Gratuity calculation in India: the formula and the new rules

Gratuity sits quietly inside most private sector CTCs, at roughly 4.8 percent of annual basic pay, and most people forget it exists until they resign. It is not a favour from the employer. It is a legal entitlement, now governed by the Code on Social Security, 2020, which replaced the Payment of Gratuity Act, 1972 when the four labour codes came into force.

Who is eligible for gratuity

The rules apply to establishments with ten or more employees, which covers most offices, shops, factories and startups past the earliest stage.

• Permanent employees qualify after five years of continuous service.
• Fixed-term employees qualify after one year of continuous service. This is the biggest change the labour codes made to gratuity.
• In case of death or disablement there is no minimum service, and gratuity is paid to the employee or their nominee.

The gratuity formula

Gratuity = last drawn wages × 15 × completed years of service ÷ 26.

The 15 stands for 15 days of wages for each year. The 26 is the number of working days assumed in a month. Wages means basic pay plus dearness allowance, and under the labour codes, if those make up less than half your total pay, the excess allowances are added back until they do. That raises gratuity for anyone whose basic was kept artificially low.

Service is counted in completed years, and a part-year of more than six months rounds up. So 7 years and 7 months counts as 8 years, while 7 years and 5 months counts as 7.

The ₹20 lakh cap, and tax on gratuity

The maximum statutory gratuity is ₹20 lakh. For private sector employees, gratuity is tax-free up to ₹20 lakh, and that limit applies across your whole career rather than per employer. Anything paid above it is taxed as salary. For government employees, gratuity is fully exempt.

When gratuity has to be paid

Your employer should pay gratuity within 30 days of it becoming payable, usually from your last working day, and interest applies if it is late. If an employer refuses or delays without reason, you can take it to the labour department in your state, which appoints an authority to decide gratuity disputes.

When gratuity can be withheld

Only in narrow cases. If you are terminated for conduct that caused the employer damage or loss, gratuity can be forfeited to the extent of that loss. For riotous or violent behaviour, or an offence involving moral turpitude, it can be forfeited wholly or in part. Resigning, being laid off or retiring does not forfeit it.