Gratuity is a lump-sum payment an employer makes to an employee as a reward for long service, and for most employees it is one of the more significant amounts they receive when they leave. For employers it is a statutory obligation with a clear formula and clear eligibility rules — but it is also one of the most commonly misunderstood parts of Indian payroll, with frequent confusion about who qualifies, what "salary" means for the calculation, and how the recent Labour Code changes affect it.
This guide lays out the rules, the 15/26 formula, worked examples in tables, the ₹20 lakh cap and its tax treatment, and the changes brought by the Code on Social Security, 2020.
| Who is covered | Establishments with 10+ employees |
| Eligibility | 5 years' continuous service |
| Formula | (Basic + DA) × 15 × years ÷ 26 |
| Statutory maximum | ₹20,00,000 |
| Tax-free ceiling (private sector) | ₹20,00,000 (lifetime) |
| Payment deadline | Within 30 days of becoming due |
What gratuity is and who pays it
Gratuity was governed by the Payment of Gratuity Act, 1972, and is now carried into the Code on Social Security, 2020 (with rules notified effective 21 November 2025). It applies to every factory, mine, shop, or establishment employing 10 or more persons on any day in the preceding twelve months. An important detail that surprises many small employers: once an establishment crosses the ten-employee threshold, it stays covered even if the headcount later drops below ten.
The payment is a legal entitlement the moment the eligibility conditions are met — not a discretionary bonus. Getting the calculation wrong can attract penalties, interest, and in serious cases criminal liability, so it is worth getting right.
Eligibility — the five-year rule and its exceptions
The general rule is that an employee must complete five years of continuous service with the same employer to be entitled to gratuity. There are three things to know around this:
| Situation | Eligibility |
|---|---|
| Resignation / retirement (standard) | 5 years' continuous service required |
| The "240-day" rule (Section 2A) | 4 years + 240 working days in the 5th year is treated as 5 years |
| Death or permanent disablement | Five-year requirement waived entirely — payable regardless of tenure |
| Fixed-term employees (Code on Social Security) | Pro-rata gratuity after just 1 year (effective 21 Nov 2025) |
That last row is the most significant recent change. Under the Code on Social Security, 2020, fixed-term contract employees now earn pro-rata gratuity after completing just one year of service, instead of waiting five years — a meaningful shift for employers who use fixed-term contracts.
The gratuity formula
For employers covered by the Act, gratuity is calculated as:
Two numbers in that formula need explaining:
- The 15 represents 15 days of wages for each completed year of service.
- The 26 represents the standard number of working days in a month (a month less its Sundays). Dividing by 26 rather than 30 gives a slightly higher daily wage — so using 30 by mistake understates the payout.
Employers not covered by the Act (fewer than ten employees) use a divisor of 30 instead of 26, which yields a slightly lower figure.
Worked example: a 10-year employee
Take an employee with Basic + DA of ₹60,000/month, leaving after 10 completed years.
| Step | Working | Amount |
|---|---|---|
| Daily wage | ₹60,000 ÷ 26 | ₹2,307.69 |
| Days of gratuity | 15 × 10 years | 150 days |
| Gratuity | ₹2,307.69 × 150 | ₹3,46,154 |
The same service computed with a divisor of 30 (for non-covered employers) would give ₹3,00,000 — over 13% less. The divisor matters.
The ₹20 lakh cap and tax treatment
However large the formula figure, two ceilings apply:
| Ceiling | What it limits | Amount |
|---|---|---|
| Statutory maximum | The most an employer is legally required to pay | ₹20,00,000 |
| Tax exemption — Section 10(10)(ii) | The most that is tax-free for a private-sector employee | ₹20,00,000 (lifetime) |
Two subtleties employers get wrong:
- The ₹20 lakh exemption is a lifetime limit across all employers. If an employee already used ₹15 lakh of the exemption at a previous job, only ₹5 lakh is tax-free with you.
- The cap limits the tax exemption, not the payment. An employer may pay more than ₹20 lakh (as ex-gratia), but the excess is taxable as salary income in the year of receipt.
Government employees have no ceiling and their gratuity is fully exempt under Section 10(10)(i). Central government employees have a higher ₹25 lakh reference in some contexts, but for private-sector payroll the operative number is ₹20 lakh. (Note the Income-tax Act, 2025 renumbered the exemption provision, but the ₹20 lakh amount is unchanged.)
When gratuity is paid
Gratuity becomes payable when employment ends by resignation, retirement, death, or disablement — typically crystallising on the last working day. The employer must pay it within 30 days of it becoming due. Delay beyond 30 days attracts simple interest at the rate notified by the government, from the due date until actual payment. Gratuity forms part of the employee's full and final settlement, alongside unpaid salary, leave encashment, and notice-period dues.
Common mistakes with gratuity
- Using gross salary or full CTC instead of Basic + DA — inflates the figure.
- Dividing by 30 instead of 26 for covered employers — understates it by ~13%.
- Ignoring the 240-day rule — denying gratuity to someone with 4 years and 240+ days who legally qualifies.
- Forgetting the fixed-term change — fixed-term staff now qualify after 1 year, not 5.
- Treating the ₹20 lakh cap as per-employer — it is a lifetime limit across all jobs.
- Missing the 30-day deadline — interest accrues automatically.
Why accurate gratuity depends on connected records
Gratuity is a liability that accrues quietly against each employee's Basic + DA, crystallises on exit, is capped at ₹20 lakh, and now — under the Labour Codes — turns on the 50% wage rule and a different eligibility clock for fixed-term staff. When join dates, Basic + DA history, contract type, and the wage-structure split sit across different spreadsheets and systems, computing the right figure at exit and provisioning the liability correctly in the meantime is manual and error-prone — which is exactly where final-settlement disputes come from.
When Indian payroll sits on a single database, gratuity accrues automatically from live Basic + DA and service data, the 240-day rule and the fixed-term eligibility clock apply themselves, the 50% wage rule is enforced at structure level, and the ₹20 lakh cap and tax treatment follow from the same record. This is how Helion handles gratuity inside a multi-country platform — computed from one source of truth rather than reconciled across tools. For a company running India alongside the UAE and Singapore, one system applying each country's distinct end-of-service rules keeps the numbers consistent and the liability visible.
This guide reflects the 2026 position under the Payment of Gratuity Act, 1972 as carried into the Code on Social Security, 2020 (rules notified 21 November 2025), including the 1-year fixed-term eligibility and the 50% wage rule. The ₹20 lakh statutory and tax-exemption ceilings are current as of 2026. Figures are illustrative. This is general information for employers, not legal or tax advice.