A Complete Guide to Gratuity Rules in India

Gratuity is an important employee benefit in India that rewards individuals for their long-term service with an organisation. It provides financial support when an employee leaves a job due to retirement, resignation, or other eligible reasons.  

Under the new labour codes effective from 21 November 2025, the calculation base for gratuity has changed, and fixed-term employees now qualify after 1 year of service.  The traditional 5-year rule still applies, but to permanent employees only.  

Key Takeaways

What is Gratuity?

Gratuity is the amount that an employee is entitled to receive from their employer if they leave the company after working there for 5 years or more. Each year of service entitles the employee to 15 days of wages.  

Recent Gratuity Rules in India

The key updates are explained below: 

Fixed-term employees (those employed under a contract with a set end date) are entitled to gratuity after just one year of continuous service, according to the new labour regulations effective November 21, 2025. Permanent on-roll employees must still complete 5 years to be eligible (except in circumstances of death or disability). 

The definition of wage for gratuity calculation has expanded: "wages" now include basic pay and dearness allowance, and must account for at least 50% of total salary. If additional allowances exceed 50% of the total salary, the surplus is added back to earnings to calculate gratuity. 

Who is Liable to Pay Gratuity? 

A factory, mine, oilfield, plantation, port, railway company, shop, or establishment is liable to pay gratuity if it has employees of 10 or more persons on any day of the preceding twelve months.  

Once the shop or establishment becomes liable to pay gratuity, it will continue to remain liable even if the number of employees falls below 10 at any time. 

Gratuity Eligibility in India 

As per the Payment of Gratuity Act, all organisations with at least 10 employees working on a single day in the preceding 12 months must pay gratuity. Under the existing framework: 

In case of the employee’s death, the gratuity is paid to the nominee. If the employee’s disablement is due to sickness or accident, the gratuity is paid to the employee. 

What are the Clauses for Nomination?  

Nomination provisions continue under the Social Security Code with similar principles as earlier Section 6 of the Gratuity Act. 

Once an employee completes one year of service, the employee can nominate a person or persons who will receive their gratuity in case of the employee’s death. Section 6 of the Payment of Gratuity Act, 1972, sets the rules for nomination. The key clauses for nomination are the following:  

When is Gratuity Paid?

Gratuity becomes payable upon: 

How Gratuity Is Calculated: Updated Formula  

Gratuity is calculated using a standard method that considers an employee’s last drawn salary and the total number of completed years of service. This calculation applies to employees working in establishments covered under the Payment of Gratuity Act. 

Gratuity = Last drawn wages × 15 × completed years of service ÷ 26 

Note: 

For example, if basic pay + DA of an employee is ₹50,000, but excluded allowances reduce total remuneration below 50%, then consider increasing the amount to guarantee the wage base is at least 50% of total pay. 

Read More: Gratuity Calculator 

Taxation on Gratuity

Taxation on the gratuity amount depends on whether the employee works for the government or in the private sector. 

For government employees, gratuity received is fully exempt from income tax as per rules specific to government service (not bound by the ₹20 lakh limit under Section 10). 

For eligible private employees, the lowest of the following amounts will be exempt from taxation: 

Forms for Gratuity Application 

The calculation of gratuity is done by two different formulas for the following two categories of employees: 

The only difference between the two formulas is that in the first case, the number of working days in a month is taken as 26, and in the second case, it is taken as 30. 

For employees covered under the Act, 26 working days are considered; for employees not covered under the Act, the calculation method is based on employer policy and commonly uses 30 days. 

The following is the gratuity formula for employees falling under the Payment of Gratuity Act 1972: 

Gratuity = Last Drawn Salary × Number of Years of Service × 15/26 

In this case, the gratuity calculation is accounted for at the rate of 15 days' wages. The last drawn salary includes: 

Sales commission, only if it forms part of wages under the terms of employment 

The gratuity formula for employees who fall outside the purview of the Payment of Gratuity Act, 1972, is, 

Gratuity = Last Drawn Salary × Number of Years of Service × 15/30 

Note: Completed years of service include any year when the employee worked for over 240 days. However, if the work involves underground work, i.e. mining, then the minimum number of days is reduced to 180. 

Employees Not Covered Under the Act  

An employee who has not completed five years of continuous service or an employee who works for an employer that is not liable to pay gratuity under the Payment of Gratuity Act, 1972, is not covered under the Payment of Gratuity Act, 1972.  

Also, the gratuity of an employee, whose services have been terminated for any act, wilful omission, or negligence, causing any damage or loss or destruction of property belonging to the employer, shall be forfeited to the extent of the damage or loss so caused.  

The gratuity payable to an employee can also be wholly or partially forfeited if the services of such employee have been terminated for riotous or disorderly conduct or any act of violence, or if the services of such employee have been terminated for any act which constitutes an offence involving moral turpitude committed during the course of employment. 

Key Differences Between Gratuity and Pension  

Gratuity and pension are both benefits received after employment ends, but they serve different purposes and follow different payment structures. The table below explains the key differences in a simple and clear manner.