For any organisation, accurate computation of liability towards employee benefit is critical to ensure they are sufficient to pay them off as they fall due. This blog focuses on Gratuity and the importance of an expert actuary in valuing it appropriately.
What is Gratuity?
Gratuity is a type of retirement benefit which is paid by a company to an employee as a reward for rendering services for a continuous period of 5 years or more. Gratuity is paid in lump sum after retirement, resignation, termination, death or permanent disablement of the employee due to an accident or disease.
How does Gratuity apply to any organisation?
If the Payment of Gratuity Act, 1972, applies to an organisation, they must mandatorily pay gratuity to an employee, if he or she has rendered at least 5 years of continuous services. However, the limit of 5 years is not applicable in case of death or disablement of the employee.
If Payment of Gratuity Act, 1972, is not applicable, the organisation can still pay the gratuity on its own accord.
What is the applicability of Payment of Gratuity Act, 1972?
Payment of Gratuity Act, 1972 applies to:
- All factories, oilfields, mines, railway companies, ports and plantations;
- Shops or establishment in which 10 or more people are employed on any day in the preceding 12 months
Once gratuity applies to an organisation (10 or more people are employed), it continues to be applicable even if the number of employees goes below 10.
What is the Income Tax Exemption Limit for Gratuity?
In the notification issued on March 29, 2018, Government had announced a bonanza for employees as tax-free gratuity limit was increased to INR 20 lacs, which is double the previous limit of INR 10 lacs.
How is Gratuity calculated?
Gratuity is calculated for employees covered and not covered under the Payment of Gratuity Act, 1972, accordingly.
For employees covered under the act:
Gratuity = Last drawn salary x number of completed years of service x 15/26
Last drawn salary = Basic Salary + Dearness Allowance
No. of completed years of service = Total no. of years during which employee continued to be employed with the establishment (any period above 6 months will be considered 1 year)
For employees not covered under the act:
Gratuity = Average salary during the past 10 months x number of completed years of services x ½
How does an actuary facilitate the valuation?
IND AS 19 (AS 15 in i-GaaP) which applies to “Employee Benefits” requires an organisation to show gratuity payable as a liability after an actuarial valuation.