Gratuity is a statutory benefit paid by an employer to an employee in gratitude for their long-term service. Governed by the Payment of Gratuity Act, 1972, it is a vital component of an employee’s final settlement (FnF).
In this guide, we’ll explain the eligibility criteria and the exact formula to calculate gratuity.
Eligibility for Gratuity
To be eligible for gratuity, an employee must satisfy the following conditions:
- They must have completed at least 5 continuous years of service with the same employer.
- The payment is triggered upon resignation, retirement, superannuation, or death/disablement (in case of death, the 5-year rule does not apply).
[!IMPORTANT] The 5-year rule is strict. If an employee resigns after 4 years and 11 months, they are legally not entitled to gratuity.
Gratuity Calculation Formulas
The calculation depends on whether the company is covered under the Payment of Gratuity Act. Most factories, mines, oilfields, and establishments with 10 or more employees are covered.
1. For Employees Covered Under the Act
The formula uses 15 days of wages for every completed year of service, divided by 26 (working days in a month).
Formula:
Gratuity = (Basic + DA) × 15/26 × Number of Years of Service
Note: For the “Number of Years”, any period over 6 months is rounded up to a full year. For example, 5 years 7 months is considered 6 years.
Example:
- Basic + DA = ₹40,000
- Tenure = 7 years and 2 months (calculated as 7 years)
- Gratuity = ₹40,000 × (15/26) × 7 = ₹1,61,538
2. For Employees NOT Covered Under the Act
Companies not covered can still pay gratuity voluntarily. The formula divides the monthly salary by 30 days instead of 26.
Formula:
Gratuity = (Basic + DA) × 15/30 × Number of Years of Service
Note: Here, fractions of a year are ignored. 5 years 11 months is considered exactly 5 years.
Tax Exemption Limits
As of the latest updates, gratuity received up to ₹20 Lakhs is completely tax-exempt for private-sector employees. For government employees, the entire gratuity amount is tax-free.
Automating Final Settlements
Calculating Gratuity, Leave Encashment, and Notice Period recovery manually during an employee’s exit is tedious. AccoNova HRMS features a dedicated Full and Final (FnF) Settlement module that calculates all statutory dues, including Gratuity, with 100% legal accuracy in one click.