Gratuity – From A Legal Perspective

One of the most pressing questions an employee has when leaving an organization after long-term involvement is “Am I eligible for gratuity?”, and then comes the questions of calculation and tax obligation. However, legal disputes arise over the question of eligibility for gratuity more often. Whether you are planning your retirement, cross-checking the reason for your employer’s refusal to pay a gratuity, researching the merits and demerits in case of a court battle, read on to find all your answers below.

What is Gratuity?

Meaning

The word "gratuity" originates from the Latin word "gratuitus" which means "free" or "freely given." Nowadays, gratuity refers to a sum of money given to someone as a reward for their services, commonly known as a tip. It also refers to a lump sum paid to an employee upon separation. While the dictionary meaning of the word indicates it to be a voluntary gift, legally it may not be so in India. For certain establishments that qualify under the Payment of Gratuity Act, 1972, (now often referred to as the “Act”), gratuity is a right of  the employeeand a mandatory obligation of the employer, governed by specific regulations. Those employees who are not eligible under the Payment of Gratuity Act, 1972 may still receive gratuity. However, the downside is that there are no such codified and fixed laws regulating it so enforcement may be difficult. 

Amount Payable

• Gratuity for monthly-salaried employees covered by the Payment of Gratuity Act, 1972 is calculated based on this formula derived from Section 4(2) of the Act:
  Gratuity = (Last drawn salary × 15 × No. of years of service) / 26

• For piece-rated employees covered by the Payment of Gratuity Act, 1972, gratuity is calculated based on this formula derived from Section 4(2) of the Act:
  Gratuity =  ((Total wages in last 3 months × 15 × No. of years of service) / No. of days worked in the last 3 months) / 2   
  
  For seasonal employees covered by the Payment of Gratuity Act, 1972, gratuity is calculated based on this formula derived from Section 4(2) of the Act:
  Gratuity = Daily Wages × 7 × No. of seasons worked

• For employees not covered by the Payment of Gratuity Act, 1972, the following formula is typically used:
  Gratuity = (Average salary for the last 10 months × No. of years of service) / 2.

• In the above formulae, the wages taken into account are those of the specific establishment paying the gratuity and of the time immediately preceding the date of separation of such establishment.

• According to Section 4(2) of the Payment of Gratuity Act, 1972, any period exceeding 6 months but less than 1 year is considered as 1 whole year of service.

• According to the definition of wages provided in Section 2 of the Payment of Gratuity Act, 1972, salary may include dearness allowance but not any bonus, commission, house rent allowance, overtime wages, and any other allowance.

• The maximum amount of gratuity payable is capped at ₹20 lakhs through the notification S.O. 1420 (E) dated March 29, 2018. An employer may pay more if they wish to but that will be voluntary and not a fixed right.

• According to Section 7(3) of the Payment of Gratuity Act, 1972, an employer must pay gratuity within 30 days from the date it becomes payable. If not, then the employer is liable to pay interest on the amount from the due date until the actual payment date (unless the employee is at fault for the delay).

In the case of Y.K. Singla vs Punjab National Bank & Ors on 14 December (2012), the Supreme Court had to decide whether an employee whose gratuity has been withheld under Regulation 46 of the Punjab National Bank (Employees) Pension Regulations is entitled to get interests because of the delay after the completion of the proceeding. The court held that even though the provisions of the 1995 Regulations, are silent on the issue of payment of interest, the appellant would be entitled to interest, on account of delayed payment under the Payment of Gratuity Act for the benefit of the employee.

Tax

The Income Tax Act, 1961 governs the tax implications of gratuity payments in India. Specifically, the provisions related to the tax exemption on gratuity which can be found under Section 10(10) of the Income Tax Act, 1961.

Here is a summary of the relevant legal provision:

• For government employees (both Central and State), the entire amount of gratuity received is exempted from tax.
• For private sector employees covered under the Payment of Gratuity Act, 1972, the least of the following amounts is exempted from tax:
  • The actual gratuity received.
  • (Last drawn salary × 15 × Number of years of service) / 26
  • INR20 lakhs.

• For private sector employees not covered under the Payment of Gratuity Act, 1972, the least of the following amounts is exempt from tax:
  • The actual gratuity received.
  • (Average salary for the last 10 months × Number of years of employment) / 2
  • ₹20 lakhs.

The ₹20 lakh threshold for tax exemption is for cumulative gratuity received.

