What is gratuity?
Gratuity is a lump-sum payment made by an employer to an employee as a token of appreciation for long and meritorious service. In India, it is a statutory right for eligible employees governed by the Payment of Gratuity Act, 1972.
The Act applies to every factory, mine, oilfield, plantation, port, railway company, and any establishment employing 10 or more workers. Once an organisation qualifies, it continues to be covered even if the headcount later falls below 10.
Eligibility — the 5-year rule
To be eligible for gratuity, an employee must have completed at least 5 years of continuous service with the same employer. This rule has important nuances:
- The 5-year threshold is strictly continuous — gaps due to resignation and rejoining reset the clock
- However, if an employee dies or becomes disabled, gratuity is payable even without completing 5 years
- For employees who are on fixed-term contracts, gratuity becomes payable even if the contract ends before 5 years (courts have ruled in favour of FTC employees on this)
Rounding up tenure: If an employee has completed more than 6 months in the final year of service, it is rounded up to the next complete year. 10 years and 7 months = 11 years. 10 years and 4 months = 10 years.
The formula — covered organisations
For employers covered under the Payment of Gratuity Act:
Gratuity = (15 × Last Drawn Salary × Completed Years of Service) / 26
The "26" represents the number of working days in a month (excluding Sundays). "15" represents 15 working days' salary per year of service. The formula effectively gives you half a month's salary for every year worked.
Example: Basic + DA = ₹50,000/month, 10 years of service:
- Gratuity = (15 × 50,000 × 10) / 26 = ₹2,88,461
Maximum gratuity: ₹20,00,000 (₹20 lakh). This cap was revised from ₹10L in 2018. Gratuity exceeding ₹20L is not mandated by the Act, though employers may pay more voluntarily.
The formula — non-covered organisations
For employers not covered by the Act (establishments with < 10 employees, or certain exempted categories):
Gratuity = (15 × Last Drawn Salary × Completed Years of Service) / 30
The divisor changes from 26 to 30, resulting in slightly lower gratuity. There is also no statutory cap — though voluntary payments above any amount are at the employer's discretion.
What counts as "last drawn salary"
Only Basic Salary + Dearness Allowance (DA) is used in the formula. The following are excluded:
- House Rent Allowance (HRA)
- Travel Allowance
- Medical Allowance
- Special Allowance
- Bonus and incentives
- Overtime payments
In most modern private companies, the salary structure doesn't include DA — so only the basic salary component is used. Check your appointment letter or salary slip for clarity.
Tax treatment of gratuity
Gratuity received by government employees is fully exempt from income tax — no limit.
For private sector employees covered under the Gratuity Act, tax exemption is the minimum of:
- Actual gratuity received
- ₹20 lakh
- 15 days' salary × years of service (same as the formula)
In practice, items 1 and 3 are typically equal, and the exemption is limited to ₹20 lakh. Gratuity above ₹20 lakh (voluntarily paid) is taxable at the slab rate.
Special cases:
- Gratuity received on death or disability: fully exempt, no limit
- Gratuity received on voluntary retirement under a VRS scheme: taxed under a special provision with some exemptions
Forfeiture of gratuity
An employer can forfeit gratuity (partially or fully) if the employee is terminated for:
- Any act of wilful omission or negligence causing loss or destruction of property
- Any act of violence or riotous behaviour
- Committing an offence involving moral turpitude
The forfeiture must be demonstrated and documented — it cannot be arbitrary. Pure performance-based terminations don't qualify for forfeiture.
When to claim gratuity
Gratuity becomes payable within 30 days of the date it falls due. If the employer fails to pay within this period, they are liable to pay simple interest at the rate prescribed by the government. File a written application with your employer using Form I under the Gratuity Rules. If denied, escalate to the Controlling Authority (usually the Labour Commissioner or Assistant Labour Commissioner of the state).