Gratuity - Meaning, Eligibility Criteria & How to Calculate it

For Employers Covered Under the Gratuity Act:

Gratuity = (N*B*15)/26

where,

N = Number of Years Serviced in the Organization

B = Basic Salary including DA

What is 15/26? - 15 defines half-month compensation of 15 days and 26 represents the number of working days in a month (excluding Sundays)

• Example:
  • 15 years of service, last drawn salary = Rs.55,000
  • Gratuity = (15 × 55,000 × 15) / 26 = Rs.4,75,962

Important Notes:

• Gratuity amount is capped at Rs.20 lakh for private sector employees; excess is treated as ex-gratia. While the amount is capped at Rs.25 lakh for central government employees.

• If service in the final year exceeds 6 months, round up to the next full year (e.g., 18 years 7 months = 19 years).

For Employers Not Covered Under the Gratuity Act:

• Formula: Gratuity = (15 × last drawn salary × years of service) / 30
• Example 1:
  • 8 years of service, last drawn salary = Rs.65,000
  • Gratuity = (15 × 65,000 × 8) / 30 = Rs.78 lakh
• Example 2:
  • Amit has worked with a company for 20 years and had Rs.25,000 as his last drawn basic plus DA amount, then,
  • Gratuity Amount for Amit = 20*25,000*15/26 = Rs.2,88,461.54

However, an employer can choose to pay more gratuity to an employee. Also, for the number of months in the last year of employment, anything above six months is rounded off to the next number while anything below six months in the last year of employment is rounded off to the previous lower number.

1. Employers Covered Under the Payment of Gratuity Act, 1972

Who is covered:

• Any establishment with 10 or more employees, including factories, offices, shops, and institutions, is covered.

• Employees are eligible for gratuity after completing five years of continuous service.

• If an employee dies or becomes disabled, gratuity can be paid before completing five years.

How gratuity is calculated:

• The calculation is based on the last drawn salary and the total number of years of continuous service.

• Last drawn salary includes basic pay plus dearness allowance. It does not include bonuses, house rent allowance, commissions, or overtime pay.

• Rounding rules: If the last year of service exceeds six months, it is rounded up to the next full year. For example, if an employee has 12 years and 8 months of service, it will be counted as 13 years.

Example:

• Last drawn salary: Rs.45,000

• Years of service: 12 years and 8 months

• Gratuity payout: Rs.3,32,307 This example shows that even partial years beyond six months are counted as full years when calculating gratuity for covered employers.

Key points:

• Gratuity is not the same as a bonus. It is a reward for long-term loyalty and is a statutory entitlement.

• Employers must pay gratuity within 30 days from the date it becomes payable.

• If payment is delayed, the employer is liable to pay interest according to the rules of the Act.

2. Employers Not Covered Under the Act (Voluntary Gratuity)

Who can receive voluntary gratuity:

• Employers not legally required to pay gratuity may still choose to do so.

• Rules and calculations for voluntary gratuity may differ according to company policy.

How gratuity is calculated for non-covered employers:

• It is generally based on the last drawn salary and completed years of service only.

• Fractions of a year are not counted; only fully completed years are considered.

• Last drawn salary usually includes basic pay and dearness allowance, but employers may choose to include other allowances.

Examples of voluntary gratuity:

• Last drawn salary: Rs.60,000, years of service: 7 - Gratuity payout: Rs.2,10,000

• Last drawn salary: Rs.30,000, years of service: 15 - Gratuity payout: Rs.2,25,000

These examples show that only completed years are considered, and the calculation method may differ from statutory rules.

Key points:

• Non-covered employers cannot use the statutory rules for covered employers unless explicitly stated in company policy.

• Voluntary gratuity is flexible, but tax rules still apply to ensure compliance.

3. Tax Exemption and Maximum Limits

Government employees:

• Entire gratuity received by Central and State Government employees is fully exempt from income tax.

Private sector employees covered by the Act:

• Maximum tax-exempt gratuity is Rs.20 lakh.

• Any gratuity paid above Rs.20 lakh is treated as an ex-gratia payment and is taxable.

Private sector employees not covered by the Act:

• Tax-exempt gratuity is the least of three amounts:

• Rs.20 lakh

• Actual gratuity received

• Half a month’s average salary for each completed year of service

Key points:

• Tax exemption rules may change periodically.

• Payments above statutory or exempt limits are considered ex-gratia and are generally taxable.

4. Additional Clarifications and Points

Early payment:

• Gratuity can be paid before completing five years in cases of death of the employee or permanent disability.

Continuous service:

• Includes periods where the employee may have short breaks of less than six months, depending on employer rules.

Ex-gratia payments:

• Any gratuity paid beyond statutory or voluntary limits is treated as an ex-gratia payment and is generally taxable.

Purpose of gratuity:

• Gratuity is designed to reward loyalty and long-term service.

• It is different from retirement benefits or provident fund, although it is often considered part of retirement planning.

