from Salaries."

• Exemption Calculation: The tax-free portion is generally determined based on the least of the actual gratuity received, the prescribed exemption limit, or the eligible amount calculated under the rules.

According to the Payment of Gratuity Act 1972, employees can be denied gratuity if they are terminated from service due to committing an offensive of moral turpitude or disorderly conduct, riotous conduct, or other violent acts.

However, no organisation can refuse payment of gratuity because of bankruptcy. And no decree of the court will be able to withhold this action.

The new gratuity rules were enacted under the new labour law on 1st July 2022 for all organisations and businesses. Under the new labour law, the Provident Fund, the in-hand salary, and working hours were reduced.

According to the 2023 rules, the base salary should be fifty per cent of the employee’s CTC (cost to the company). And the other fifty per cent includes housing, overtime, allowances, etc.

Extra allowances and exemptions over fifty per cent of the cost to the company paid by the employer will fall under remuneration.

Gratuity is a statutory compensation as per the Payment of Gratuity Act but the amount can be partially or totally waived off in certain situations as mentioned in the said Act. The forfeiture can only be made in respect of the employee's conduct in circumstances specified in the Act. 

• Loss to Employer's Property: Gratuity may be lost to the proportion of the financial loss sustained due to the employee's wilful misconduct or negligence. 

• Disorderly or Violent Conduct: The employer may lose the right to pay gratuity if the employee is discharged for riotous, violent or seriously disorderly conduct. 

• Forfeiture: Gratuity can be forfeited in case of termination due to an offence involving moral turpitude committed during the tenure of employment. 

• Termination Required: The term "forfeiture" is typically only relevant if the employee's services are being terminated because of the alleged misconduct. 

• Minor misconduct not covered: Ordinarily, there is no forfeiture of gratuity for minor misconduct, resignation or forfeiture for voluntary retirement.