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Gratuity is an important financial security cover for employees who have served for a long time in any organized sector company, factory, bank or corporate institution. It is a lump sum statutory benefit given by the employer (company) in recognition of the employee’s loyalty, dedication and continuous service. Payment of gratuity in India is governed under the ‘Payment of Gratuity Act, 1972’. This law applies to all factories, mines, oil fields, plantations, ports and all such commercial establishments where 10 or more employees are employed on any day during the previous 12 months. An employee gets the right to receive gratuity when he has completed at least 5 years of continuous service in the same organization. This lump sum amount is transferred to the bank account on resignation from job, retirement or taking VRS.
There is a clear and legally prescribed formula for arriving at the amount of gratuity for employees covered under the scope of the Gratuity Act:
$$\text{Gratuity} = \frac{15 \times \text{Last Drawn Wages} \times \text{Total years of service}}{26}$$
The two most important components of this formula are ’15’ and ’26’, the meaning of which is important to understand:
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Multiplier (15 days): According to the law, for every 1 year of service completed by an employee, he is given 15 days’ salary as gratuity.
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Denominator (26 days): In calculating gratuity, a month is not considered to be of 30 or 31 days, but of 26 working days, because 4 Sundays of the month are excluded from working days. Thus, to arrive at the per day salary, the monthly salary is divided by 26.
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Final Salary: Only Basic Salary and Dearness Allowance (DA) are included in the calculation. Items like House Rent Allowance (HRA), Special Allowance, Medical Allowance, Conveyance or Bonus are not included in this.
Let us now do the exact calculations on real data as per your question:
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Last received Basic Salary (Basic + DA): ₹60,000
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Service Period in the Institute: 10 years
Step 1: Withdraw one day’s salary
Dividing ₹60,000 by 26:
$$\frac{60,000}{26} = ₹2,307.69 \text{ (per day salary)}$$
Step 2: Withdraw 15 days salary per year
Calculation of 15 days salary:
$$2,307.69 \times 15 = ₹34,615.38$$
Step 3: Multiply by 10 years of total service
Total amount payable for 10 years:
$$34,615.38 \times 10 = ₹3,46,153.84$$
Thus, after completing 10 years of service at a basic salary of ₹60,000, the employee will get a total salary of Rs. ₹3,46,154 (approximately three lakh forty six thousand rupees) Gratuity of Rs will be paid.
The ‘6 month rule’ plays an extremely important role while calculating the duration of employment. If an employee has spent more than 6 months in a year after completing minimum service of 5 years, that additional period is treated as one full year.
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For example, if your total service period was 10 years and 7 months, the total years of service considered in the calculation would be 11. In this situation the amount of gratuity would have increased to $\frac{15 \times 60,000 \times 11}{26} = ₹3,80,769$.
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Whereas if the service period was 10 years and 5 months, then since it was less than 6 months, only 10 years would have been counted and the gratuity would have remained ₹ 3,46,154.
The biggest relief for the employees is that the entire amount received as gratuity will be 100% tax-free. The rules for tax exemption on gratuity under Section 10(10) of the Income Tax Act are as follows:
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For Government Employees: The entire amount of gratuity received by central and state government, defense personnel and local authority employees is completely tax-free.
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For Private Sector Employees: The maximum legal limit for tax exemption on gratuity for organized private sector employees is set at Rs 20 lakh (₹20,00,000). Since in your calculation the total gratuity comes to ₹3,46,154, which is much less than the limit of ₹20 lakh, hence not even ₹1 of income tax or TDS will be deducted on it. This entire amount will be received net by the employee.
Even if a small private institution is not covered under the ‘Payment of Gratuity Act, 1972’, it can still give gratuity to its employees voluntarily. The calculation formula changes slightly for such non-notified institutions. There the working days of the month are considered to be 30 days instead of 26:
$$\text{Gratuity} = \frac{15 \times \text{Basic Pay} \times \text{Service Years}}{30}$$
Calculating with this alternative formula:
$$\frac{15 \times 60,000 \times 10}{30} = ₹3,00,000$$
However, more than 95% of the country’s corporate, IT, manufacturing and banking sector organizations are covered under the Gratuity Act 1972, so based on the standard calculation, the actual and legal entitlement for 10 years on a basic pay of ₹ 60,000 comes to only ₹ 3,46,154.