The payment of Gratuity Act, 1972

The payment of Gratuity Act, came into existence on 21st August, 1972. The Act applied to only
certain establishments prior to its amendment. The gratuity was paid to persons who are covered
within the meaning of the term 'employee' under section 2(e) of the Act, subject to the conditions
mentioned in Section 4 of the Payment of Gratuity Act, 1972.

The Payment of Gratuity Act, 1972 applies to the establishments employing 10 or more persons. The
main purpose for enforcing this Act is to provide social security to workman after retirement,
whether retirement is a result of superannuation, or physical disablement or impairment of body
parts. Therefore, the Payment of Gratuity Act, 1972 is an important social security legislation to
wage earning population in industries, factories and establishments. It is a welfare act and
envisioned to those workman who renders their service for long period of time and they were
considered as faithful employees. The employee has to complete at least 5 years in the organization
to claim the gratuity amount.

Gratuity act is the primary act and considered to be a social security benefit for the employee. The
amendment aims to double Gratuity limit from the previous limit of INR 1 million (approx. US$
15,000) to INR 2 million (approx. USD 30,000). Gratuity payable as per the Payment of Gratuity Act,
1972 of India ("Gratuity Act"), is considered.

The Payment of Gratuity (Amendment) Act, 2018 received Presidential assent on 28th March, 2018
and came into force on 29th March, 2018 notified by the Ministry of Labour and Employment.

This amendment has aimed to ensure harmony amongst employees in the private sector and in
Public Sector Undertakings/ Autonomous Organizations under the Government who are not covered
under CCS (Pension) Rules. These employees will be entitled to receive higher amount of gratuity at
par with their counterparts in the Government sector. An employee is entitled to receive gratuity if
he has rendered continuous service for at least five years with an organization and usually given at
the time of retirement under certain terms and conditions.

This gratuity is payable to the employee on his superannuation, or on his retirement or resignation
or in case of Death or Disablement caused due to accident or disease.

After taking into consideration the increasing factors of inflation and wage relating to employees
engaged in private sector, the Government decided that the entitlement of gratuity should also be
revised in respect of employees who are covered under the Payment of Gratuity Act, 1972.

Key Amendments

The first change has been brought about in the definition of ‘employee’ in the act which has
generalised the concept of employee and is now applicable on many. The section reads as :
Section 3; (e) “employee” means any person (other than an apprentice) who is employed for wages,
whether the terms of such employment are express or implied, in any kind of work, manual or
otherwise, in or in connection with the work of a factory, mine, oilfield, plantation, port, railway
company, shop or other establishment to which this Act applies, but does not include any such
person who holds a post under the Central Government or a State Government and is governed by
any other Act or by any rules providing for payment of gratuity.

The amendment has also side-tracked the ceiling limit of the maximum amount of gratuity payable
i.e. Rs.10 lakh set in 2010. This upper cap prescribed by Section 4(3) of the Act, has been removed.
Section 4(5) of the Act prescribes that if the terms of employment contract provide for a higher
amount of gratuity over and above the ceiling limit stated in the Act, then the employee will be
entitled to such higher amount. This transition has been introduced for the implementation of the
7th Central Pay Commission, whereby the ceiling of gratuity for Central Government employees has
been enhanced from Rs. 10 lakhs to Rs. 20 lakhs. Instead of mentioning and specifying the ceiling
amount in Act, the amendment empowers the Central Government to notify the ceiling proposed so
that the limit can be revised from time to time keeping in view the increase in wage and inflation,
and future Pay Commissions.

Another significant feature was introduced in relation to the period of maternity leave. The period
of maternity leave for females in continuous service was twelve weeks under section 2A of the
earlier Act. The amendment has modified the maternity leave period from 'twelve weeks' to 'twenty-
six weeks 'in order to keep the Act in tune with the recently amended Maternity Benefit Act. This
also resolves calculation of continuous service for the payment of gratuity to employees who are on
maternity leave.

Thus, The Amendment Act of 2018 brought two grave changes befitting the employees. Firstly,
employees receiving a higher amount of gratuity payable by the employer as compared to that of
1972. Secondly, it enhances the maximum maternity leave period to 26 weeks against the backdrop
of the Maternity Benefit (Amendment) Act, 2017. The entire duration of a female employee's
statutory maternity leave will now be considered while calculating continuous period of service for
gratuity payments. It would be in line with the entitlement of maternity leave under the Maternity
Benefit Act, 1961. Thus, considering the dynamism in the environment, it is a requirement that
employees should be provided with adequate beneficial terms and rewards for an appropriate
sustenance of life.

What is the Rule of Gratuity?