Payment timeline:

• Employers must pay gratuity within 30 days of it becoming due.

• Failure to pay on time can result in interest charges and penalties.

Employer obligation:

• For covered employers, gratuity is mandatory under the law.

• For non-covered employers, payment is voluntary, but once committed, it becomes binding.

Eligibility Criteria for Payment of Gratuity

Following are the few instances when you will be eligible to receive gratuity:

• Must be a permanent or fixed-term employee (not an apprentice).
• Service requirement of, minimum of one year of continuous service with the same employer.

• Gratuity is paid on resignation, retirement, or voluntary exit after five years.

• Applies to companies with 10 or more employees in the past 12 months.

• All such employees (except apprentices) are eligible, even if temporary.

Calculation of Gratuity in Case of Death of an Employee

If an employee dies, the gratuity amount is still payable, subject to certain conditions as outlined in the Payment of Gratuity Act, 1972:

• Minimum Service Requirement: Gratuity is payable if the employee had completed at least one year of continuous service before death.

• Recipient of Gratuity: Paid to the nominated person; if no nominee exists, it goes to the legal heirs.

• Gratuity Calculation:
  • Based on completed years of service up to the date of death.
  • Any service exceeding six months is rounded up to the next full year.

• Formula Used:
  • Gratuity = (Last drawn salary × 15 × completed years of service) / 26

• Tax Implications: Gratuity received by nominee/legal heir is tax-exempt up to a specified government limit; excess may be taxable.

• Payment Timeline: Employers must pay the gratuity within 30 days from the date it becomes due (date of death).

In case of the death of an employee, the gratuity benefits are calculated based on the tenure of service of the employee. The amount is, however, subject to a maximum of Rs.20 lakh for private sector employees. The following table shows the rates at which the gratuity will be payable in case of death of an employee:

Advantages of Gratuity

The benefits of gratuity are outlined below:

• Boosts Employee Confidence: Enhances employee confidence by providing a sense of financial security for the future.

• Employee Loyalty: Demonstrates that employers value their employee's contributions and long-term financial well-being, fostering loyalty and a positive work environment.

• Ensures Fair Compensation: Ensures employees are fairly compensated for their years of service, especially in cases of termination, death, or disability.

• Financial Security: Provides crucial financial support after retirement, helping employees cover expenses like healthcare, travel, and other post-retirement needs.

• Helps in Retirement Planning: Forms an essential part of retirement planning, providing a lump sum payment that supplements pension or personal savings.

• Improves Employer-Employee Relationship: Builds trust and mutual respect, as offering gratuity shows the employer’s commitment to supporting their workforce.

• Legal Protection: The Payment of Gratuity Act, 1972, ensures employees’ right to gratuity, guaranteeing payment and preventing denial or delay by employers.

• Tax Benefits: Gratuity is tax-free up to a certain limit, offering employees tax savings and reducing their overall tax liability.

Gratuity Rules and Taxation in India -2026

Gratuity is a lump-sum payment from an employer to an employee as a reward for long-term service. Taxation depends on the type of employee and whether the employer is covered by the Payment of Gratuity Act, 1972.

1. Government Employees

• Employees of central/state government, local authorities, defence, and civil services.

• Fully exempt from income tax, regardless of the amount.

• Payment applies on retirement, resignation, superannuation, or termination.

Example: An employee retires after 28 years with a last drawn salary of Rs. 90,000. Entire gratuity is tax-exempt.

2. Private Employees Covered by the Gratuity Act

• Applies to establishments with 10 or more employees.

• Eligible after 5 years of continuous service. Fixed-term employees may be eligible after 1 year.

• Gratuity must be paid within 30 days; 10% annual interest if delayed.

Tax exemption:

• Maximum tax-free: Rs. 20 lakh.

• Exempt amount is the least of: Rs. 20 lakh, gratuity actually received, or statutory calculation based on last drawn salary (basic + DA) and completed years of service.

Example: 12 years 8 months of service, last drawn salary Rs. 50,000. Service rounded to 13 years. Gratuity Rs. 4,87,500 – fully tax-exempt.

3. Private Employees Not Covered by the Act

• Employers may voluntarily pay gratuity.

• Only completed years of service count; fractions ignored.

Tax exemption:

• Maximum tax-free: Rs. 20 lakh.

• Exempt amount is the least of: Rs. 20 lakh, gratuity actually received, or average salary of last 10 months (basic + DA) multiplied by completed years of service. 

Example: 15 years of service, average salary Rs. 28,000. Calculated gratuity Rs. 4,20,000, actual received Rs. 4,50,000. Rs. 4,20,000 is tax-free; Rs. 30,000 is taxable. 

4. Key Updates (Nov 2025)

• Fixed-term employees eligible after 1 year instead of 5.

• Expanded wage definition increases gratuity base.

• Employers must pay within 30 days; 10% interest if delayed.

• Reforms encourage direct hiring, reduce contractualisation, and extend social security benefits to fixed-term employees.