Remedy for Grievances

According to Section 7(4)(b) of the Payment of Gratuity Act, 1972, in case of non-payment of gratuity, or disputes regarding eligibility or amount payable, etc., one can approach the Controlling Authority under Section 3 of the Act for resolution. Employees not governed by the Payment of Gratuity Act, 1972 may approach the Labour Commissioner or Labour Court (or Civil Court in case of employees holding a managerial position). If you are confused about the process, where to complain, or looking for alternative means of resolution, etc. reach out to a lawyer experienced in employment or labour laws.

In M/S Steel Authority of India LTD.  Vs Raghbendra Singh & Ors. (2020) and ONGC Ltd. & Anr. Vs. V.U. Warrier (2005), the Hon'ble Supreme Court of India held that gratuity payment can be withheld by the employer for recovery of dues from the employee.
 

Who is eligible to get Gratuity?

To determine the eligibility for gratuity under the Payment of Gratuity Act, 1972, apart from completing a minimum 5 years of continuous service, an employee must meet at least one criterion from each of the following categories:

Type of Establishment [Section 4(1) of the Act]

• An employee of a factory, mine, oilfield, plantation, port, railway company, shop, or other establishment where 10 or more employees are employed or were employed on any day of the preceding 12 months.
• If an establishment becomes applicable as per the criteria above, it will remain so even if the number of employees falls below 10.
  
  

Type of Separation [Section 4(1) of the Act]

• An employee who has completed a minimum of 5 years of continuous service at the time of his superannuation, retirement, resignation, or termination.
• An employee who has become disabled due to an accident or disease is eligible regardless of the length of their service.
• In the unfortunate event of the death of an employee, the gratuity is paid to the nominee or legal heir of the employee, regardless of the length of their service. If the nominee or heir is a minor, the minor's share of the gratuity is deposited with the controlling authority, who invests the minor’s share in a bank or financial institution until the minor reaches the age of majority.
  
  

Type of Employment

• Permanent
• Full Time
• Part-Time, Casual, and Ad Hoc
  • In the case of National Bal Bhawan vs Vandana & Ors. (Delhi High Court, 2019), the appellant employer challenged the payment of gratuity to its part-time teachers. The court held that an employee is an employee, whether on a casual, ad-hoc, or part-time basis. The definition of employee in the Act, 1972 does not speak of any specific categories of employees for its applicability, be it regular, ad-hoc, part-time, casual, etc.
  • In the case of Netram Sahu v. State of Chhattisgarh (2018), the appellant employee had, in all, rendered 25 years and 3 months of service (22 years and 1 month as a daily wager and 3 years and 2 months as a regular work charge employee). However, the Appellant was refused payment of gratuity after his retirement because, out of the total period of 25 years of his service, he worked 22 years as a daily wager and only 3 years as a regular employee. The Hon’ble Supreme Court of India held that the state should release the gratuity amount to the employee because the Appellant had rendered the service for a period of 25 years. Because the services were regularised, the Appellant was entitled to claim their benefit for a period of 25 years, regardless of the post and the capacity in which he worked for 22 years.

• Contractual
  • In the case of Superintending Engineer, Mettur Thermal Power Station, Mettur vs. Appellate Authority, Joint Commissioner of Labour, Coimbatore & Anr, 2012 supports the fact that contractual employees are eligible for gratuity, the Madras High Court held that gratuity, being a termination payment required by law, constitutes ‘wages’ under the Contract Labour (Regulation and Abolition) Act, 1970 (CLRA). This judgment arose when an employee, who worked as a contract employee from 1988 to 1999 and then as a direct employee from 1999 to 2003, claimed gratuity for his entire period of service upon termination. The Power Station argued that it was only responsible for paying gratuity for the period during which the employee was directly employed (1999-2003). However, the Court ruled that, in accordance with Section 21(4) of the CLRA, the principal employer (the Power Station) is responsible for the payment of gratuity for the period the employee was a contract worker. The Court interpreted that gratuity payable under the Payment of Gratuity Act, 1972 falls within the definition of ‘wages’ in the CLRA, specifically under clause (d) of Section 2(h), which includes sums payable due to the termination of employment under any law. This decision emphasizes the principal employer's obligation to ensure the payment of gratuity to contract employees in the event of a contractor's failure to do so, thereby affirming the eligibility of contractual employees for gratuity, either by the contractor or principal employer.

