Gratuity is a benefit most employees know about, but few think about until they leave a job. It’s also an area where employers often make mistakes paying late, using the wrong salary for the calculation, or assuming fixed-term employees aren’t eligible. Not knowing the rules can cost both employees and employers.
This guide explains who is eligible for gratuity, the 2025 rule change that expanded eligibility, how gratuity is calculated, when it must be paid, and what happens if an employer delays the payment.
The Basic Rule Who Qualifies
Gratuity applies to every establishment with 10 or more employees. Once a company crosses 10 employees on any day, the Payment of Gratuity Act kicks in permanently even if headcount later drops below 10.
For a permanent employee, the threshold is 5 years of continuous service. That means 5 full years at the same organisation resignation, retirement, death, and disablement all trigger the payment. A person who resigns after 4 years and 11 months gets nothing. A person who completes exactly 5 years gets the full amount.
The 6-month rounding rule: if someone has served 7 years and 7 months, it rounds up to 8 years for gratuity calculation. If they’ve served 7 years and 4 months, it stays at 7 years. The cutoff is 6 months.
| Employee Type | Eligible? | Condition |
|---|---|---|
| Permanent employee | Yes | 5 years continuous service. Applies on resignation, retirement, death, or disablement. |
| Fixed-term contract employee | Yes 1 year | New from Code on Social Security 2020 (effective Nov 2025). Pro-rata on contract completion. |
| Employee who died or is disabled | Yes no minimum | Payable regardless of service duration. Paid to nominee/legal heir. |
| Probationer | Yes if 5 yrs served | Probation period counts as service. No exemption from gratuity law. |
| Part-time employee | Depends | If on company payroll and serves required period yes. If through contractor contractor’s obligation. |
| Contract worker (via agency) | Contractor’s obligation | Principal employer liable only if contractor defaults. |
| Apprentice (Apprentices Act) | No | Apprentices are not employees under the Gratuity Act. |
| Company under 10 employees | No legal obligation | Act doesn’t apply but employer may pay voluntarily or per employment contract. |
The 2025 Change That Most Employers Missed
Fixed-term contract employees are now eligible for gratuity after just 1 year of service.
The Code on Social Security 2020, notified for implementation on 21 November 2025, changed the eligibility threshold for fixed-term workers. Before this, even a contract worker who served 4 years and 11 months on a series of contracts got nothing because the 5-year permanent employee rule applied. Under the new code, a fixed-term employee who completes 12 months of continuous service is entitled to proportionate gratuity when the contract ends.
The calculation is pro-rata gratuity for the actual years served, not a full 5-year payout. But it’s a real liability. Example: a fixed-term employee on ₹30,000 basic salary serves 18 months and leaves. Gratuity = (15 × 30,000 × 1) ÷ 26 = ₹17,307. Multiply that across 50 contract workers and you have ₹8.6 lakh in unprovisioned liability that most companies with large contract workforces haven’t budgeted for.
Companies that rely heavily on fixed-term contracts manufacturing, logistics, retail, IT services need to review their cost models now if they haven’t already. The gratuity liability starts accruing from month 12 of every contract employee’s tenure.
The Formula How Gratuity Is Calculated
For companies covered under the Gratuity Act (10+ employees)
Gratuity = (Last drawn basic salary + DA) × 15 × Years of service ÷ 26
Example: Priya has served 8 years. Last drawn basic: ₹50,000/month. DA: ₹0 (most private companies don’t pay DA).
Gratuity = 50,000 × 15 × 8 ÷ 26 = ₹2,30,769
The ’15’ represents 15 days of salary per completed year of service. The ’26’ represents working days in a month (4 weeks × 6.5 days, rounded). Only basic salary and DA are included HRA, special allowance, and other components are excluded from the formula.
For companies not covered under the Act (under 10 employees, voluntary payment)
Gratuity = Average monthly salary of last 10 months × 15 × Years of service ÷ 30
The divisor here is 30, not 26, and the salary base is the average of the last 10 months rather than last drawn.
| The 50% basic wage rule and gratuity (2025 update): The Labour Code requires basic salary to be at least 50% of gross CTC. Since gratuity is calculated on basic salary, companies that kept basic artificially low to reduce PF liability now face a higher gratuity base too. A company with basic at 35% of CTC is both non-compliant on salary structure and underprovisioning gratuity. Fix the structure before the next salary revision both liabilities compound over time. |
When Must Gratuity Be Paid
Within 30 days of the gratuity becoming payable. If the employer delays beyond 30 days, interest accrues at 10% per annum from the due date. A ₹2 lakh gratuity paid 6 months late costs the employer ₹10,000 in interest plus the administrative cost of managing the complaint.
Under the new Labour Code framework, full and final settlement must be processed within 2 working days of the last working day. Gratuity is part of that settlement. For companies still processing F&F manually across a payroll spreadsheet and a separate HR system, this 2-day window is genuinely tight. Connected systems where attendance, leave, and payroll are in one place make it achievable.
The employee (or nominee in case of death) must submit Form I to claim gratuity. The employer must acknowledge receipt and pay within the timeline. If disputed, the employee can approach the Controlling Authority (typically the Labour Commissioner) in their district.
Tax Treatment How Much Is Actually Tax-Free
| Employee Category | Tax Treatment |
|---|---|
| Government employees (central/state) | 100% tax-free. No ceiling. |
| Private sector covered under Gratuity Act | Tax-free up to ₹20 lakh. Amount above ₹20 lakh added to income and taxed at slab rate. |
| Private sector not covered under Gratuity Act | Tax-free up to ₹20 lakh (calculated on 10-month average salary). Above ₹20 lakh taxable. |
| Fixed-term employees (post-2025 rules) | Same as private sector tax-free up to ₹20 lakh. |
| Received gratuity from multiple employers | ₹20 lakh ceiling is cumulative across all employers in a lifetime, not per employer. |
The ₹20 lakh ceiling is cumulative across your entire working life not per employer. If you received ₹12 lakh tax-free gratuity from your first employer and ₹10 lakh from your second, only ₹8 lakh of the second payment is tax-free. The remaining ₹2 lakh gets added to taxable income.
Common Mistakes Employers Make
- Not provisioning for fixed-term employees post-November 2025. Many companies are still processing contract exits without including gratuity for employees who’ve crossed 12 months. This is now non-compliant.
- Calculating on gross salary instead of basic + DA. HRA, LTA, and special allowances are not part of the gratuity formula. Calculating on gross overpays but more commonly, companies include only basic and miss DA where it applies.
- Delaying payment beyond 30 days. F&F getting stuck in approvals while the 30-day clock runs. Interest accrues automatically and the employee has a legal remedy.
- Assuming gratuity doesn’t apply because the company recently crossed 10 employees. The Act applies from the day the 10-person threshold is crossed retroactively for service already completed. Employees who were with you before you crossed 10 still have their tenure counted.
- Not maintaining nomination records. Every employee should have a Form F nomination on file. In case of death, the nominee gets the gratuity regardless of service duration. If no nomination exists, the legal heir has to claim it through a more complex process.
For HR teams, gratuity is an important part of the full and final (F&F) settlement. The calculation depends on accurate salary details, service dates, and payroll records. When all of this is maintained in one system, calculating gratuity at the time of exit becomes much easier.
Waggex’s payroll module keeps employee and payroll records updated throughout their tenure, so gratuity calculations are based on verified data instead of manually maintained spreadsheets. For more on payroll rules and compliance, see Payroll Compliance in India: Complete Guide.
