Gratuity

Definition

Gratuity is a lump-sum monetary benefit paid by an employer to an employee as a reward for long-term service upon separation from employment. Governed by the Payment of Gratuity Act, 1972, it becomes payable when an employee completes five or more years of continuous service. The benefit applies to establishments with 10 or more employees.

Detailed Explanation

Gratuity is a critical component of employee compensation in India, serving as both a retention tool and a retirement benefit. The Payment of Gratuity Act, 1972 applies to factories, mines, oilfields, plantations, ports, railway companies, shops, and other establishments employing 10 or more persons. Once the Act becomes applicable to an establishment, it continues to apply even if employee strength falls below 10.

The standard gratuity calculation formula is: Gratuity = (Last drawn salary x 15 x Number of years of service) / 26. Here, “last drawn salary” includes basic pay plus dearness allowance. Service exceeding six months in the final year is rounded up to one full year. The maximum gratuity payable under the Act is INR 20,00,000 (twenty lakh rupees), though employers may pay more as a contractual obligation.

Gratuity becomes payable on superannuation, retirement, resignation after five years of service, death (no minimum service required), or disablement due to accident or disease (no minimum service required). In cases of death, the gratuity amount is paid to the nominee or legal heir. Employers can forfeit gratuity partially or fully if the termination is due to moral turpitude or violent conduct proven through disciplinary proceedings.

Organizations must account for gratuity liability in their financial statements as per Accounting Standard 15 (AS 15) or Indian Accounting Standard 19 (Ind AS 19). Many companies fund gratuity through group gratuity schemes with insurance companies or through an approved gratuity trust.

Key Rules

• Applicable to establishments with 10 or more employees at any point
• Employee must complete 5 years of continuous service (except in case of death or disability)
• Maximum gratuity payable is INR 20,00,000 under the Act
• Gratuity must be paid within 30 days of it becoming due; delay attracts interest
• Employer can insure gratuity liability through LIC or other approved insurers
• Gratuity is tax-exempt up to INR 20,00,000 for employees covered under the Act
• Nomination must be obtained from every employee within prescribed timelines

How TMS Helps

TMS manages gratuity compliance for all contract and payroll employees, including liability computation, actuarial valuation coordination, and timely payment upon separation. Our systems track service tenure accurately across employment periods, ensuring correct gratuity calculation. We also assist clients in setting up gratuity trusts and insurance policies for provisioning.

Related Terms

• Statutory Compliance
• CTC (Cost to Company)
• Provident Fund (EPF)
• Full and Final Settlement