What is the Payment of Gratuity Act, 1972?
The Payment of Gratuity Act, 1972 is a crucial legislation that mandates employers to pay gratuity to employees as a gesture of appreciation for their long-term service. This Act covers employees working in mines, oilfields, railways, factories, ports, shops, and other establishments, ensuring financial security post-employment.
Passed on: 21st August 1972
Came into force on: 16th September 1972
What is Gratuity?
Gratuity is a lump sum payment made by employers to employees as a reward for their dedicated service.
How is Gratuity Paid?
- Directly from the employer’s account.
- Via a group gratuity insurance plan (provides financial security and tax benefits).
Who is Liable to Pay Gratuity?
Organizations with 10+ employees are legally bound to pay gratuity. Even if the workforce reduces later, the obligation remains.
Eligibility for Gratuity
An employee (including contractual or temporary workers) qualifies for gratuity if they complete 5 continuous years of service. However, interruptions due to leave, accident, sickness, lockout, strike, layoff, or termination do not break continuity.
- 240 working days per year (for above-ground workers)
- 190 working days per year (for underground workers)
Exception: No minimum service period required in case of death or disablement.
Nomination Clauses
Employees can nominate a recipient for their gratuity in case of an untimely demise.
For employees with a family: Nomination must be made in favor of a family member(s).
If nominated outside the family, it is considered void.
Employees can change the nominee anytime.
When is Gratuity Paid?
Gratuity is payable when an employee:
- Retires
- opts for Voluntary Retirement Scheme (VRS)
- Resigns after 5 years
- Is terminated or retrenched
- Suffers disablement due to accident or illness
- Passes away (gratuity is given to the nominee/legal heir)
How is Gratuity Calculated?
There are two formulas based on whether the organization is covered under the Payment of Gratuity Act, 1972 or not.
For Organizations Covered Under the Act:
Formula:
Gratuity = (15 × Last Drawn Salary × Completed Years of Service) / 26
Any period above 6 months is rounded up to 1 year.
Less than 6 months is excluded.
Example:
Mr. Ganguly worked for 30 years and 8 months (rounded to 31 years).
Last drawn salary: ₹85,000
Gratuity = (15 × 85,000 × 31) / 26
Total Gratuity = ₹15,20,192
For Organizations NOT Covered Under the Act:
Formula:
Gratuity = (15 × Average Salary for Last 10 Months × Completed Years of Service) / 30
Only full years are counted, partial years are ignored.
Example:
Mrs. Talwar worked for 26 years and 6 months (rounded to 26 years).
Average salary of last 10 months: ₹65,425
Gratuity = (15 × 65,425 × 26) / 30
Total Gratuity = ₹8,50,525
Quick Tip: Use an online gratuity calculator to determine your gratuity instantly!
Income Tax Implications on Gratuity
Government Employees
Fully tax-exempt. Private Sector Employees (covered under the Act) – Tax exemption on the least of the following:
- Actual gratuity received
- ₹20 Lakh (cumulative from all employers)
- (15 × Last Drawn Salary × Completed Years of Service) / 26
Private Sector Employees (not covered under the Act)
Tax exemption on the least of the following:
- Actual gratuity received
- ₹10 Lakh
- (15 × Average Salary for Last 10 Months × Completed Years of Service) / 30
Example: If Mr. Khan received ₹25 Lakh in gratuity from multiple employers, the taxable amount will be ₹5 Lakh (₹25L – ₹20L exemption limit).
Gratuity paid to a widow/legal heir of a deceased employee is completely tax-free!
Conditions for Termination of Gratuity
An employee can be denied gratuity if they are dismissed for: Moral turpitude-related offenses (fraud, theft, etc.).
Violence, riots, or disorderly conduct.
Note: Gratuity cannot be denied due to bankruptcy or employer insolvency!
Conclusion
Gratuity is not just a financial benefit—it is a well-earned reward for years of dedicated service. Understanding the eligibility, calculation, tax implications, and legal aspects ensures both employees and employers navigate gratuity seamlessly.
Know your rights. Secure your financial future. Plan ahead with gratuity!