Gratuity is an important employee benefit paid by an employer in recognition of an employee's continuous service. It is generally payable when an employee leaves an organisation due to resignation, retirement, superannuation, death or disablement.
The rules relating to gratuity in India have traditionally been governed by the Payment of Gratuity Act, 1972. Under the new labour-law framework, gratuity is covered under the Code on Social Security, 2020.
Which Companies Are Covered Under Gratuity Rules?
Gratuity provisions generally apply to:
- Factories
- Mines
- Oilfields
- Plantations
- Ports
- Railway companies
- Shops and establishments employing 10 or more employees
- Other establishments notified by the appropriate government
An important point is that once an establishment becomes covered under the gratuity provisions, it generally continues to remain covered even if the employee count subsequently falls below 10.
Rule - Payment of Gratuity Act, 1972
Under the Payment of Gratuity Act, 1972, an employee generally became eligible for gratuity after completing five years of continuous service.
The five-year condition was not applicable in cases of:
- Death of the employee
- Disablement due to an accident or disease
Therefore, if a regular employee resigned before completing the required five years of continuous service, gratuity was generally not mandatory under the statutory provisions.
Rule- Under the New Labour Code?
Under the Code on Social Security, 2020, the general five-year eligibility rule continues for regular employees.
Regular Employees
A regular employee generally becomes eligible for gratuity after completing five years of continuous service.
However, the five-year requirement does not apply if employment terminates due to:
- Death
- Disablement due to accident or disease
Fixed-Term Employees
The new labour-law framework provides a separate provision for eligible fixed-term employees.
A fixed-term employee who is directly employed by the organisation may become eligible for gratuity after completing the applicable one-year service requirement, with gratuity payable on a proportionate basis.
It is important to distinguish a fixed-term employee directly engaged by the employer from contract labour engaged through a contractor, as the applicable gratuity provisions may differ.
Can a Company Pay Gratuity Before Five Years?
Yes. The statutory five-year rule is generally the minimum requirement for mandatory gratuity eligibility for regular employees. However, a company can choose to provide more favorable gratuity benefits through its:
- Company policy
- Employment agreement
- Appointment terms
- Other applicable arrangements
For example, a company may decide to pay gratuity after:
- 1 years of service
- 2 years of service
- Any other period specified in its policy
Therefore, organisations should not assume that gratuity can only be paid after five years. A company may voluntarily provide gratuity before five years as an additional employee benefit.
Tax Implications
The tax treatment of gratuity is governed by the Income-tax Act, 1961 and is separate from gratuity eligibility under labour laws.
Regular Employees
For eligible non-government employees, gratuity received may be eligible for tax exemption under the applicable provisions of the Income-tax Act.
The exempt amount is generally determined as the lowest of:
- Actual gratuity received
- The applicable prescribed gratuity calculation
- The maximum exemption limit of ₹20 lakh
Any amount that does not qualify for exemption is generally taxable as salary.
Gratuity Paid Before Five Years
A company may voluntarily pay gratuity before the statutory five-year eligibility period as part of a more favourable company policy.
However, payment of gratuity before five years is fully taxable.
Fixed-Term Employees
Eligible fixed-term employees may receive proportionate gratuity after completing the applicable service period under the labour-law framework.
However, receiving gratuity after a shorter service period does not automatically make the entire amount tax-free. The applicable exemption provisions and the overall ₹20 lakh exemption limit must be considered. Any non-exempt portion may be taxable.
Conclusion
The general gratuity rules can be summarized as follows:
- Gratuity provisions generally apply to covered establishments employing 10 or more employees.
- Regular employees generally become eligible for statutory gratuity after completing five years of continuous service.
- The five-year condition does not apply in cases of death or disablement.
- Eligible fixed-term employees may qualify for gratuity after completing the applicable one-year service requirement, subject to the relevant provisions.
- A company may provide gratuity benefits before five years if it offers more favourable terms to its employees.
- Tax treatment is separate from gratuity eligibility, and gratuity paid before five years is not automatically fully tax-free.
- For eligible non-government employees, gratuity tax exemption is subject to the applicable provisions and limits, including the ₹20 lakh maximum exemption ceiling.
Therefore, when determining gratuity eligibility, organisations should consider the employee's type of employment, length of service, reason for separation, statutory provisions and the company's own gratuity policy.