What is Gratuity?

Gratuity is a sum of money that is paid to an employee at the end of the service. According to Section 4 of the Payment of Gratuity Act, 1972 (“PG Act”), Gratuity is payable to an employee after termination of their employment after continuously serving for 5 years. The objective of this PG Act is to ensure welfare benefits for the employees across the nation.

To which employers does the PG Act apply to?

The PG Act applies to-

- All factories, mines, oilfields, plantations, ports, and railway companies or

-Shops or establishments where ten or more persons were employed on any day in the preceding twelve months, as per state laws.

Additionally, once applicable, this Act continues to govern a shop or establishment even if the number of employed persons falls below ten. The applicability of the Gratuity Act depends on the branches of the establishment. If the company operates only within one state, the respective State Gratuity Rules apply. However, if the company has branches in multiple states, the Central Rules will be applicable.

Do Employers have to obtain insurance towards gratuity?

Section 4A of the Payment of Gratuity Act, 1972 (Gratuity Act) requires employers of establishments with ten or more employees to obtain insurance to cover their gratuity liabilities to eligible employees or their nominees. However, this obligation to secure gratuity insurance only applies if the relevant state government issues rules through a notification to enforce this section.

Several Indian states, including Andhra Pradesh and Telangana, have already enacted mandatory gratuity insurance rules. Karnataka has also implemented such regulations, introducing the Karnataka Compulsory Gratuity Insurance Rules, 2024 (Gratuity Rules) through a notification dated January 10, 2024. Please refer to our article on this at the hyperlink: http://kb.bizprout.com.
What is the foremost compliance mandated to employers?

Employers are required to intimate the respective State Government (except Andhra Pradesh and Telangana) within 30 days of reaching the headcount of 10 (ten) employees, in a Form-A which is also known as Notice of Opening.

Further, employers are required to collect Form-F nominations from the employees and hand over an acknowledgement to the employee. An employee can only nominate ‘family members’ and if they have no family only then can they nominate anyone else. In case they acquire a family, the existing nomination becomes invalid, and a fresh nomination should be filed. In case an unmarried employee who has nominated his parents wishes to change the nomination in the name of the spouse or children after marriage, the employer is required to collect fresh nomination forms.

When is gratuity payable?

According to Section 4 of the PG Act, Gratuity is payable to an employee after continuously serving for 5 years upon termination of their employment due to:

1. Superannuation
2. Dismissal
3. Resignation
4. Disablement
5. Death

However, for death or disablement, the mandatory 5 years of service is not applicable.

What compliance are necessary when the gratuity becomes payable?

Employee Responsibility: The eligible employee, their nominee, or legal heir must submit an application in Form-I, J, or K to avail of the gratuity.

Employer Responsibility: The employer must issue a notice in Form-L to the employee, nominee, or legal heir within 30 days from the employee’s last working day. Additionally, the employer must ensure the gratuity payment is made within 30 days. If the payment is delayed, the employer is required to pay interest at the rate fixed by the Reserve Bank of India from the 31st day after the last working day. Further, the Employer is also required to file a copy of the Form-L with the jurisdictional labour officer. The employer may also reject the claim. Employer has to display an abstract of the Payment of Gratuity Act on the notice board.

What is the penalty if employer fails to pay gratuity to employee?

If the employer fails to pay gratuity to an employee, they can be punished with imprisonment for a term of up to 6 months, a fine of up to 10,000 rupees, or both.

How are the days used to calculate gratuity determined?

According to Section 2A deals with continuous services. An employee must have continuously served for not less than 5 years at the establishment. This includes periods of interruptions like sickness, accident, etc., For employees not in continuous service excluding seasonal establishments, one year period deemed continuous if the employee has worked for at least 190 days for employees employed in a mine or in an establishment which works for less than 6 days a week. And 240 days for any other case.

Six months period deemed continuous service if the employee has worked for at least 95 days if employed in a mine or in an establishment which works for less than 6 days a week. And 120 days in any other case.

Seasonal establishment: for employees in seasonal establishment not in continuous service: deemed continuous if the employee has worked at least 75% of the days the establishment operated during the period.

How is gratuity calculated?

Per Section 4(2), the formula for calculating gratuity is-

Last drawn salary x Number of years of service x 15/26

The last drawn salary is the basic salary + Dearness allowance (DA).

The number of years of service is the total number of completed years of service.

15/26 this fraction represents 15 days salary for each completed year of service, considering there are 26 working days in a month.

Example-

An employee’s last drawn salary (Basic + DA) is Rs. 30,000 and has completed 15 years of service.

Gratuity = 30,000 x 15 x 15/26

=2,59,615

Hence the gratuity amount is Rs. 2,59,615/-

Conclusion

The PG Act is a vital piece of legislation that recognizes and rewards employees for their long-term service to an organization. By ensuring a gratuity fund, it not only promotes employee loyalty but also provides financial security. The PG Act empowers both employers and employees to handle career transitions with transparency and fairness, contributing to a more stable and equitable workplace.