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What Is Gratuity and Who Qualifies?
Gratuity is a statutory monetary benefit paid by an employer to an employee as a token of appreciation for long-term service. It is governed by the Payment of Gratuity Act 1972 and applies to all establishments — factories, mines, oil fields, plantations, ports, railways, shops, and other establishments — that employ 10 or more persons.
Once an establishment crosses the threshold of 10 employees, it continues to be covered under the Act even if the employee count later falls below 10. This prevents employers from reducing workforce to evade gratuity obligations.
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Who Gets Gratuity
Employees completing 5 years of continuous service (1 year for fixed-term under new Labour Code 2026).
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When It's Paid
On retirement, resignation (5yr+), death, disablement, or termination without misconduct.
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Who Must Pay
All employers with 10+ employees — private companies, PSUs, factories, shops, hospitals, schools.
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Payment Deadline
Within 30 days of becoming payable. Late payment attracts 10% interest per annum.
Gratuity Formula Explained with Examples
There are two formulas depending on whether the establishment is covered under the Payment of Gratuity Act:
For employees COVERED under the Act (organisations with 10+ employees)
Gratuity = (Basic + DA) × 15 ÷ 26 × Years of Service
For employees NOT COVERED under the Act
Gratuity = (Basic + DA) × 15 ÷ 30 × Years of Service
The factor 15/26 represents 15 days' wages calculated on the basis of 26 working days per month (4 Sundays excluded from a 30-day month). The factor 15/30 is used when 30 working days per month is the basis (less favourable to the employee).
Worked examples
Example 1: Private sector employee, covered under Act
Basic Salary: ₹60,000/month | DA: ₹0 | Service: 12 years 8 months → rounds up to 13 years
Gratuity = ₹60,000 × 15 ÷ 26 × 13
= ₹60,000 × 0.5769 × 13
= ₹4,50,000 — fully tax-free (below ₹20 lakh limit)
Example 2: Senior employee near the ₹20 lakh cap
Basic Salary: ₹1,50,000/month | DA: ₹0 | Service: 25 years
Calculated Gratuity = ₹1,50,000 × 15 ÷ 26 × 25 = ₹21,63,461
Maximum payable under Act = ₹20,00,000 (cap applies)
= ₹20,00,000 payable — ₹20L tax-free, ₹0 taxable (employer pays capped amount)
💡Service rounding rule: If service includes more than 6 months beyond a complete year, it rounds up to the next year. 12 years 7 months = 13 years. 12 years 5 months = 12 years. This rounding can add ₹20,000–₹60,000 depending on Basic salary.
Gratuity Tax Exemption — 2026 Rules
| Employee Category | Tax-Free Amount | Taxable Portion |
|---|---|---|
| Government employees (central/state) | Entire amount | Nothing |
| Private sector — covered under Act | Minimum of: (i) Actual gratuity, (ii) ₹20 lakh, (iii) 15/26 × Basic × Years | Amount above ₹20 lakh |
| Private sector — not covered under Act | Minimum of: (i) Actual gratuity, (ii) ₹20 lakh, (iii) Half month salary × Years | Amount above ₹20 lakh |
| Death or disablement | Entire amount (no limit) | Nothing |
⚠️The ₹20 lakh tax exemption limit applies to the cumulative gratuity received from all employers over your lifetime — not per employer. If you change jobs and receive gratuity multiple times, the total exemption across all employers is ₹20 lakh.
New Labour Code 2026 — What Changed for Gratuity
The new Labour Codes consolidate 29 central labour laws into 4 codes. The Code on Social Security 2020 (notified for implementation in 2026) brings significant changes to gratuity eligibility:
- Fixed-term contract employees: Now eligible for gratuity after just 1 year of service (vs 5 years for permanent employees). This is a major change for the gig economy and contract workforce.
- Proportionate gratuity: Fixed-term employees receive gratuity proportional to their service duration even if less than 5 years.
- Gig and platform workers: Partially covered — the government is expected to notify specific rules for gig workers (delivery, ride-sharing, freelance platforms) under the code.
- Apprentices and trainees: Still excluded from gratuity entitlement.
- Definition of wages simplified: New uniform definition of "wages" makes Basic salary calculation more standardised across industries.
📌The new Labour Codes are notified but implementation varies by state. Check with your HR department or a labour lawyer for the current applicable rules in your state and industry.
5 Common Gratuity Calculation Mistakes
Mistake 1 — Using CTC or gross salary instead of Basic
✗ "My CTC is ₹12 lakh so my monthly Basic for gratuity is ₹1 lakh"
✓ If Basic is 50% of CTC, monthly Basic = ₹50,000 — use only this for gratuity
Gratuity is calculated on Basic Salary + DA only. Not on CTC, not on gross salary, not on HRA or allowances. Using CTC inflates the gratuity estimate significantly. Check your payslip for the specific Basic Salary line item.
