Gratuity is one of the most important terminal benefits for employees in India — and one of the most frequently miscalculated by HR and payroll teams. With the new Social Security Code 2020 changing eligibility rules for fixed-term employees, getting gratuity right in 2026 is more important than ever.
This guide covers everything you need to know — who is eligible, how to calculate gratuity, the impact of the new Labour Codes, and worked examples for different scenarios.
What Is Gratuity?
Gratuity is a lump sum payment made by an employer to an employee as a token of appreciation for the services rendered. It is a statutory benefit governed by the Payment of Gratuity Act, 1972 (now consolidated under the Social Security Code 2020).
Who Is Eligible for Gratuity?
Under the traditional Payment of Gratuity Act:
An employee is eligible for gratuity if they have completed a minimum of 5 years of continuous service with the employer. This applies on resignation, retirement, superannuation, death, or disablement.
The Act applies to every factory, mine, oilfield, plantation, port, railway company, and any other establishment with 10 or more employees. Once an establishment comes under the Act, it continues to be covered even if the employee count falls below 10.
Under the new Social Security Code 2020 (2026 implementation):
A significant change has been introduced for fixed-term employees. They are now eligible for pro-rata gratuity regardless of tenure — even if they have not completed 5 years. The gratuity is calculated proportionally based on the actual period of service.
This is a major change from the earlier law and directly impacts organisations that use contractual or project-based staff.
The Gratuity Formula
The standard formula for calculating gratuity in India is:
Gratuity = (Last Drawn Basic Salary + DA) × 15/26 × Number of Years of Service
Breaking this down:
— Last Drawn Basic Salary + DA: The basic salary and dearness allowance as on the last working day. Under the new Code on Wages, Basic + DA must be at least 50% of CTC — this directly increases the gratuity base for most employees.
— 15/26: 15 days of salary for every completed year of service. Divided by 26 because the working month is considered to be 26 days (excluding Sundays).
— Number of Years of Service: Any period of 6 months or more is rounded up to the next full year. A period of less than 6 months is ignored.
Worked Examples
Example 1 — Standard Employee (5+ years)
Employee details:
— Last drawn Basic Salary: ₹50,000 per month
— DA: ₹0 (DA is common in government; most private sector employees have no DA)
— Years of service: 7 years and 8 months (rounds up to 8 years)
Gratuity = ₹50,000 × 15/26 × 8
Gratuity = ₹50,000 × 0.5769 × 8
Gratuity = ₹2,30,769
Example 2 — Employee with DA
Employee details:
— Last drawn Basic Salary: ₹40,000
— DA: ₹5,000
— Years of service: 10 years and 4 months (rounds up to 10 years)
Gratuity = (₹40,000 + ₹5,000) × 15/26 × 10
Gratuity = ₹45,000 × 0.5769 × 10
Gratuity = ₹2,59,615
Example 3 — Fixed-Term Employee under new Social Security Code
Employee details:
— Last drawn Basic Salary: ₹30,000
— DA: ₹0
— Period of service: 2 years and 3 months (2.25 years — pro-rata, no rounding)
Gratuity = ₹30,000 × 15/26 × 2.25
Gratuity = ₹30,000 × 0.5769 × 2.25
Gratuity = ₹38,942
Note: For fixed-term employees under the new code, the exact period of service is used for pro-rata calculation — not rounded to the nearest year.
The Maximum Gratuity Limit
The maximum gratuity payable under the Payment of Gratuity Act is ₹20,00,000 (₹20 lakhs). This ceiling was last revised in 2018. Any gratuity above this limit paid by the employer is a voluntary payment and is taxable in the employee's hands above the ₹20 lakh threshold.
Tax Treatment of Gratuity
For government employees: Gratuity received is fully exempt from income tax.
