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Derived from the word ‘Gratitude’, Gratuity is a token of appreciation from an employer to its employees who have served in the organization for a minimum of 5 years, thereby proving to be faithful and dedicated towards work. The extraordinary contribution of employees falling under this category is reciprocated by a cash prize reward. This amount is not deducted from the concerned employee’s salary, rather given as a gratuitous gift, entirely funded by the employer. Now the question is –
How is Gratuity Calculated?
There are several gratuity calculation formula to use while calculating the amount but the most authentic and widely accepted one is:

Gratuity = 15 / 26 * (A * B)


A = Last Drawn Salary of the Employee + Dearness Allowance

B = Total No. of Years of Service

‘*’ = Product or Multiplication

Having understood the meaning and calculation method of Gratuity, let us walk through some of the major advantages that this reward/ benefits scheme holds for working professionals:
Benefits of Gratuity

  • The only eligibility and applicability of availing Gratuity is that the employee works with a single organization for 5 years or more and the organization has over 10 working employees
  • The companies registering for Gratuity just have to be covered under the Payment of Gratuity Act, 1972 or they can voluntarily opt for offering the same
  • In case of death/ permanent disability or other unavoidable circumstances, employees have the power to transfer the Gratuity fund to their legal heir, else they can name a nominee for receiving the amount on their behalf later on
  • The eligible employee can get a maximum of INR 20 lakhs as the Gratuity amount
  • The amount won by an employee through the Gratuity Benefits Scheme is absolutely exempt from tax for government employees in case they withdraw the same on retirement
  • The payment of Gratuity by a company does not depend on the profit or loss faced, the employers are bound to give the amount once committed
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Gratuity is given by the employer to an employee for the services rendered by him. It is usually paid at the time of retirement but it can be paid before provided certain conditions are met.

As per Sec 10 (10) of Income Tax Act, gratuity is paid when an employee completes 5 or more years of full time service with the employer(minimum 240 days a year). However, it can be paid before the completion of five years at the death of an employee or if he has become disabled due to accident or disease.

There is no set percentage stipulated by law for the amount of gratuity an employee is supposed to get – an employer can use a formula-based approach or even pay higher than that.

Gratuity payable depends on two factors: Last drawn salary and years of service. To calculate how much gratuity is payable, the Payment of Gratuity Act, 1972 has divided non-government employees into two categories:

a) Employees covered under the Act
b) Employees not covered under the Act

An employee will be covered under the Act if the organisation employees at least 10 persons on a single day in a preceding 12 months. And once an organisation comes under the purview of the gratuity Act, then it will always remain covered even if the number of employees is falls below 10.

Hope this helps.


Drake Hosted Tax Software Consultant

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Neelima Bansal (anonymous) 0 Comments

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Gratuity: The benefit which is given by an employer to the employee, it can be availed after 5 years by the employer and can be calculated 

Gratuity = Average salary (basic + DA) * ½ *

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The gratuity amount depends upon the tenure of service and last drawn salary. It is calculated according to this formula: Last drawn salary (basic salary plus dearness allowance) X number of completed years of service X 15/26.

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