As new legislation comes into effect, employers in India should make sure they understand the rules for paying gratuity to retiring employees.

After passing both houses of India’s government - the Lok Sabha and the Rajya Sabha - amendments to the Payment of Gratuity Bill came into effect on 29 March, 2018. The bill has a number of effects - not least regarding the way employees in the private sector are paid their retirement gratuity. To ensure compliance and accuracy going forward, it’s vital that Indian businesses get up to speed with the changes…

What is the Payment Gratuity Bill?

First introduced in 1972, the Payment of Gratuity Act was intended to support labourers in Indian factories, railways, plantations, mines, oilfields, and similar establishments, by providing a financial gratuity upon retirement - when that retirement was a result of superannuation, impairment, or disability. The act applies only to businesses with 10 or more employees - and employees only become eligible for a gratuity payment after a minimum of 5 years' service. Tax-exempt up to a certain limit, the retirement gratuity is a popular benefit in India, and is considered an important part of the social security system by most employees.

Essentially, 2018’s Payment Gratuity Bill amends the 1972 Act, by raising the ceiling for how much tax-free gratuity can be paid to employees upon retirement - from Rs 10 lakh, to Rs 20 lakh (2 million rupees). The standard gratuity amount depends on the number of years an employee has worked for their employer - the longer their service, the greater the gratuity. Employers are entitled to pay above the gratuity ceiling, but tax will be due on amounts exceeding Rs 20 lakh.

How to calculate Gratuity?

Broadly speaking, a retiring employees’ gratuity will comprise half a month’s combined Basic Salary and Dearness Allowance (DA) for every year’s service they completed. In more detail the calculation is as follows:

  • (Number of years of service) x ((Basic Salary + DA) x 15 days) /26

By way of an example, an employee with 30 years’ service, retiring on a salary and DA of Rs 40,000, would receive a gratuity of Rs 692,308. The 5 year minimum service limit is not applicable in cases where employment is terminated due to disablement or death. When working out ‘years of service’, any amount of a year in excess of 6 months should be considered a completed year.

Benefits of the Amendments

The Payment of Gratuities Bill holds a number of benefits for Indian employees:

  • The Gratuity Bill follows the Indian government’s 7th Central Pay Commission (2016), which raised the gratuity ceiling for government workers by the same degree (from Rs 10 lakh, to Rs 20 lakh). The 2018 Bill aligns the Indian business landscape with the public sector - with gratuity benefits now applicable to private sector employees.
  • The new gratuity ceiling refers to the tax-free amount payable to a retiring employee - which means retirees can now receive up to Rs 20 lakh tax free. The benefit extends across different employments: if an employee has previously received a gratuity of Rs 10 lakh from a previous employer, they are now eligible to receive up to a further Rs 10 lakh tax free from subsequent employments.
  • While the new gratuity ceiling would seem to deliver the most immediate benefits for higher-salaried employees, those at the start of their careers will be better placed to achieve higher levels of gratuity benefits over the long-term.

Additional Benefits

The Payment of Gratuity Bill delivers changes in addition to its effects on the gratuity ceiling including the possibility for the government to make further adjustments by executive order, rather than having to go through the time-consuming process of parliamentary assent - and so keep better pace with inflation.

Another notable effect of the bill is to amend the provision of gratuities for women who take maternity leave. After an amendment to the Maternity Act in 2017, which raised the maximum maternity leave period from 12 to 26 weeks, the Payment of Gratuity Bill aligns the calculation of gratuities with that increased period.

For more information on India’s tax system and business environment, browse activpayroll’s dedicated Global Insight Guide.

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