For private sector employees covered under the Payment of Gratuity Act: Gratuity is exempt from tax up to the least of the following three amounts:
— Actual gratuity received
— ₹20,00,000
— 15 days' salary for each completed year of service (calculated as last drawn salary × 15/26 × years of service)
For private sector employees not covered under the Act: Exempt up to least of actual gratuity, ₹20 lakhs, or half month's average salary for each completed year of service.
Impact of the 50% Basic Wage Rule on Gratuity
Under the Code on Wages 2026, Basic Salary + DA must be at least 50% of total CTC. This has a direct and significant impact on gratuity calculations.
Previously, many companies kept Basic artificially low — at 30-35% of CTC. With the new 50% rule, the gratuity base has effectively increased for most employees. HR and finance teams need to recalculate gratuity provisions for all employees based on the revised salary structures.
Practical impact: An employee with a CTC of ₹10 lakhs per year whose Basic was previously ₹2.5 lakhs (25% of CTC) will now have a Basic of ₹5 lakhs (50% of CTC). Their annual gratuity provision doubles as a result.
When Must Gratuity Be Paid?
Gratuity must be paid within 30 days of the date it becomes payable. If payment is delayed beyond 30 days, the employer is liable to pay simple interest on the gratuity amount.
The employee or their nominee must submit a written application for gratuity to the employer. The employer must determine the amount payable and give written notice to the employee within 15 days of receiving the application.
Gratuity on Death or Disablement
In case of death or disablement due to accident or disease, gratuity is payable regardless of the 5-year minimum service requirement. The gratuity is paid to the employee's nominee or legal heir.
The gratuity payable in case of death is subject to the following slab based on years of service:
— Less than 1 year: 2 times monthly Basic + DA
— 1 year or more but less than 5 years: 6 times monthly Basic + DA
— 5 years or more but less than 11 years: 12 times monthly Basic + DA
— 11 years or more but less than 20 years: 20 times monthly Basic + DA
— 20 years or more: Half month's Basic + DA for each completed six-monthly period, subject to a maximum of 33 times monthly Basic + DA
HR Action Checklist — Gratuity 2026
— Update gratuity calculation base in payroll system to reflect new 50% Basic Wage rule
— Identify all fixed-term employees and flag them for pro-rata gratuity under the new Social Security Code
— Ensure gratuity nominee forms (Form F under the Payment of Gratuity Act) are collected from all employees at joining
— Update nominee details whenever an employee's personal circumstances change
— Maintain a gratuity provision register updated annually
— Process gratuity payment within 30 days of separation to avoid interest liability
Frequently Asked Questions
Q: Is gratuity compulsory for all companies in India?
A: The Payment of Gratuity Act applies to organisations with 10 or more employees. However, many organisations voluntarily pay gratuity even below this threshold. Under the Social Security Code 2020, the applicability may extend further once all provisions are notified.
Q: Can an employer forfeit gratuity?
A: Yes — under specific circumstances. If an employee is terminated for wilful omission or negligence causing damage or loss to the employer, or for an act involving moral turpitude, the employer can forfeit the gratuity wholly or partially. This must be backed by a proper domestic enquiry.
Q: Does gratuity apply to employees who resign before 5 years?
A: For regular permanent employees, no — the 5-year minimum applies. For fixed-term employees under the new Social Security Code, yes — pro-rata gratuity is payable regardless of tenure.
Q: How is gratuity calculated if an employee takes unpaid leave?
A: Periods of absence without pay or unauthorised leave can be excluded from the continuous service calculation, depending on the employer's policy and the specific circumstances. Authorised leave, paid leave, and maternity leave are generally included.
Q: Is gratuity included in CTC?
A: Many employers include a gratuity provision (typically 4.81% of Basic Salary, which is 15/26 divided by 12 months) as part of the CTC structure. Whether gratuity is shown in CTC or treated as an additional cost depends on company policy.
For ready-to-use gratuity calculation templates and HR policy documentation, visit our Stores and Services page.
Related reading: New Salary Structure Compliance Checklist under Labour Codes
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