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Gratuity - Definition and Calculation

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Last editedOct 20212 min read

Anyone who has ever dined at a restaurant should be familiar with the concept of tipping your server. But while it might be common practice in the developed world to offer a little something extra for a job well done, few people truly understand the history and the etymology of gratuity, let alone the true meaning or what it means for salaried employees in certain countries. 

What is a gratuity?

The dictionary definition of a gratuity is “something given voluntarily or beyond obligation, usually for some service”. In most environments, gratuity means the same thing as a “tip”, it’s just a more formal term. However, in recent years, many establishments have decided to add a service charge onto all bills, which on the surface appears to go against the ideals of gratuity.

A salaried gratuity, meanwhile, refers to a sum gifted by an employer to an employee, often at the time of retirement. In some countries, such as India, it is legally mandatory for employers to pay gratuity to departing employees, as long as certain criteria have been met. The key condition is that the worker must have been an employee within the organisation for at least five years.

Where does gratuity come from?

While the concept of gratuity has been around for much longer, it wasn’t given an official name until the 18th century. Prior to this, it had become common in Tudor England for overnight guests to provide a sum of money to their hosts and the concept quickly spread to London’s cafes and commercial establishments. The word “tip” can be traced even further back to the early 1600s, with the word originating as a slang term for “giving a small present of money”.

Why do we offer gratuity?

There remain certain countries (such as Japan and Australia) where tipping is not customary, but in the countries where it is there are several reasons why we might choose to tip a server.

  • A service charge has been added to the bill that has been assessed and will be paid directly by the business. Note that this sum will not always make it directly into the hands of the server, but could be used to cover admin fees and other costs.

  • To supplement the income of a server whom you feel has gone above and beyond the call of duty and deserves compensation.

  • Because you plan on returning to the establishment at a later date and hope your tip will ensure continued quality service next time.

  • A sense of duty, showing off to friends or the server themselves, or simply because you don’t want to disappoint a server who expects a tip.

Gratuity calculation

A gratuity calculation will always depend on local customs, the individual paying the gratuity and the quality of the service. In many western countries it is customary to add on 10% to 20% of the bill as a bare minimum, whereas in others the figure is far lower or non-existent.

In countries where it is mandatory for businesses to pay gratuity under a payment of gratuity act, the employee will either be paid directly by their employer or from a general gratuity insurance plan. There is no fixed percentage but a typical calculation might look something like this:

Gratuity = Years of service x last drawn salary x 15 ÷ by 26

It’s also worth noting that gratuities received by government employees are usually fully tax-exempt and that employers reserve the right to forfeit the gratuity if the employee in question was fired due to negligence or misconduct.

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If you’re interested in finding out more about gratuity, or any other aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.

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