Gratuity is a lump-sum amount your employer owes you for staying with the company long enough. Under the Payment of Gratuity Act, 1972, any employee who puts in five continuous years or more gets this payout at the time of resignation, retirement, or termination. The calculation? Last drawn salary, multiplied by 15, multiplied by years served, divided by 26.
If your business has 10 or more people on the rolls, this law applies to you. Doesn’t matter if you’re running a garment unit in Surat or a diagnostic centre in Pune. Miss a gratuity payment, and you’re looking at interest penalties, labour court notices, and a damaged reputation among staff.
Key Takeaways
- Gratuity kicks in after 5 years of continuous service (1 year for fixed-term contracts since November 2025)
- The formula: (Last Drawn Salary x 15 x Years of Service) / 26
- Tax-free limit: up to Rs 20 lakh for private-sector employees (ClearTax, 2026)
- Employers must pay within 30 days or face 10% annual interest on the delayed amount
Who qualifies for gratuity?
Five continuous years with one employer. That’s the baseline. A machine operator at a plastics factory in Pimpri, an accountant at a logistics firm in Gurgaon, a chef at a hotel in Jaipur, all of them qualify once they cross that five-year mark.
Two exceptions exist. First, the five-year rule doesn’t apply if the employee dies or becomes permanently disabled from an accident or disease during service.
Second (and this one’s new), fixed-term contract workers now qualify after just one year if they’ve clocked 240 working days in that period. Section 53 of the Code on Social Security, 2020 introduced this change, effective 21 November 2025. It caught a lot of warehouse operators and construction companies off-guard because their contract staff had never been in the gratuity conversation before.
One thing many business owners don’t realise: the Act sticks once it applies. Your headcount hit 12 in January, so the Act kicked in. Even if three people quit in March and you drop to 9, you’re still covered. The obligation doesn’t go away.
How does the gratuity formula work?
Pick up any gratuity calculator online and you’ll find the same formula:
Gratuity = (Last Drawn Salary x 15 x Years of Service) / 26
“Last drawn salary” here means basic pay plus dearness allowance. Nothing else. Not HRA, not conveyance, not special allowance. The 15 represents half a month’s wages per year of service, and 26 is the working-day count in a month after you exclude Sundays.
Employees who aren’t covered under the Act (typically in organisations with fewer than 10 people, or those receiving gratuity voluntarily) use a slightly different divisor: 30 instead of 26.
There’s a rounding rule that trips people up. If someone has worked 7 years and 8 months, the 8 months round up because they exceed 6 months, so the calculation uses 8 years. But 7 years and 4 months? That stays at 7. The six-month cutoff is strict.
A quick example
Meena managed a retail electronics store in Ahmedabad for 12 years. Her last drawn salary (basic + DA) was Rs 28,000 per month.
Gratuity = (28,000 x 15 x 12) / 26 = Rs 1,93,846
Her employer had exactly 30 days from her last working day to release this amount. After that, a 10% annual interest starts piling on.
Three rule changes from November 2025 that affect your gratuity liability
The new Labour Codes rewrote parts of how gratuity works. Most SME owners we talk to are still running their books on the old rules.
The first change hits contract-heavy businesses the hardest. Fixed-term employees now qualify for pro-rata gratuity after just one year (with 240 working days). A warehouse in Bhiwandi rotating 50 contract workers a year suddenly has a gratuity line item it never budgeted for. Same goes for construction companies in Hosur that cycle project-based hires every 14-18 months.
Then there’s the wage-base expansion. The Code on Wages, 2019 says basic pay must be at least 50% of total CTC. Many Indian businesses, especially in retail and hospitality, had structured salaries where basic was 30-35% of CTC and the rest was loaded into allowances. Under the new rules, any allowance amount exceeding 50% of CTC gets reclassified as “wages” for gratuity calculation. Across 30,000+ Payroll clients, we’ve noticed this single rule bumping gratuity liabilities up by 25-40% for businesses that haven’t restructured yet.
The tax-exempt cap for private-sector employees stays at Rs 20 lakh. Central government employees got theirs raised to Rs 25 lakh starting from the 2024-25 financial year (Bajaj Finserv, 2026). If you’re in the private sector, that Rs 20 lakh number hasn’t moved in years, and there’s no indication it will anytime soon.
How much of the gratuity amount is tax-free?
Up to Rs 20 lakh. But that number is a lifetime ceiling, not a per-employer figure. Say you got Rs 8 lakh from your first company after 7 years, and then Rs 14 lakh from your second company after 9 years. The first Rs 8 lakh was fully exempt. From the second, only Rs 12 lakh qualifies for exemption (because 8 + 12 = 20). The remaining Rs 2 lakh gets taxed as salary income.
The exemption under Section 10(10) of the Income Tax Act is the least of these three:
| Component | What it covers |
|---|---|
| Actual gratuity received | Whatever your employer actually pays you |
| Rs 20 lakh | The statutory ceiling (Rs 25 lakh for Central Govt.) |
| Formula amount | (15 x last drawn salary x years of service) / 26 |
Government employees are different. They get full exemption with no upper limit, though Central Government staff have an operational ceiling of Rs 25 lakh.