Rules pertaining to the applicability of gratuity are mentioned below –

1. Gratuity is payable if an organisation employs 10 or more individuals –

Organisations with a workforce of 10 employees on a single day in the preceding 12 months are
liable to pay gratuity. If the number of employees of the same organisation reduces to under 10, it
will still have to pay the gratuity, as per regulations of the Act.

2. Employees have to complete 5 years of service to be eligible –

To be eligible, an employee has to render his/her services for 5 continuous years. However, this
condition is not taken into consideration in situations of demise or disablement of an employee.
For the calculation of the 5 years, a single year is assessed as 240 working days for employees
working in organisations that do not involve work underground. For those working in mines and
other such fields, a year is assessed as 190 days.

For instance, if Mr. A has worked for 4 years and 7 months in an organisation, it will be counted as 5
years. Contrarily, if he has worked for 4 years and 1 month, it will be taken as 4 years.

The 5 years of continuous service also include interruptions caused by strike, lockout, accident,
leaves, layoff, absence from duty without leave, and termination of service not on the part of an
employee.

3. Gratuity can be paid not only upon retirement –

As per the gratuity rules, an employee will be eligible to avail gratuity upon –

[ol]

[li]Retirement.[/li]

[li]Resignation.[/li]

[li]Demise.[/li]

[li]Disablement due to an accident or a disease.[/li]

[li]VRS.[/li]

[li]Termination.[/li]

[li]Lay off due to retrenchment.[/li]

4. Calculation of gratuity is based on the last drawn salary and years of service –

Gratuity is calculated based on an individual’s last drawn salary and years of service. The formula for
calculation differs from the applicability of the Payment of Gratuity Act, 1972.

a. Gratuity calculation for employees covered under the act

As mentioned before, organisations with 10 employees in a single day in the preceding 12 months
are covered under this act.

For calculation of gratuity of employees in such organisations, the formula is –

Gratuity = (15 x last drawn salary x number of completed years of service) / 26

Here,

The last drawn salary includes basic and dearness allowance (DA). Any other component of income
will not be included in the salary.

Completed years of service include any year where an employee has served for more than 6 months.
For instance, if Mr. B works for an organisation for 12 years and 8 months, his completed years of
service will be taken as 13 years as per the gratuity rules. However, if he had worked for 12 years
and 3 months, it would be considered as 12 years.

Now, let us assume that Mr. B’s last drawn salary was Rs.77,000. If he worked for 13 years, his
gratuity will be –

(15 x 77,000 x 13) / 26 = Rs.5,77,500.

b. Gratuity calculation for employees not covered under the act

For calculation of gratuity of employees not covered under the act, the formula is –

(15 x average salary for the last 10 months x number of years employed) x 30

Here,

Salary includes basic, DA, and commissions. Any other component of salary is not to be included.

The number of years employed is only considered based on the completion of each year of service.

For instance, if Mr. C has been employed at an organisation for 15 years and 8 months, his number
of years employed will be considered as 15 years.

Now, let’s assume that Mr. C’s average salary for the last 10 months was Rs.92,350. Then, his
gratuity will be –

(15 x 92,350 x 15) /30 = Rs.6,92,625.

5. Gratuity can be forfeited for several reasons –

As per the gratuity rules, employers can forfeit to pay a gratuity of the employee who has been
terminated for the following reasons –

Committing an offence involving moral turpitude.

Riotous or disorderly conduct or any other violent act.

6. Employers cannot refuse to pay gratuity even during bankruptcy –

An organisation is liable to pay gratuity to its employees even if it declares bankruptcy. No court
decree or order can restrict an employer against it.

7. Gratuity up to the tune of Rs.20 Lakh is exempt from taxation –

A gratuity of up to Rs.20 Lakh paid by organisations covered under the Payment of Gratuity Act,
1972, other than central and state government departments, defence, and local governing bodies, is
exempt from tax as per the gratuity rules 2020. Earlier, this threshold was set to Rs.10 Lakh.

8. Income tax applicability differs for different employees –

Organisation type Gratuity tax implications

Covered under the act

Not applicable up to least of the following:

Rs. 20 Lakh.

Actual gratuity received.

15 x last drawn salary x number of completed years of service) / 26

Not covered under the act Not applicable up to least of the following:

Actual gratuity received.

Rs. 10 Lakh.

15 x average salary for the last 10 months x number of years employed) x 30

Central/state government, defence, and local government authorities Not applicable

9. The Rs.20 Lakh threshold for tax exemption is for cumulative gratuity received –

For instance, Mr. D received a gratuity of Rs.17 Lakh after leaving an organisation. After that, he
joined another company that paid him a gratuity of Rs.5 Lakh. The cumulative gratuity he received
was Rs .23 Lakh.

Hence, Mr. D will be liable to pay income tax on Rs. 3 Lakh (Rs. 23 Lakh – Rs. 20 Lakh).