Gratuity Explained for Employers: Eligibility, Formula and Limits

Gratuity is a statutory reward for long service, historically governed by the Payment of Gratuity Act, 1972 and now brought within the Code on Social Security, which came into force from 21 November 2025. It is paid by the employer; the employee does not contribute to it.

It matters because it is a real liability that grows every year an employee stays. A small manufacturing unit or a school with long-serving staff can find itself owing several lakh rupees when a group of senior employees retires in the same year. Knowing the numbers early turns a shock into a planned expense.

Gratuity law applies to establishments that meet the coverage conditions laid down in the statute, and once covered, an establishment generally continues to be covered even if headcount later drops. Many smaller businesses voluntarily pay gratuity as part of good practice, and some employment contracts promise it regardless of statutory coverage.

On the employee side, the classic condition is five years of continuous service. Gratuity is payable on superannuation, retirement, resignation, or termination after that period, and on death or disablement the five-year condition traditionally does not apply. The Labour Codes have introduced changes for certain categories such as fixed-term employees, so check the current position for each type of worker you employ.

• Retirement or superannuation after five years of continuous service
• Resignation after five years of continuous service
• Termination (other than in specified misconduct situations) after five years
• Death or disablement — paid to the employee or nominee, without the five-year condition

The commonly used formula for covered establishments is: Gratuity = Last drawn monthly wages × 15 × Completed years of service ÷ 26. Here, wages traditionally mean basic pay plus dearness allowance. The figure 26 represents working days in a month, and 15 represents the days' wages earned for each year.

How a part year is treated also matters. In practice, many employers round up a final part year of more than six months to a full year, following the long-standing interpretation. Confirm this treatment with your adviser, because the definition of wages and service under the new Codes may affect your calculation.

1. 1Find the employee's last drawn basic + DA per month.
2. 2Work out completed years of continuous service, and note the remaining months.
3. 3Apply the rounding treatment your adviser confirms for part years.
4. 4Multiply wages by 15, then by years of service.
5. 5Divide the result by 26 to get the gratuity amount.
6. 6Compare with the tax-exempt limit and any contractual promise that is more generous.

Example 1: A store keeper in Nagpur leaves after 7 years and 8 months. Last drawn basic + DA is ₹20,000 a month. Treating the final 8 months as a full year gives 8 years. Gratuity = 20,000 × 15 × 8 ÷ 26, which is about ₹92,308.

Example 2: A senior accountant in Chennai retires after 22 years and 3 months with basic + DA of ₹60,000. Counting 22 years, gratuity = 60,000 × 15 × 22 ÷ 26, which is about ₹7,61,538.

Example 3: A supervisor resigns after 4 years and 2 months. Under the classic five-year rule, statutory gratuity would generally not be payable on resignation. These examples are illustrations only; actual eligibility and amounts should be confirmed against the current law.

For income tax purposes, gratuity received by an employee is generally exempt up to ₹20 lakh over their working life, subject to the conditions in the Income Tax Act. Any amount paid above this limit is usually taxable in the employee's hands as salary.

Employers are free to pay more than the statutory amount, for example as a long-service reward. If you do, explain the tax treatment to the employee in writing, and make sure the extra amount is shown correctly in the payslip and Form 16. A qualified tax professional can help you structure this properly.

The law allows gratuity to be wholly or partly forfeited only in specific situations, such as termination for certain kinds of serious misconduct or for causing damage to the employer's property, and usually only to the extent of the loss caused. Do not withhold gratuity casually; record the reasons and follow due process, ideally with legal advice.

Collect a nomination from each employee early in their service and update it when family circumstances change. When an employee becomes eligible, pay within the time limit prescribed by law; delays can attract interest. Build gratuity into your full and final settlement checklist so it is never forgotten.

A simple first step is to list every employee with their joining date and current basic + DA, then calculate what you would owe if each left today. Update the sheet every year after appraisals. Even a basic Excel tracker gives a much clearer picture than guessing.

Many organisations fund gratuity through a group gratuity scheme offered by insurers, paying an annual premium so the payout does not hit cash flow all at once. Larger companies typically need an actuarial valuation for their financial statements. Your chartered accountant can tell you which approach fits your size.

• Maintain joining dates and service breaks accurately from day one
• Recalculate the liability annually after salary revisions
• Consider a group gratuity policy if you have many long-serving staff
• Mention gratuity in offer letters and the employee handbook

Gratuity is part of total cost to company, and many experienced candidates ask whether it is included in the CTC figure. Be clear in offers: say whether gratuity is shown inside the CTC and that it is payable as per law on eligibility. Clarity here avoids disputes years later.

For roles where you want long tenure, such as supervisors or accountants, gratuity is a genuine retention benefit worth mentioning. When you post a job on BetterJobs, add a short benefits line — “PF, gratuity as per law, annual increments” — so serious, stable candidates see it upfront.

Most gratuity disputes come from poor records rather than bad intent. A missing joining date, an undocumented break in service or a salary history kept only in an old accountant's laptop can make it hard to prove what is actually owed.

Another frequent issue is calculating on the wrong wage base. Using gross salary instead of basic + DA inflates the amount, while ignoring components that the new wage definition may count back into wages can understate it. Ask your payroll adviser to confirm the base before you pay.

• Forgetting gratuity entirely in the full and final settlement
• Treating transfers between group entities as a fresh start without checking continuity of service
• Missing nominations, which delays payment to families
• Paying late without accounting for interest that may apply