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How to calculate gratuity

Gratuity is given by the employer to his/her employee for the services rendered by him
during the period of employment. It is usually paid at the time of retirement but it can be
paid before provided certain conditions are met.

A person is eligible to receive gratuity only if he has completed minimum five years of
service with an organisation. 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.

Calculation of gratuity
a) For employees covered under the Act

There is a formula using which the amount of gratuity payable is calculated. The formula is
based on the 15 days of last drawn salary for each completed year of service or part of
thereof in excess of six months.
The formula is as follows:

(15 X last drawn salary X tenure of working) divided by 26

Here last drawn salary means basic salary, dearness allowance, and commission received
on sales.

Suppose A’s last drawn basic pay is Rs 60,000 per month and he has worked with XYZ Ltd
for 20 years and 7 months. In this case, using the formula above, gratuity will be calculated
as:

(15 X 60,000 X 21)/26 = Rs. 7.26 lakh

In the above case, we have taken 21 years as tenure of service because A has worked for
more than 6 months in year. Had he worked for 20 years and 5 months, 20 years of service
would have been taken into account while calculating the gratuity amount.
b) For employees not covered under the Act

There is no law that restricts an employer from paying gratuity to his employees even if the
organisation is not covered under the Act.

The amount of gratuity payable to the employee can be calculated based on half month’s
salary for each completed year. Here also salary is inclusive of basic, dearness allowance,
and commission based on sales.

The formula is as follows:

(15 X last drawn salary X tenure of working) divided by 30

In the above mentioned example, if A’s organisation was not covered under the Act, then
his gratuity will be calculated as:

(15 X 60,000 X 20) /30 = Rs 6 lakh

Here the number of years of service is taken on the basis of each completed year. So, since
A has worked with the company for 20 years and 7 months, his tenure will be taken as 20
and not 21.

As per the government’s pensioners’ portal website, retirement gratuity is calculated like
this: one-fourth of a month’s basic pay plus dearness allowance drawn before retirement for
each completed six monthly period of a qualifying service. The retirement gratuity payable
is 16 times the basic pay subject to maximum of Rs 20 lakh.

In case of death of an employee, the gratuity is paid based on the length of service, where
the maximum benefit is restricted to Rs 20 lakh.