• Seasonal
  • In short, any employee who is not a trainee can claim gratuity.
    • In the case of IREL (India) Limited vs P. N. Raghava Panicker (2020), the Karnataka High Court clarified that the definition of 'employee' under the Payment of Gratuity Act, 1972 does not exclude trainees, but only apprentices. The court emphasized that while the Act expressly excludes apprentices from gratuity benefits, it does not preclude trainees who perform regular duties as employees from receiving a gratuity. The court highlighted that denying gratuity to individuals designated as trainees but engaged in substantial work would undermine the welfare objectives of the Gratuity Act.

Nomination [Section 6 of the Payment of Gratuity Act, 1972]

As stated earlier, in the unfortunate event of the death of an employee, a nominee can receive the gratuity payment instead. The nominee can be chosen based on the below criteria:

• Gratuity may be distributed among more than 1 nominee.
• A nominee must be a family member if the employee has a family at the time of nomination; nominations for non-family members will be invalid.
• If the employee has no family when making the nomination, any person can be nominated, but once the employee acquires a family, the previous nomination becomes invalid, and new family members must be nominated.
• A nominee can be changed anytime by the employee through written notice to the employer in the prescribed form and manner.
• If a nominee dies before the employee, the nomination becomes void, and a new nominee must be designated by the employee.
  
  

Forfeiture [Section 3(6) of the Payment of Gratuity Act, 1972]

If an employee is terminated for misconduct, such as causing damage to the employer's property, behaving violently, or committing a serious crime during their employment, the employer can withhold part or all of the gratuity payment. Specifically, the gratuity can be reduced by the amount of damage caused, and for more severe offences, such as violence or serious crimes, the employer can deny the gratuity entirely.

What qualifies as Continuous Service?

Uninterrupted service that includes periods of absence due to :

• sickness,
• accidents,
• temporary disablement from work-related accidents,
• authorized leaves with full wages earned in the previous year,
• layoffs permitted under applicable labour laws,
• strikes,
• lockouts,
• stoppage of work not caused by the employee's fault,
• Maternity leave for female employees, provided it adheres to the duration specified by the Central Government (12- 26 weeks currently).

If an employee working in a seasonal establishment does not meet the criteria for continuous service above for a period of 1 year or 6 months, they will still be considered to have been in continuous service if they have worked for at least 75% of the days when the establishment was operational during that period.

If an employee does not qualify for continuous service as above for a period of 1 year or 6 months, they will still be considered in continuous service under the employer if:

• In 1 year, the employee has actually worked for at least:
  • 190 days if employed below ground in a mine or an establishment working less than 6 days a week, or
  • 240 days in any other case.
    
    
• In 6 months, the employee has worked for at least:
  • 95 days if employed below ground in a mine or in an establishment working less than 6 days a week, or
  • 120 days in any other case.

In the case of Lalappa Lingappa & Ors Vs. Laxmi Vishnu Textile Mills Ltd., Sholapur [1981], the court held that,

1. permanent employees absent without leave and not working for at least 240 days in a year are not entitled to gratuity under Section 4(1) of the Act. The court emphasized that "actually employed" in Explanation I is synonymous with "actually worked," thereby requiring actual presence at work for the specified number of days to qualify for gratuity.
2. Badli employees, though required to report for work, were not entitled to gratuity for periods when they were not actually provided with work. The court clarified that merely reporting to work without actual work assignments does not constitute rendering service eligible for gratuity.

In the case of Surendra Kumar Verma v Central Govt the Supreme Court of India(1980) held that 240 days’ service in the preceding twelve months is sufficient, it is not essential that the employee should have completed one year of service. It also applies to the Payment of Gratuity Act, therefore an employee who has served for 4 years, 10 months and 11 days shall be taken to have served 5 years continuous service under sec. 4(2) to be eligible for gratuity. The Payment of Gratuity (Second Amendment) Act, 1984 explains this further. For example, an employee, who works in an organization that has a 5 days a week regime, will receive gratuity when he serves the company for 4 years and 6 months (190 days = 1 year), while an employee in the firm operating a 6 days a week will be eligible after 4 years and 8 months; (240 days = 1 year). Employees here get gratuity based on the day of their joining and the end of the years of service, and not calculated years and days into the service. This benefit however is available to an employee if at any one time he serves for more than 5 years within a given period and qualifies for gratuity.  The payment of gratuity is also extended to dependents or nominees in the event of the employee’s death before rendering 5 years of service.