Mistake 2 — Not rounding up service period correctly
✗ "I worked 10 years and 7 months — so gratuity is for 10 years"
✓ 7 months > 6 months → rounds up to 11 years for gratuity calculation
Under the Gratuity Act, if the last year of service exceeds 6 months, it counts as a complete year. 10 years 7 months = 11 years. 10 years 4 months = 10 years. This rounding on a ₹60,000 Basic adds approximately ₹34,615 to your gratuity.
Mistake 3 — Thinking 5 years means exactly 60 months
✗ "I've worked 4 years 8 months — so I get no gratuity"
✓ 4 years 8 months rounds up to 5 years — you ARE eligible for gratuity
The same rounding rule applies at the 5-year eligibility threshold. An employee who has worked 4 years and 7+ months is treated as having completed 5 years and is therefore eligible for gratuity. Many employees miss this critical point and don't claim their entitlement.
Mistake 4 — Assuming death/disability requires 5 years
✗ "Employee died after 3 years — family is not entitled to gratuity"
✓ Death and total disablement waive the 5-year requirement — gratuity is payable from day one
Section 4 of the Gratuity Act explicitly waives the 5-year minimum service requirement in case of death or total disablement. The family nominee receives gratuity calculated for the actual service period, however short. This is a statutory right that cannot be denied by the employer.
Mistake 5 — Confusing the Act's ₹20 lakh cap with actual employer liability
✗ "My gratuity formula gives ₹25 lakh — but employer can pay only ₹20 lakh"
✓ ₹20 lakh is the statutory MINIMUM cap — employer can voluntarily pay more as ex-gratia
The ₹20 lakh ceiling under the Gratuity Act is the maximum the employer is legally obligated to pay under the Act. Many PSUs, MNCs, and large corporations have more generous gratuity policies and pay higher amounts. The ₹20 lakh tax exemption limit is separate — amounts above ₹20 lakh paid voluntarily are taxable as income.
Frequently Asked Questions
Gratuity is a statutory retirement/separation benefit under the Payment of Gratuity Act 1972. It applies to organisations with 10+ employees. Permanent employees are eligible after 5 years of continuous service. Under the new Labour Code 2026, fixed-term contract employees are eligible after 1 year. Death or disablement waives the minimum service requirement.
For employees covered under the Act: Gratuity = (Basic + DA) × 15/26 × Years of service. The 15/26 factor = 15 days wages on 26-working-day month basis. For employees not covered: (Basic + DA) × 15/30 × Years. Service fraction exceeding 6 months rounds up to the next full year.
For private sector employees, the tax-free limit is ₹20 lakh cumulative across all employers in a lifetime. Government employees receive full tax exemption with no upper limit. Death and disablement gratuity is entirely tax-free for all categories. Amounts above ₹20 lakh are added to income and taxed at the applicable slab rate.
For permanent employees, yes — 5 years is required. But if the last year exceeds 6 months, it rounds up (4 years 8 months = 5 years eligible). For death or disablement, the 5-year rule is waived. Under new Labour Code 2026, fixed-term contract employees need only 1 year.
Only Basic Salary + Dearness Allowance (DA). Not CTC, not gross salary, not HRA, bonus, or any other allowances. For most private sector employees, DA is zero, so only Basic salary is used. Government employees typically have a DA component which must be added.
Within 30 days of the gratuity becoming payable (i.e., within 30 days of the employee's last working day). If payment is delayed, the employer must pay interest at 10% per annum from the due date. If the employer fails to pay, the employee can file a claim with the controlling authority (labour commissioner).
Yes, but only in specific circumstances under Section 4(6) of the Gratuity Act — if the employee is dismissed for proven riotous or disorderly conduct, violence, or an act of wilful omission causing damage to the employer's property. Forfeiture must follow due process. The right to forfeit is not absolute — it can be challenged before the controlling authority.
The Code on Social Security 2020 (implemented 2026) extends gratuity eligibility to fixed-term contract employees after 1 year of service (vs 5 years for permanent). This significantly benefits contract workers and those in the gig economy. Apprentices and trainees remain excluded. The basic gratuity formula and Act coverage rules remain unchanged.
💼 Planning Your Retirement?
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📅 June 2026 · Written by the ToolLoom Team · Reviewed for accuracy June 2026
About ToolLoom: We build free tools for Indian students, professionals and creators. Gratuity formula per Payment of Gratuity Act 1972 and new Labour Code notifications. Tax exemption as per Income Tax Act Section 10(10). Found an error? Email contact@toolloom.in
About ToolLoom: We build free tools for Indian students, professionals and creators. Gratuity formula per Payment of Gratuity Act 1972 and new Labour Code notifications. Tax exemption as per Income Tax Act Section 10(10). Found an error? Email contact@toolloom.in