Gratuity

What it means

Gratuity is a lump sum an employer pays an employee as a reward for long service, when the employee leaves through resignation, retirement, termination, death or disablement. It is a legal obligation for employers covered by the gratuity law, which is now part of the Code on Social Security, 2020, in force from 21 November 2025.

How it works

Gratuity is generally payable after five years of continuous service. The five-year condition does not apply on death or disablement. Under the Code, fixed-term employees become eligible after one year of service.

• Formula: 15 days’ wages for each completed year of service, worked out as last drawn wages x 15 / 26 x years of service.

• Wages: basic pay plus DA. Under the Code, if allowances excluded from wages are more than 50% of total pay, the excess is added back to wages, which can increase gratuity.

• Rounding: a part year of more than six months counts as a full year.

• Ceiling: the maximum payable under the law is ₹20 lakh.

• Timeline: it must be paid within 30 days of becoming payable, otherwise interest applies.

Example

Rohit resigns from a private company after 7 years and 8 months. His last drawn basic pay plus DA is ₹40,000 a month.

Years of service: 7 years 8 months, rounded to 8 years (part year over six months)

Gratuity = ₹40,000 x 15 / 26 x 8

= ₹40,000 x 15 = ₹6,00,000; divided by 26 = ₹23,077; multiplied by 8 = ₹1,84,615

Tax: for a private sector employee, the exempt amount is the lowest of the actual gratuity (₹1,84,615), ₹20 lakh, and the formula amount (₹1,84,615). So the entire ₹1,84,615 is tax-free. If Rohit had received ₹25 lakh, ₹5 lakh would be taxable as salary.

Key points to remember

• The ₹20 lakh tax exemption is a lifetime limit across all employers, not per job.

• Gratuity for government employees is fully exempt from tax.

• Employers should provide for gratuity every year in their books, based on an actuarial valuation where required, rather than recording it only when paid.

• Check the revised wage definition under the Code; many employers have had to recalculate gratuity because allowances exceeded 50% of pay.

• Keep proof of continuous service, as disputes often arise over breaks in service.