Payment of Gratuity and Gratuity Qualifying Salary

Having clarified by the Apex Court of India that PF qualifying salary is the amount of salary that the employer has agreed to give to the employee in return for the labour the latter gives, the next question that arises into the minds of all employees is that what will be the salary for the purpose of calculating Gratuity?

Section 2 (s) of the Payment of Gratuity Act, 1972, defines the term “wages” as  “ all emoluments which are earned by an employee while on duty or on leave in accordance with the terms and conditions of his employment and which are paid or are payable to him in cash and includes dearness allowance but does not include any bonus, commission, house rent allowance, overtime wages and any other allowance”.

The above definition of wages is almost similar to the one given for wages under the Employees Provident Fund and Miscellaneous Provisions Act, 1952, which provides under section 2 (b) as follows:

Basic wages means all emoluments which are earned by an employee while on duty or on leave or on holidays with wages in either case in accordance with the terms of the contract of employment and which are paid or payable in cash to him, but does not include-

(i) The cash value of any food concession;

(ii) Any dearness allowance (that is to say, all cash payments by whatever name called paid to an employees on account of a rise in the cost of living), house-rent allowance, overtime allowance, bonus, commission or any other similar allowance payable to the employee in respect of his employment or of work done in such employment;

(iii) any presents made by the employer.

Under both these Acts the meaning of basic Salary is same, ie, the total or gross emolument payable as per terms and conditions of employment or, simply, the contract of employment. It is true that an employee joins an organisation after accepting the terms and conditions of employment which will include a salary structure with a basic pay and other components. It is also common now a days to show how much will be the contribution by the employer towards Provident Fund and even the gratuity payable at the time of exit of the employee. For an employee, whatever is offered as salary is the salary on which he has agreed to work with the employer, and he is not concerned with the heads under which he is paid the same. As such, even if the agreement contains a break up of salary, the total should be regarded as the remuneration for his labour.

In the case of most of the private companies who treat Provident Fund and other social security schemes as a mandatory requirements or obligation rather than employee welfare schemes, it is obvious that they would keep the salary on which these contributions are to be made at a very low level. The history which induced the Supreme Court of India to clarify the meaning of Basic Wages to include all allowances is known to all. It is nothing but a dispute raised by the Employees Provident Fund Organisation against those employers who bifurcated the salary payable into small compartments with distinguishing headings leaving only a small fraction as under “Basic Salary” to attract Provident Fund deduction. This was done by following section 6 of the EPF and MP Act, which says that contribution is payable on Basic Wages and Dearness Allowances only. (in the case where there is no work and the employees are retained and as such instead of salary, if an allowance is paid to retain them, viz, retaining allowance, the same will also attract PF contribution) But the employers did not go to the scope of the meaning of Basic Wages as total wages but took it as the basic wages that they fix. Now having clarified that Basic Wages means the total salary payable as per agreement with an exception of house rent allowance (HRA) many have also restructured the salary with huge amounts shown as HRA.

What is House Rent Allowance?

This is an allowance paid or payable to an employee who stays in and around the place of office/ factory as mandated by the employer for the purpose of his occupation. It is not payable to all employees uniformly but is payable only to those who stay in leased houses. The basic feature of this allowance like any other allowance which are exempted from the scope of Basic Wages is that it will be payable even if the employee is on leave without pay. For example, the salary agreed is Rs 30000 per month. But the employee is given an additional amount of Rs 5000 as house rent allowance so that he can take a house on lease near the establishment and stay there. If the employee takes three days’ leave when is short of any paid leave, his salary will be subjected to deduction of three days’ salary at the rate of Rs 1000 per day on a calculation that monthly wages divided by 30 would be the average daily wage. But he will be paid HRA of Rs 5000 in full. HRA will not be subjected to proportionate deduction. If he is given telephone allowance of Rs 300, the same will be paid in full and no deduction proportionate to the days that he remained on leave will be made.

HRA is part of Salary

Let us take the same example with a difference that HRA is part of salary. The salary will be Rs 35000 and of this HRA as a component will be Rs 5000. In this case, if the employee takes three days’ leave without pay, it will be Rs 1166 per day which will be deducted from the salary. In this case HRA becomes part of Salary and in the former case, of course, it is a perquisite not falling under the scope of Salary. The same test applies to other allowances also. Most of the private establishments follow this pattern of salary structure. They would even consider the employers’ contributions towards PF, ESI, Gratuity etc as part of personnel cost and add it to the salary (commonly referred to as Cost to Company or CTC)  so that the total amount would lure the job seeker.

Special Allowances

The issue of treatment of Special Allowance is no exemption.  It is to be noted that Special Allowance is something that is paid only to a particular employee or particular category of employees in return for a special skill that they contribute to perform their task. Special Allowance in such cases can be excluded from the scope of definition of wages. But if special allowance is paid to all the employees, it will be considered as an allowance universally applicable to all the employees and in such cases,  it will become part of Wages/ Salary for any purpose.  

In the current system or custom of pay fixation, whatever left after allocating to segments like Basic Pay, HRA, Conveyance allowance etc is taken as Special Allowance. Obviously, it will have nothing to do with special skill nor is given only to a few employees who require special skill to do the work. Right from the decision of the Supreme Court in Bridges and Roofs (India) Ltd Vs Union of India (1963 (2)LLJ 490) there have been directions from the appropriate authorities that (Special) Allowance paid to all the employees would be part of Basic Salary and only those allowances which  are paid to some employees considering the nature of their duties or purely out of management's own interests or pleasure, can be excluded from the scope of Basic Wages.

A variant of Special Allowance is “other allowance”. Obviously, this is another head which will also form part of Wages or Salary or all purposes including payment of EPF, Bonus and Gratuity.

Meaning of Gross Wages/ Salary

Gross wage is the total wage paid or payable as per contract of employment. It is the amount of wage that one gets if he works on a day or takes an authorised leave. On the other hand, it is from the same gross wage that one’s salary for the day on which he remained leave without pay is deducted. For example, let us say that the gross salary of an employee is Rs 30000 per month. The salary is bifurcated as follows:

Basic Salary                           :   7000

HRA                                       :   5000

Conveyance                            :   3000

Special Allowance                  : 15000

Total                                        : 30000

Let us assume that the above employee has taken one day leave without pay. For the purpose of deduction, it is 30000 taken as base and it will account for Rs 1000 for a day, assuming that there are 30 days in the month. Accordingly, he will get Rs 29000 as salary for that month.

Why deduction is made from the base of 30000? It is because the salary as per contract of employment is Rs 30000 and the average salary per day is Rs 1000 and if you do not work on a day, you will lose Rs 1000 for that day.

In order to treat House Rent Allowance, Conveyances Allowances, Special Allowance, Telephone allowance etc as allowances not forming part of salary or basic salary, we should deduct the day’s salary in respect of the leave taken on without pay basis from the Basic Pay alone, and give the other allowances in full without subjecting them for deduction. But what is the practice? We deduct it from the total.

Gratuity qualifying Salary

Now coming to the calculation of Gratuity we have to take average salary. What the Act says?  The Payment of Gratuity Act, 1972, by its section 4(2) says that “……..the employer shall pay gratuity to an employee at the rate of fifteen days wages based on the rate of wages last drawn by the employee….”

We have seen the definition of wages under section 2(s) of the Act as total emoluments which are earned by the employee. As such it is the gross salary that should be taken as the base for the calculation of gratuity. But the practice is to take the Basic Pay alone. In companies that pay dearness allowance, naturally, they consider DA also as part of Gratuity Qualifying salary. This is also a custom followed at par with the treatment of Wages for Provident Fund contribution.

The payment of Gratuity Act has further said how to arrive at the average rate of wages. The average rate of wages is the monthly wages divided by 26 and not 30.

In respect of piece rated workers, it is the average of the total wages received by him for a period of

three months immediately preceding the termination of his employment. In respect of an employee who has been disabled but has been reemployed on reduced wages is to be calculated prorate for the period preceding his disablement and for the period subsequent to his disablement on average wages of the respective periods.

In the above cases, including wages of seasonal employees and daily rated workers, you cannot bifurcate the piece rated wages into basic, HRA, Special Allowance etc but whatever is paid is the wages. Only those amounts which can be excluded from it are any overtime wages, commission or incentive though it is also paid along with the wages.  It is only in respect of employees who receive monthly salary,  the bifurcation of gross salary normally happens. As such when two employees with the same length of service leave the establishment, one with a higher salary but on monthly basis may get lesser gratuity when compared to another employee with daily rated salary. Since the Provident Fund is also contributed on the daily wages without any bifurcation as to HRA, Conveyance allowance etc, the latter may get more PF and may also be eligible to more Pension!

The issue of Basic Wages regarding Provident Fund has been clarified by the Apex Court. Now everybody is looking to find a solution for payment of Gratuity, and he base for calculating amount of Gratuity. As the definition of wages given under both the Acts are the same, I am of the impression that Gratuity is to be calculated on the gross salary and not alone on Basic salary and Dearness Allowance. Simply, gross salary is:

·         The salary as per contract of employment

·         The salary paid to the employee on duty or on (authorised) leave

·         The salary which is deducted for any leave without pay

Therefore, the gross salary should qualify for calculating the amount payable as Gratuity.