One relief that most people don’t know about: Section 157 of the Income-tax Act, 2025 lets employees spread the tax hit over previous years. If you served 5-15 years, the gratuity income splits across 2 preceding years for tax purposes. Served over 15 years? It spreads across 3 years (India Briefing, 2026). This can drop you into a lower slab and save a fair bit.
Can your employer refuse to pay gratuity?
Only in two narrow situations, and even then, there’s a process they must follow.
The first is termination for misconduct involving moral turpitude. Violence on the premises, theft, fraud, that sort of thing. The Supreme Court clarified in Western Coal Fields Ltd. v. Manohar Govinda Fulzele that a criminal conviction isn’t required. An internal disciplinary inquiry is enough. But the employer must give a show-cause notice, hear the employee’s side, and document everything. Skipping any of these steps makes the forfeiture legally shaky.
The second is damage to employer property. And even here, the forfeiture is capped at the value of the damage. An employee who broke machinery worth Rs 40,000 can lose Rs 40,000 from their Rs 1,80,000 gratuity, but not a rupee more.
What we’ve seen at Petpooja across thousands of exit processes: business owners who try to withhold gratuity without proper documentation almost always lose at the labour court. A café owner in Vadodara held back Rs 62,000 in gratuity after a dispute with a departing manager in August 2025. No show-cause notice, no inquiry. The labour commissioner ordered full payment plus interest within 45 days. The legal fees cost more than the gratuity itself.
Staying compliant without the last-minute panic
Most gratuity problems aren’t legal problems. They’re cash-flow problems. A business owner finds out they owe Rs 3-4 lakh the same week an employee resigns, and the money isn’t there because nobody was tracking the liability.
Set aside a monthly provision per employee. It doesn’t have to be exact, just directional. A diagnostic lab chain in Pune with 32 staff learned this the hard way when three people resigned in March 2026. Combined gratuity: Rs 4.7 lakh. They had 30 days to arrange it, and the quarter had already been tight.
After the wage code changes, audit your salary structures. If basic pay is below 50% of CTC (which it is for most Indian businesses that haven’t restructured since 2024), you’re calculating gratuity on the wrong base. A textile manufacturer in Tirupur with 45 employees told us their annual gratuity liability climbed by Rs 3.2 lakh once they corrected the basic-to-CTC ratio.
Manual tracking in Excel works when you have 8-10 employees. Beyond that, the formulas get messy, someone forgets the rounding rule, and exit payouts go wrong. Petpooja Payroll runs gratuity as part of the full-and-final settlement: it picks up the right salary base, applies the 15/26 formula using the current wage code definitions, and generates the amount the moment you process an exit. No spreadsheet needed.
And pay on time. 30 days. A Rs 2 lakh gratuity delayed by six months costs you an additional Rs 10,000 in statutory interest, plus whatever goodwill you lose with remaining staff who hear about it.
Conclusion
Gratuity is straightforward on paper but messy in practice because most businesses don’t track it until someone resigns. The formula is simple, the eligibility rules are clear, and the tax limits are well-documented. Where things go wrong is execution: wrong salary base, no monthly provisioning, delayed payments.
- Set aside a gratuity provision every month for each employee
- Fix your salary structures so basic pay meets the 50% CTC threshold
- Don’t withhold gratuity without proper documentation and due process
- Automate the calculation through your payroll system instead of relying on spreadsheets
The rules got tighter in November 2025, especially for businesses using fixed-term contracts. If you haven’t adjusted yet, start with a salary structure audit and work outward from there.
Frequently Asked Questions
Yes. Since November 2025, fixed-term and contract employees who complete one year of continuous service with at least 240 working days qualify for pro-rata gratuity. The five-year rule still applies to permanent staff. Industries like construction, warehousing, and event management are most affected by this change.
Yes. Each employer calculates and pays gratuity independently based on your tenure and last drawn salary with them. The Rs 20 lakh tax exemption under Section 10(10) is cumulative across your entire career, not per job. So track how much exemption you’ve already claimed.
File a complaint with the Controlling Authority (usually the Labour Commissioner of your district) under the Payment of Gratuity Act. They investigate the claim and order the employer to pay if valid. Delayed gratuity attracts 10% annual interest from the date it became due. Most cases get resolved within 3-4 months.
PF is a monthly contribution deducted from your salary and matched by the employer, accumulating over your working years. Gratuity is a one-time lump-sum paid entirely by the employer at exit. PF has no five-year lock-in for withdrawal, while gratuity strictly requires five continuous years unless death or disability is involved.
The Payment of Gratuity Act covers establishments with 10 or more employees. Below that, you’re not legally required to pay. Some smaller businesses in professional services and healthcare pay voluntarily for retention. Once your headcount crosses 10 even briefly, the Act applies permanently and doesn’t switch off when numbers drop.
