The Cabinet on Tuesday approved an Amendment Bill seeking to double tax-free gratuity for formal sector employees to Rs 20 lakh from the current limit of Rs 10 lakh.

With this amendment, the maximum limit of gratuity for employees in the private sector will fall at par with that of government employees.

As per the Amendment Act, the proposed raise in allowance will increase remunerations by 23.55 percent.

But, what is gratuity?

Gratuity is a sum of money that the employer pays to the employee for services rendered in the company. But, the sum is given once the employee completes 5 or more years in the same company.

The gratuity amount is completely paid by the employer unlike provident fund where the employee too contributes.

In India, there exists a Payment of Gratuity Act, 1972 for regulation of gratuity payments by the employer. The Act covers companies that have more than 10 employees employed at factories, mines, oilfields, plantations, ports, railway companies, shops or other related establishments.

It is applicable to all states in the country, except Jammu and Kashmir.

Eligibility criteria - According to section 4 of the Act, it covers any person who has completed 5 years or more with the company or an employee who is eligible for superannuation. A retired employee or an employee who has passed away or one suffering from any illness or disability are also eligible for gratuity.

Gratuity is calculated as 15 days last drawn wages for every year completed with the organisation. The 15 days wages is calculated by dividing the last drawn salary by 26 and multiplying the result with 15.

The maximum gratuity that can be paid is Rs 20,00,000, according to the section 4(3) of the Act.

As per the Act, gratuity is exempt from tax for government employee and employees covered under the Gratuity Act.

As per the assessment year 2016-17, Gratuity Received by government employees is fully exempt from tax. Statutory corporations are not included under this.

For gratuity received via death or retirement, the least of following amount is exempt from tax - Rs 10 lakh, gratuity actually received or (*15/26) X Last drawn salary** X completed year of service or part thereof in excess of 6 months as mentioned in the Article 10(10)ii.

For those who are not covered under the Act, half month's average salary multiplied by completed year of service or Rs 10 lakh or actual gratuity received is considered.

No company can now pay gratuity of more that Rs 20 lakh irrespective of the number of years of service completed. This limit is also applicable for gratuity received from different employers.

In case someone dies while in service and before the 5-year period, his/her gratuity is paid to the legal heir. To nominate a heir, a form F needs to be filled while joining the company.