Example: Fixed-term employee with 18 months’ service and last drawn salary Rs. 40,000. Gratuity calculated for 1 year of service, paid within 30 days.

5. Quick Takeaways

• Government employees: Fully tax-free.

• Private employees covered: Tax-free up to Rs. 20 lakh; based on last drawn salary and years of service.

• Private employees not covered: Tax-free up to Rs. 20 lakh; based on average last 10 months’ salary and completed years.

• Payment within 30 days to avoid 10% interest.

• Only basic + DA counts; other allowances excluded unless company policy includes them.

Key Highlights of the 2025 CCS Gratuity Amendment Rules

The Central Civil Services (Payment of Gratuity under NPS) Amendment Rules, 2025 update gratuity rules for central government employees, including permanent, fixed-term, and re-employed staff under the CCS framework.

1. Broader Definition of Gratuity

Gratuity now includes:

• Retirement gratuity - paid on normal retirement.

• Death gratuity - paid to the employee’s family in case of death.

• Residuary gratuity - adjustments for prior service or missed payments.  Rule 4A restricts gratuity benefits for employees re-employed post-retirement.

2. Recognition of Service in State/Autonomous Bodies

Past service in State Governments or autonomous bodies counts for gratuity if:

• Transition to central service was approved by the competent authority.

• No gratuity was previously claimed for that service. The Central Government bears the gratuity cost; states do not need to reimburse.

3. Gratuity for Missing Employees

Families of employees missing in service can claim gratuity. Death gratuity may be paid:

• After seven years if the employee remains untraceable.

• Earlier, if death is confirmed. Claims require FIR and police confirmation.

4. Withholding or Recovery of Gratuity

Gratuity may be withheld or recovered if an employee is found guilty of:

• Corruption

• Misconduct

• Negligence causing financial loss. The competent authority may consult UPSC before issuing orders where required.

5. Notional Pay and Promotions

• Retrospective promotions or post-retirement pay revisions are included in gratuity calculations.

• Gratuity is based on actual emoluments, not just last drawn pay.

6. Interest on Late Payments

• Administrative delays in paying gratuity attract interest.

• Officials responsible may be held accountable.

• Standard interest rate is 10 percent per year until payment is made.

7. Extraordinary Leave Treatment

Medical extraordinary leave counts as qualifying service. Guidelines exist for non-medical extraordinary leave, which may be prorated depending on circumstances.

8. Gratuity During Penalty Periods

If an employee dies while serving a penalty period, gratuity is calculated on original pay, ignoring any penalty.

9. Employment Covered

Rules apply to:

• Permanent central government employees

• Fixed-term contract employees under central service

• Re-employed central government staff Rules do not apply to private sector employees, gig workers, seasonal workers, or startup employees. Employees terminated for misconduct are not eligible for gratuity.

10. Payment Timelines

• Gratuity must be paid within 30 days of becoming due.

• Delayed payments incur 10 percent annual interest until settlement.

• Procedural timelines are specified for claims, verification, and payments, including cases of missing or deceased employees.

Employment Types Affected by New Gratuity Rules

The type of employees who will be impacted by the new gratuity rules are:

• Seasonal and temporary workers

• Workers in startups

• Terminated employees due to misconduct

• Fixed-term contract employees with less than one year of service

• Gig economy workers, such as share-ride drivers, freelancers

• Newly hired employees or employees on probation

Nomination Procedure for Gratuity

Once an employee completes one year of service, they are required to submit a nomination within 30 days. This nomination should be in favour of one of their family members. For employees with at least one year of service when these rules begin, the process should normally be completed within 90 days from that date of commencement of the rules.

Any nomination made in favour of a person outside the family will be deemed invalid. If the nominee passes away before the employee, the interest in the nomination reverts back to the employee. In such instances, the employee must create a new nomination for that interest using Form F.

Gratuity Application Form

There are multiple gratuity application form which are mentioned below:

Investment Options for Gratuity Amount

When investing in gratuity funds, it's essential to consider financial goals, risk tolerance, and investment duration. Here are some options:

• Fixed Deposits (FDs): This is a low-risk option giving secure returns with capital preservation.

• Public Provident Fund (PPF): This is a tax-efficient option with long-term savings with a 15-year lock-in.

• Employee Provident Fund (EPF): Secure retirement savings with tax benefits.

• National Pension System (NPS): Mix of equity and debt for long-term growth.

• Mutual Funds (Equity & Debt): Equity for higher returns, debt for stability.

• Sovereign Gold Bonds (SGBs): Paperless gold investment with tax perks.

• Real Estate & REITs: Direct property or market-based real estate exposure.

• Stock Market: Direct investment in high-risk, high-reward opportunities.

• Recurring Deposits (RDs): Systematic, monthly savings with fixed returns.

Key Differences Between Gratuity and Pension

The differences between Gratuity and Pension scheme are mentioned in the table below: